Public pensions hiding trillions in liabilities, SEC commissioner saysNews added by Benefits Pro on June 4, 2014
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By Nick Thornton

Lax governmental accounting standards that have allowed systemic underfunding of public pensions would amount to fraud were those public plans subject to laws governing the private sector, according to SEC Commissioner Daniel Gallagher.

“In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games,” said Gallagher. “And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions. We should not treat municipalities any differently.”

Gallagher’s comments were made in a May 29 address at the first Municipal Securities Regulator Summit. The SEC’s Office of Municipal Securities oversees the $3.7 trillion municipal bond market. Munis can be an important fixed-income vehicle for retirement, as the interest earned on them is tax-exempt.

Nearly three-fourths of muni bonds are held by retail investors.

Gallagher said that municipal bond issuers are misleading investors by failing to disclose the true extent of pension and other post-employment benefits (OPEB), like retiree health care obligations.

"Trillions of dollars in liabilities ... are not appropriately reflected on government books, thereby seriously misleading investors about the riskiness of their investments in municipal securities," he said.

The most optimistic estimates (often made by plan administrators) show state and local pension plans are underfunded by $1 trillion. Others believe the more accurate number is more than $4 trillion. Gallagher said that in order to fund the shortfalls, every household in the U.S. would need to pay $14,000 a year for the next 30 years.
With the most grievous shortfall — Gallagher did not name the city or state — each household in that municipality is on the hook for more than $88,000 in unfunded pension liabilities. Median income in the unnamed city is $47,000.

In Detroit, pensions will be bailed out with an infusion of liquidated assets and federal relief, but general obligation bondholders are only expected to recover 10-13 percent of their principal.

Gallagher said that Detroit proves that bankruptcy courts will favor underfunded pension funds over bondholders. “It is imperative the bondholders know with precision the size of the potential pension liabilities of the entities in which they are investing. And yet, they do not.”

Public pension plans have been over-optimistic in assuming future rates of returns that will be used to pay liabilities. Generally, a 7 1/2 to 8 percent return is factored. Gallagher says a return in the mid-6 percent range is more realistic. Risk is potentially exacerbated when funds chase yield to account for inflated return goals.

“This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees, or not to make the promises in the first place,” Gallagher said.

Gallagher applauded GASB efforts to bring transparency to public pensions and urged all municipalities follow the board’s improved accounting standards. But reform of this scale isn’t expected overnight. Gallagher recommends the requirement of supplemental disclosures to fully inform investors.

Originally published on BenefitsPro.com
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