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Aaron Brown

Young Versus Old Will Define Fight Over Public Pensions

The market rout is exposing the vulnerability of the US public pension system. Inflation and the tight labor market will force the worst-hit states into some hard decisions.

US public pension funds are getting a wake-up call.

US public pension funds are getting a wake-up call.

Photographer: Ralph Orlowski/Getty Images Europe

The firestorm among UK pension funds is a wake-up call for their peers across the Atlantic. The end of an era of cheap money is exposing an industry that’s chronically underfunded and overexposed to market turbulence.

Imagine a meeting of executives of a typical public pension fund following last quarter’s rout.

I will leave these professionals to thrash out the net effect on their pension fund though clearly, they face numerous crosscurrents. Investment returns, discount rates and inflation all affect the reported funded status of a pension plan — or the assets currently held relative to long-term obligations — an abstraction based on unknowable assumptions. Whether the average fund will pay out its promised liabilities or not is something we won’t know for decades.

What matters in the knowable here and now is whether some of the worst-funded large plans will collapse in the next year or two. If yes, we’ll have to deal with a major financial crisis soon. If no, pension funds can continue to muddle along — whether the officially reported statistics around their funded status look good or bad — until the next crisis.

Public pension funds are on pace for the biggest annual decline in assets since the fallout of the global financial crisis, according to estimates from the New York-based nonprofit Equable Institute. The effect of higher market discount rates and inflation — both observed and anticipated — on liability valuations depends on work actuaries are doing now. But it’s possible 2022 will increase funding gaps by half a trillion dollars or more. State and local governments will be faced with hard choices.

Many people think of state and local employees as having gold-plated benefits, but there is a catch. First, you generally must put in long service with a single employer to collect full value. Moving around or taking time off means you lose coverage. Second, many public employees, especially newer and lower-paid ones, are excluded from the most generous plans.