Can States Fix Their Pension Problems?
Thursday, May 20, 2010
An article in The Times today details how “errors, misunderstandings and wishful thinking” have caused public pension costs in New York State to explode. The problem is not limited to New York or to the fiscal crisis poster state, California, whose ballooning pension obligations have stoked battles between anti-tax crusaders and public sector unions, with the legislature paralyzed in between. Even states like Kansas, where retirees’ payouts are relatively small, are facing grim forecasts.
Stories about $150,000-a-year pensions for retired officials are fueling anger and demands for action, but there seems to be little that officials can do about existing contracts, for legal and other reasons. The focus has turned to reforming the state systems, to make sure they are fiscally sustainable in the future. What states have led the way? And what political obstacles have arisen in other places?
* Girard Miller, Governing magazine
* Alicia H. Munnell, Center for Retirement Research
* E.J. McMahon, senior fellow at Manhattan Institute
* Teresa Ghilarducci, New School for Social Research
* Steven Greenhut, author of “Plunder!”
No More Magic Tricks
Girard Miller is the public money columnist for Governing magazine and a senior strategist at the PFM Group, a financial services company with government clients.
The pension crisis in New York State parallels a dozen others such as those in Illinois and California that also require serious solutions. Each has its own historical roots usually involving funding malpractices and awarding retroactive benefits on the assumption that investments would magically pay the bills.
Pension officials should look to Washington State and South Dakota for ways to reform their systems
Without depriving retirees and incumbent employees of benefits they have already earned, states must fix their pension laws to enable public employers to install lower-cost benefits for future service. Where employees pay less than half the current costs of their benefits, the underfunded plans need to shore up those features.
States looking to reform their plans for new employees should look at Washington State’s hybrid plan, which is half pension and half defined contribution. That shares the investment risks and rewards equitably.
South Dakota’s moderate pension plan design limits the pension payment multiplier at 1.7 percent times years of service times final compensation — and they avoid using investment surpluses to buy into irrevocable higher benefits. Giving all new employees a legal right to elect into a modest defined contribution plan will also prevent future “pension creep” as more workers take that option.
Hysteria Now Won’t Help
Alicia H. Munnell, a former member of the Council of Economic Advisers, is the Peter F. Drucker professor of management sciences at Boston College’s Carroll School of Management and director of the college’s Center for Retirement Research.
Public pension plans — like the rest of us — are suffering from the financial crisis and ensuing recession. States and localities were on a path toward full funding, but they were seriously knocked off track with the collapse of asset prices.
Better accounting might have helped avoid the benefit liberalizations that took place in the 1990s when many plans appeared to be overfunded.
Between 2008 and 2009, the ratio of assets to liabilities for a sample of 126 plans in a report conducted by the Center for Retirement Research dropped to 78 percent from 84 percent, and ratios are likely to continue declining for the next five years as actuaries average in the losses.
It is true that the financial numbers would look worse under more appropriate accounting. Discounting liabilities by a low rate that reflects the riskless nature of the liabilities (that is, the benefits being guaranteed) would reduce the 2009 funded ratio to 55 percent.
Better accounting in the past would have led to more assets today and may have helped avoid the benefit liberalizations that took place in the 1990s when many plans appeared to be overfunded.
For example, in 1997 CalPERS, the California public employees pension system, reported that assets equaled 111 percent of liabilities. In response, the California legislature enhanced benefits for current and future employees. If CalPERS liabilities had been valued at a riskless rate, the plan would have been only 76 percent funded.
Although the present value of promised benefits depends on the choice of the discount rate, the promised benefits themselves do not. When teachers or firefighters retire, they will get the amount calculated under the plan provisions, and how that future amount is reported today has no impact on the ultimate payment.
Moreover, an average ratio of assets to annual benefits of 15 (among the sample of plans in the Center’s study) suggests that plans — with notable exceptions such as most Illinois plans, Oklahoma Teachers and New Jersey Teachers — have enough on hand to pay benefits for decades. So liquidity is generally not an issue.
The key question is what should be done. A major increase in contributions is not realistic at this time. Because of court rulings, states and localities have virtually no ability to cut benefits for existing employees and may have only limited ability to increase employee contributions. And any changes for new employees will take a long time to have any substantial effect.
That means if funding levels are to be restored quickly, the money must come primarily from taxes. But the recession has significantly reduced tax revenues and increased the demand for services. Thus, finding additional taxes will be extremely difficult. The only real option is to wait for the market and the economy to recover.
Stop the Bleeding
E.J. McMahon is a senior fellow at the Manhattan Institute and director of the institute’s Empire Center for New York State Policy.
New York’s latest stab at pension reform, which created a new “tier” of slightly reduced benefits, was an enormous missed opportunity. While the plan shaved away a few of the most costly sweeteners added to pension benefits since the early 1990s, it preserved the basic defined benefit plan structure. This is the core of the problem: a huge and growing financial risk for current and future taxpayers.
