One of the reasons why we find ourselves in a public pension pickle is that states can hide the real cost of the promises it makes with handy accounting techniques, including a robust “assumed” rate of return. We assume an investment return of 8.5% here in Minnesota on pension funds invested by the State Board of Investment (SBI). We are one of five states that assume this top rate; most states assume 8.0% and about a third of states assume between 7.25—7.8%. By comparison, private pension funds, to the extent they still exist, assume about 6.0-6.5%.

We heard testimony this week in Saint Paul from Howard Bicker from SBI on what it takes for him to achieve a return of 8.5% or better over time—in his words, an aggressive and high risk investment strategy. (SBU has pension funds in 60% stocks, 18% bonds and 20% other–and reports better than 9.0% returns over 25 years but over the last 10 years, the rate drops to 3.8%–that’s the nature of the beast.) Bicker, who has been running SBI to great acclaim for years, has a lot of swagger and at least public confidence in his ability to deliver.

Why have we asked Howard Bicker and SBI to assume such a high rate of return and adopt such an aggressive investment policy? Because then we do not have to put as much money aside in the pension funds. The state (you) and the employee share in that burden here in Minnesota. Pension plan administrators will tell you that we have always been very responsible here in Minnesota by putting money aside. True—we are better than some states. But we have not put enough aside, hence the large unfunded liabilities we see today.

When we talk about pensions, we report two different numbers to you—first, the actuarial value and second, the market (or more realistic) value. Lawmakers, employees and taxpayers need to get the real numbers to understand the cost of public employee compensation packages and pensions. Several folks in Congress, including Rep. Devin Nunes from California and Rep. Paul Ryan from Wisconsin, have proposed legislation (The Public Employee Pension Transparency Act ) that would require public pension funds to report their liabilities to the Treasury using their own formulas but also the liability assuming a more modest Treasury bond rate.

This would actually be a welcome and useful intrusion from the Feds—as the Wall Street Journal pointed out today, this bill does not tell states how to calculate the pension liabilities. But it requires them to get at least one of the fudge factors out (there are several) so responsible lawmakers and their advisers have better numbers in front of them when making compensation decisions.  

We’d like to think that Governor Dayton and both sides of the aisle would welcome this approach so that we can be sure we are able to keep the promises we make to public employees. In fact, we do not need the Feds to tell us to do this. We can require this kind of realistic reporting as part of the budget process each year. The excellent staff at Minnesota’s Legislative Commission on Pensions and Retirement (LCPR) already keeps two sets of numbers as noted above (actuarial and market), so more realistic numbers are already available.

We are still waiting for the 2010 numbers (and should have them in a few days) but in 2009, the actuarial value of Minnesota’s unfunded liabilities was $12-15 billion whereas the market value was more than $24 billion. The actuarial value is bad enough! That is twice the size of our state deficit. Defenders of the status quo will point to an improvement in investment returns as well as some significant tweaks to the pension system in the 2010 Omnibus legislation, but absent fundamental reform, we will just keep finding ourselves in a public pension pickle.