An overly optimistic investment outlook could be setting up a pension collapse, but two new reports say scaling back could leave Florida taxpayers on the hook for billions.
That's because Florida and other states plan for what a growing number of economists and investors say is an unrealistic rate of return on their investments that hides the true cost of public pensions.
The reports, prepared by state advisers, come as pension funds across the country are recovering from losses during the financial crisis, facing shortfalls and rethinking how they gauge their long-term viability. Corporate pension managers have adjusted their expectations to account for smaller investment returns, and pressure is building on state and local governments to do the same.
One report suggests that more conservative planning would mean state and local agencies might have to set aside twice as much money to keep their pension promises to nearly 1 million current and future retirees.
Florida pensions are paid with a combination of contributions from government employers and investment returns. So assuming a high rate of return — called the "discount rate" — lowers the cost to taxpayers.
"Which makes everybody happy," said Jeremy Gold, an actuary and economist who advises pension plans. "The employees enjoy the benefits. Today's politicians don't pay for it. And today's taxpayers pay less."
One report was prepared by Milliman Inc. at the request of the governor's office. The other was written by Hewitt EnnisKnupp, the firm that advises the State Board of Administration on investments.
Florida assumes its investments will make 7.75 percent a year, about average for the largest public pension plans. Private companies tend to assume a lower risk — an annual rate of return of 51/2 to 6 percent.
The SBA report says that if Florida lowered its expectations to 6 percent, pension obligations for current employees would jump from $114 billion to $141 billion. To meet their pension promises, school districts, towns and government agencies now have to pay an average of 12 percent of their payrolls. If the rate dropped, they could pay between 18 and 25 percent, the reports indicate.
Taking into account the current rate of return as well as market losses, Florida's pension fund faced a shortfall of about $16.7 billion as of July 1. A rebounding stock market provided a boost, but the deficit would grow again with a lower expected investment return. The report done at the request of the governor's office suggests that if Florida dropped its return assumption to 6 percent, the pension fund's shortfall could grow to more than $50 billion.
Some economists say states should adopt a so-called ''riskless" rate in the range of 4 to 5 percent. That rate compares to U.S. Treasury bonds, which are guaranteed by the government.
"The only way you can earn more than 41/2 percent today is by taking risk," Gold said. "If the benefits you are promising are supposed to be 'risk-free,' then you shouldn't be taking risks on investments and assuming you're going to win. Because if you lose, you're simply passing the costs and the risks on to future taxpayers, and that's a dangerous way to run an enterprise."
It's a problem across North America, added Leo de Bever, chief executive of Alberta Investment Management Corp. "The return on risk has been grossly overstated and the year-to-year variability of that return has been grossly understated, so at some point in the future, a prolonged period of low return could cause the whole thing to blow up."
Microsoft co-founder and philanthropist Bill Gates joined the public pension controversy this month. He criticized states' "accounting gimmicks" that create unfunded shortfalls and drain public education funds.
"The guys at Enron never would have done this," Gates said at a recent conference. "This is so blatant, so extreme. … Is anyone paying attention?"
Unions and groups representing state and local governments say Florida has one of the nation's best plans and defend its 7.75 percent return assumption. Lowering the rate, they say, would be a disaster because of the extra burden on already cash-strapped cities and counties.
What's more, cutting the rate could lead to riskier investments — not an appealing option for taxpayers, as the SBA has come under criticism in recent years for too-risky investments and lax oversight.
With the nation's fourth-largest pension fund, Florida says it averaged more than 8 percent return on investments over the past 20 years. The return was just 4.6 percent since 2000, and many economists see uncertainty ahead.
In Tallahassee, lawmakers are considering cost-saving bills to make public employees contribute to their pensions and move future employees into 401(k) plans. But they haven't focused on whether Florida is accurately accounting for its pension liabilities.
Computer-assisted reporting specialist Connie Humburg contributed to this report.