As bad as the underfunding of state pension plans appears, the economic reality could be much worse, says a vocal faction of actuaries and financial economists.

The reasoning goes like this: States can no more neglect to pay their pension obligations than they can pass on paying interest to bondholders. If it’s a near-certainty that the benefits will have to be paid, then they should be valued with a commensurate conservative discount rate, such as the yields on U.S. Treasury bonds. It’s this sort of thinking that led the Financial Accounting Standards Board and Congress in 2006 to require corporate defined benefit sponsors to value their pension obligations using yields on high-grade corporate bonds.

Instead, governmental accounting standards have allowed pension plans to value their liabilities at the assumed rates of return on their investment portfolios, which range from 7 to 8.5 percent; the average is 8 percent, although some states have started to scale back the rate a bit. The logic is that because it’s the rate the assets are going to earn, or at least are expected to earn, it’s appropriate to value the liabilities the same way. ....

Read More: Pensions · states · accounting · actuaries