RALEIGH – North Carolina has one of the healthiest public-employee pension systems in the country – and has also been underfunding the system in recent years, creating a risk of taxpayers having to pay far more in the future to finance promised benefits.

Can these two statements both be true? Yes, because whatever fault one might find with North Carolina’s pension system, one can find far greater fault in the pension plans of almost every other state.

First the good news. A new Heartland Institute paper (not yet online) ranks all 50 state pension systems according to six criteria: employee contribution, choice, taxable benefits, vesting period, earning basis, and fund solvency. “The first five variables concern the kinds of promises states make to public-sector workers,” wrote the report’s co-authors, Eli Lehrer and Steve Stanek. “The final variable, fund solvency, concerns the ability of states to keep the promises they make.”

After adding or subtracting points for each of the variables, Lehrer and Stanek then assigned letter grades to each state based on variation. State pensions with a score more than a standard deviation higher than the national mean got an A. Those below the mean by more than 1.5 standard deviations got an F.

So here’s the good news: North Carolina was only of only eight states to get an A for its pension system. In fact, our state ranked third in the nation. Within our region, only Florida (2nd) ranked higher. Next-door neighbor South Carolina got an F.

When I looked closer at the numbers, however, I noticed that North Carolina was close to the mean for most of the variables. What really jacked our grade up was a high rating for the last variable, fund solvency.

There’s no question that North Carolina’s pension plan is more solvent than most. There are states with woefully underfunded systems, systems requiring bailouts in the short run. No one believes that our system faces any immediate risk. However, as Carolina Journal’s Sara Okeson recently reported, the office of State Treasurer Janet Cowell assumes an unrealistic rate of return in computing the plan’s solvency:

A report by the same consultant that the U.S. Treasury tapped to help oversee its bailout fund for banks says that the North Carolina pension fund has an expected long-term return of 6.7 percent, below the level the state has been predicting.

North Carolina uses an investment return rate of 7.25 percent when calculating how much the state needs to contribute to the Teachers’ and State Employees’ Retirement System each year, even though its average annual return for the last 10 years is less than half that — about 3.4 percent, according to the latest annual report.

SNIP

Edward Siedle, a former attorney with the U.S. Securities and Exchange Commission, noted that the expected rate of return for famed investor Warren Buffett’s Berkshire Hathaway Inc. is 6.9 percent.

“How can a group of lug nuts dramatically outperform the best investor in the world?” asked Siedle, the president of Benchmark Financial Services in Ocean Ridge, Fla. “I would never claim to outperform Warren Buffett. For them to claim that is, in my opinion, the height of stupidity or arrogance. If they’re wrong, which is likely, the repercussions are enormous for North Carolina taxpayers.”

Cowell’s office defended its use of the 7.25 percent assumption by arguing that it is relatively conservative. That appears to be true. Most states use a higher rate-of-return forecast. The median is 8 percent.

Still, that means only that other states are imposing greater risk on future taxpayers than North Carolina is. It doesn’t mean that North Carolina is in the clear.

Essentially, we get an A because we’re being grade on a curve. It’s better than getting an F – I’m looking southward in your general direction, oh puffed-up Palemtto State – but North Carolina can do better still.

Hood is president of the John Locke Foundation.