Separating 'legacy debt,' changing the discount factor, and improving accounting offers a more rational approach
In an earlier study, my colleague JP Aubry identified the importance of “legacy debt” in public pension plans. This debt arises because many of the retirement systems have been providing benefits since the early 1900s, but the benefits were not funded using modern actuarial practices until much later. The impact of these unfunded liabilities from a bygone era is still felt today, because the shortfall keeps getting passed forward.
In a recent study, JP highlights the role of legacy debt and two other factors that impede sponsors’ abilities to manage the current financing of their state and local plans. Specifically, the current approach for managing pension liabilities suffers from three problems:At a high level, the new approach presents a trade-off. On the one hand, spreading the cost of legacy liabilities over multiple generations reduces annual pension costs.
While it will increase costs somewhat, it involves a more rational definition and allocation of costs that results in improved intergenerational fairness, better resource allocation by government, and — ultimately — greater public credibility.
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