Moral hazard and public employee pensions

Though the term seems to have popped up just in the last few years, moral hazard has long been a financial and ethical concern in the insurance industry.  The "hazard" in moral hazard is that once property is insured, the owner of the insured property has more incentive to risk that property since the financial consequence of property losses are borne by someone else.  This is why there are deductibles, co-pays, and co-insurance in insurance policies.  By forcing the insured to have some skin in the game, the insurer can mitigate moral hazard, charge reasonable rates, and make a profit.

However, the current use of the term moral hazard and its counterpart "too big too fail" usually refer to financial markets.  In a similar vein as insurance moral hazard, large financial firms are more likely to take risks because the government will be there to rescue them if they get in trouble.  Because the demise of one large financial firm can affect the entire world economy, those managing those firms may feel that they are, in essence, "insured" by the government.  Of course, the government (i.e taxpayers) never agreed to be this insurer of last resort and is paid neither profits from risky ventures nor any underwriting fees.

This brings us to the moral hazard of PSPRS and other public employee pensions.  Though PSPRS is a multi-billion dollar fund, its demise would pose no risk to the world economy.  The moral hazard in PSPRS comes from legal protections based on both contract law and the Arizona Constitution.  Since benefits can never be altered once they are awarded, the incentive will always be for current employees to obtain as many benefits as possible at every opportunity available and never concern themselves with the ultimate risk to PSPRS.  When those benefits become financially unsustainable, the taxpayers, primarily, and future hires, secondarily, will be stuck paying the tab as the final "insurers."  The members receiving enhanced benefits, the politicians who approved the benefits, and the unions who lobbied for them suffer none of the consequences of this folly.

The question posed in the last post about why Stockton borrowed to fund enhanced pension benefits is partially answered here.  And to bring things full circle since this started with a discussion about insurance, read the following New York Times article by Mary Williams Walsh (Creditors of Stockton Fight Pension Funding While in Bankruptcy) to see how moral hazard is being dealt with by actual insurance companies.