July 2, 2013

GENEROUS PENSIONS and retiree health plans have long distinguished jobs in state and local government from private-sector work. Whether so much deferred compensation was as necessary and appropriate to recruiting a top-flight workforce as many claim is open to debate. But there’s no doubt such promises helped politicians secure the support of public-sector unions — without alienating the taxpayers who might have recoiled if all compensation costs were clearly and transparently presented to them in the short term.

When the tide goes out, though, you see who’s been swimming naked. The Great Recession, and the resulting stock market plunge, exposed the fact that many states had been chronically underfunding their pensions but concealing the impact on their liabilities by assuming overly optimistic rates of return, among other devices. Several states responded with reforms. But there’s still a need for objective, realistic measures of pension liability that can help taxpayers and investors understand the true risks.

In May, Moody’s, a credit-rating agency, took a step in the right direction by refiguring state pension liabilities based on the rate of return of high-grade corporate bonds, rather than the higher number — about 8 percent — that states often choose as a proxy for their portfolios’ long-term performance. Moody’s choice is not perfect; none could be. Just as today’s commonly used assumptions enable pension-contribution avoidance, a too-conservative measure risks forcing states to overspend on pension contributions to the detriment of other needs. However, given that pension obligations are legally binding on the states, and thus as unavoidable as debt service, Moody’s choice strikes us as appropriately cautious. Indeed, some pension critics favor assuming a risk-free rate of return, such as that on U.S. government debt.

Last week, Moody’s used its new methodology to estimate unfunded state pension liabilities for the first time — and to do so relative to indicators such as annual state revenue or personal income. This, too, was a much-needed attempt to create apples-to-apples comparisons among the states; not surprisingly, Illinois’s notoriously profligate state pensions ranked at or near the bottom by every metric.

Somewhat more surprisingly, Maryland had the ninth-biggest unfunded liability, according to Moody’s: $28.6 billion in fiscal 2011. This is about $8 billion higher than the state reported last year based on its assumed 7.75 percent return on investment.

Moody’s numbers do not reflect the subsequent impact of reforms enacted over the last three years by Gov. Martin O’Malley (D) and the General Assembly. Those reforms were designed to achieve an 80 percent funding level by 2023. But the Moody’s figures do suggest that the challenge was already greater than Maryland’s leaders assumed when they acted. Accordingly, they still have work to do.