Unfunded liabilities and the investment smokescreen
February 16, 2015 12:00 AM
The Feb. 6 article “Unfunded Pension Liabilities Up for City” says our city’s “unfunded liabilities increased because of a lowering in expected investment returns.” If you think about it for a minute, this makes no sense.
The unfunded liability is just the difference between the value of the promises that have been made to city employees less the value of the city’s pension-fund assets. The value of the promises is pretty easy to figure out. This is the amount that we’d have to pay Warren Buffett to agree to make good on the promises. The value of the assets is even easier to figure out. Just look at the city’s brokerage statement! According to the article, there is $672 million in the account. OK. Now just take the Warren Buffett amount, subtract $672 million and there you have it, the unfunded liability.
But wait a minute. What happened to the “expected investment returns”? They are a smokescreen, all too often used to cover up what some people don’t want you to know. They depend on how the $672 million is invested, not how much is invested.
If the $672 million is in stocks, then the expected returns are high, but so is the risk that this might turn into $572 million. If the money is in bonds, then the expected returns are low, but there’s less risk. But no matter how the money is invested, $672 million is worth — wait for it —$672 million! This all seems pretty obvious.
But it’s also both interesting and important. This is interesting because people with a vested interest in understating the unfunded liability often make the fallacious argument that higher expected returns on the assets reduces the size of the unfunded liability. If this is true, then either $672 million is worth $772 million, or Warren Buffett is a sucker. Why is this important? Ask the city employees of Detroit.
CHRIS TELMER Squirrel Hill
The writer is associate professor of financial economics, Tepper School of Business, Carnegie Mellon University.
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