For starters, New York should close existing defined-benefit pension plans to new entrants.
That risk is likely to be compounded by the next state budget. Gov. David Paterson and legislative majorities apparently have agreed to cap rising pension bills by “amortizing” them, which essentially means borrowing $2.5 billion from the pension fund in the next four years alone. Of course, this won’t reduce costs — it will merely push them into the future. Meanwhile, as documented in this recent Manhattan Institute report, public pension obligations are grossly understated to begin with.
Unfortunately, there is no way to reverse the pension cost spiral in the short term. The state Constitution is generally interpreted as locking in all current employees’ retirement benefits — even those not yet earned.
But this should not be an excuse for paralysis. The first order of business should be to stop the bleeding — by closing existing defined-benefit pension plans to new entrants and enrolling newly hired general employees in defined-contribution plans. A ready-made model is the Optional Retirement Program favored by employees of the State University of New York.
Republicans and Democrats alike in Albany have long treated fundamental pension reform as a political third rail. But there is at least one tiny crack in the wall of fear. State Assemblyman Jack Quinn, a Buffalo-area Republican running for state Senate, just unveiled the most far-reaching and comprehensive pension reform proposal we’ve seen from any member of the New York Legislature in decades. Mr. Quinn’s plan represents the kind of approach New York needs — before it’s too late.
The Right Pension Plan
Teresa Ghilarducci, director of economic policy analysis at the New School for Social Research, is the author of “When I’m 64: The Plot Against Pensions and the Plan to Save Them.”
Most public employees have pensions plans most every worker wants and should have. The defined benefit plans provide a benefit credit for every year of service tied to an employee’s wage.
Employees and employers should pay more in good times and less in bad times.
Employers and employees contribute, professionals invest the money for a low fee and the benefit is paid out as a pension for life. Even better, the funds are invested in the economy to promote growth and public pensioners provide consumer demand when they retire. And, unlike 401(k) plans workers can’t spend the funds before retirement.
The core benefit design is good. But cheating is not.
I was a trustee of the Indiana public employees’ pension plan in the late 1990s and early 2000. We made mistakes but we had good bones. Today the fund is not hugely underfunded, which means cities and the state do not have to make large and unexpected contributions in a recession.
Indiana public employers and employees always contributed — there were no pension holidays. In the go–go years we didn’t invest in what we didn’t understand. No Enron, no derivatives, very little private equity, no hedge funds. We kept the assumed interest rate assumptions on the low side.
In contrast, in good times many states and municipalities speculated that their funds would earn high rates of return so they could contribute less: their taxpayers, by the way, benefited in the short-term and shouldn’t complain now that it is payback. Pension funding should work the opposite way: employees and employers should pay more in good times and less in bad times. The funding status should range from about 120 percent to 80 percent. There are technical ways to do that; they have to be embedded in the funding design.
Steven Greenhut is the author of “Plunder! How Public Employee Unions Are Raiding Treasuries, Controlling Our Lives And Bankrupting the Nation.”
There’s no denying that California’s pension problem has turned into a full-fledged fiscal crisis. Unfunded pension liabilities are soaring — as high as one half-trillion dollars, according to a recent Stanford University estimate — as the result of a market downturn, followed by years of absurdly generous pension increases for government employees. The state’s $100,000 pension club has more than 15,000 members from all retirement systems — and the numbers are growing rapidly.
California voters are going to have to take matters into their own hands, through the state’s clumsy initiative process.
Not only libertarian and conservative government critics have been noticing. Former Democratic Assembly Speaker Willie Brown wrote in his San Francisco Chronicle column early this year that “[W]e politicians — pushed by our friends in labor — gradually expanded pay and benefits . . . while keeping the job protections and layering on incredibly generous retirement packages.” The chief actuary for the California Public Employees’ Retirement System (CalPERS) called the current pension system “unsustainable.”
Gov. Arnold Schwarzenegger’s pension adviser, David Crane, recently told a state Senate hearing on pension reform, “One cannot both be a progressive and be opposed to pension reform. The math is irrefutable that the losers from excessive and unfunded pensions are precisely the programs progressive Democrats tend to applaud. Those programs are being driven out of existence by rising pension costs.”
Yet the modest reform legislation Mr. Crane backed, which would have provided a still-generous second retirement tier for new hires, was dead on arrival in the Democratic-dominated Legislature, which has simply ignored these compelling “depletion of services” arguments. In California, there is no hope of reform coming from the Legislature, period. California voters — who are showing signs of agitation at the pension debt and the unfairness of the current system — are going to have to take matters into their own hands, through the state’s clumsy initiative process.
Courts have ruled that current pension deals are vested benefits that cannot be reduced, but there’s no reason not to fix the problem going forward. No initiative has so far gotten the backing necessary, but that’s only a matter of time. When unions complain about their vilification in a coming battle, they and their political allies will only have themselves to blame for ignoring the words of progressive Democrats like Willie Brown and David Crane.