Tom Sgouros: Accounting for the the Real Risks

Tom Sgouros: Accounting for the the Real Risks

I wrote a few weeks ago about how the biggest problem our state pension plan faces is in the accounting rules we follow. These accounting rules were designed for private companies, to help protect pension funds from the risk that the employer who set up the fund would go out of business. The state won't cease to exist, so protecting against that risk is pointless -- and expensive. But there is a flip side to this point: there certainly are risks that a public pension plan suffers from. I don't know a way to say whether they're greater in the public over the private sector, but do the accounting rules we use protect us against those risks?

When I think about the funding problems undergone by the pension system, I can't help but think about Ed DiPrete's early retirement program in 1989, Bruce Sundlun's skipped pension payments in 1991 and 1992, Lincoln Almond's early retirement incentives of 1996, and the way Don Carcieri encouraged twice as many people to retire in 2008 as usually do in a single year.

That's four governors in a row who mucked with the fund. Given that the fund in its modern form was only established in 1986, that's an impressive record.

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Each of these incidents was a travesty -- a deliberate attempt to save a few dollars on the state budget by pushing the expenses over to the pension fund where they were made much more expensive by compounding over time. Short-term smart, but long-term dumb. When I'm done with that list, I can't help think about the no-pay legislative pensions, the various ways in which favored insiders used to be granted pension credit at a discount rate, as well as cases where union contracts were settled by using increases in future pension benefits in exchange for foregone pay increases in the present.

Pension costs are invisible to the budget

All of these abuses were made possible by the invisibility of costs to the pension system. The pension system is a freestanding fund, with its own budget and its own set of expenses and revenues, so the state budget need not account for it in any way. Plus it's all masked by actuarial mumbo-jumbo that make it hard for people who haven't spent time immersed in amortization calculations to make sense of it. Even worse, the pension fund's accounting is two years out of date. That is, revenues and expenses in fiscal year 2011 (which ended last June) are being analyzed and added now, but the results won't be ready until next June. They will be incorporated into the annual report by the fall of 2012, and used to set the rates for fiscal year 2013. What this means is that any cost the fund incurs isn't really apparent for quite a while after the damage is done.

The result is that the accounting rules in place don't force honesty, which is why Don Carcieri was able to claim credit for saving $9.8 million per year by cutting health care costs for retirees in 2008, while conveniently ignoring the fact that he blew a $145 million per year hole in the pension fund. Similarly, all those special pension deals from the 1980s were only possible because no one had to account for them.

(And yes, even if you think it appropriate to begin to charge retirees for some of their health insurance, there were other ways to do this that wouldn't have encouraged the mass exodus. But Carcieri and the Assembly leadership apparently felt this was a good way to reduce employee head count, and so purposely set the deadline months out in order to encourage exactly the debacle that happened.)

There is an alternative

Imagine, for a minute, that we stopped pretending the pension fund was a separate entity from the state budget. Obviously the money parked in the fund must be restricted, and can't be used for anything besides paying pensions. There is other restricted money that still appears in the budget -- unemployment insurance, college tuitions, and Medicaid reimbursements to name just a few. If the pension checks were written from the state's budget and if the revenue and caseload estimators added these predictions to the predictions they prepare about tax revenue and child protection caseloads, then the sheer irresponsibility of DiPrete's early retirement push or the travesty of Sundlun's missed payments would have been clear to all, in real time.

I want a pension system to be immune from these kinds of abuse, and the best way to create that kind of immunity is to make it clear to all what's going on. Obviously you can't insure against all risks. A pension system is about payments way in the future and giveaways and abuse can get lost in the uncertainty of predictions made for decades in the future. But the history of the past couple of decades tells me unequivocally that we can do a lot better than we've done.

The fact is that I don't want a fully-funded pension system, and neither should you. Under the current rules, a fully-funded system is one that is ripe for abuse. That's a system from which a negotiator can always scrape a little more to substitute for a pay increase or an insider can find a little something for a pal. If I had to choose between a fully-funded system whose accounting kept it susceptible to these kinds of abuses and a partially funded system whose pressure on the state budget kept abuses to a minimum, it wouldn't be a very difficult choice for me. How about you?

Tom Sgouros is the editor of the Rhode Island Policy Reporter, at whatcheer.net and the author of "Ten Things You Don't Know About Rhode Island." Contact him at [email protected].

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