Pension Lessons From Down Under; Australians could teach Americans a thing or two about the benefits of reform

October 2, 2013, 12:15 p.m. ET

Pension Lessons From Down Under

Australians could teach Americans a thing or two about the benefits of reform.

America’s municipal finance woes are well known, especially unfunded pension liabilities. For a lesson in how to fix the mess, the Yanks could do worse than get a plane ticket to Australia. That’s the lesson in a recent Moody’s report that shows how Australia’s state governments are reaping the rewards of reforms that began 15 years ago. Starting in the 1990s, they enrolled new employees in defined-contribution plans. As a result, although the old defined-benefit plans still exist for older employees, the states’ unfunded liabilities are smaller and more manageable—something for Americans to envy.Australia can thank several factors for its good fortune. In the early 1990s, most states were suffering some degree of fiscal strain, in a few cases due to collapsed state-owned enterprises. That decade also saw the introduction of accrual accounting for Australian government entities, a method that forces the earlier recognition of future liabilities. This transparency highlighted the looming cost of overly generous pensions.

External pressure played a role. In 1990, credit-rating firms started evaluating state creditworthiness separately from that of the commonwealth government in Canberra. As a result, state government officials risked significant increases in borrowing costs if they didn’t bring their pension plans under control.

Another factor will sound familiar to Americans. In the 1980s Canberra established a compulsory national defined-contribution pension system for most Australians (similar to the 401(k) plans common in U.S. private companies). Voters started to ask why civil servants deserved defined-benefit pensions when everyone else was on the defined-contribution model.

Although reform was controversial, state governments eventually followed through, some faster than others. They are not entirely clear of trouble. As Moody’s notes, the unfunded liabilities of the old defined-benefit plans continue to grow as actuaries adjust life expectancies, expected rates of return and other parameters.

But those payouts will eventually start shrinking since no new employees are joining the defined-benefit plans. That fact offers some fiscal breathing room even to Tasmania, the state with the largest unfunded pension liability at 165% of annual revenue.

Reform has brought benefits for government employees, too. As Detroit’s stressed-out cops and firefighters could tell you, a generous pension is not so great when you’ll have to get in line with other creditors to collect it. The beneficiaries of Australia’s defined-contribution plans aren’t hostage to future fiscal meltdowns.

Australia is only one example of pension reform done right. If bondholders and taxpayers start demanding greater fiscal responsibility from Chicago, Denver and Los Angeles, conditions could be right for a repeat in America.