Wednesday, October 27, 2010

Heartland Institute Report Requires Careful Reading and Discerning Consideration

Readers of the “The State Public Crisis: A 50-state Report Card” developed by Eli Lehrer and Steve Stanek of the Heartland Institute should view its assertions, findings, and recommendations with skepticism, or at least acknowledge the need to do some additional research.

First, neither Lehrer or Stanek are trained economists or actuaries. Both have substantial political or media backgrounds, but neither states any experience that’s directly involved with pensions. That’s a red-flag in my view, right from the start. (Their bios are included at the bottom of this entry.) There are people who dedicate their lives to understanding pensions and their public policy complexities but Lehrer and Stanek are not such people. They are treating this complicated subject from a very political viewpoint.

Second, their report is so general as to be dangerous and misleading. Across the United States, and especially in Texas, there are so many types and varieties of pension systems that the broad-brush, sky-is-falling approach taken by Lehrer and Stanek throughout their report is more misleading than it is informative. The report’s first paragraph is enough to demonstrate the hyperbole: “Taxpayers in almost every U.S. state owe large and possibly unpayable (sic) retirement pensions to the men and women who work for the government. The deep recession of 2008-2009 has moved up the day of reckoning, requiring immediate action by many states to avoid financial catastrophe.” Really? That certainly is not happening in Texas.

Third, more facts are weighing against their prescription to “Move to Defined Contribution Plans.” They make some statements in that section that are false or coming under increasing fire.

For instance, they say “Defined benefit plans put virtually no risk on the workers or retirees, because taxpayers must make up any funding shortfalls.” This is not totally true. Many public sector employers and employees do not pay into the Social Security system, so there is considerable risk to the employees, as they must rely on the performance of their pension system. And any expected shortfalls fall on the back of both the employees and their city or municipal district. Most employees have seen their personal contribution rate gradually increase over the years and many in Texas are at 8 percent or more, which is higher than the 7.62 percent contribution for Social Security.

Here’s another statement that deserves exploration: “the amount available for retirement (in defined contribution plans) depend on how much money was set aside and the success of the investments. The risk is on the workers.” The reason they offer is “the number of U.S. businesses that offer defined benefit plans has dropped to about 38,000 compared with more than 114,000 in 1983, according to the IRS. Yet they remain the standard benefit for government.”

A couple of problems here. Private businesses have moved to defined contribution plans of various sorts because of tax breaks they receive from doing so. This policy change resulted from concerns about some companies’ use of retirement investments to operate their own business. Public entities do not receive any such tax breaks and they weren’t using the retirement funds as part of their general fund. If anything, many public pension problems that exist today result from cities that hold back their contributions to their employees’ plans. In that sense they are operating their city with funds that should be contributed to the pensions. We advise against this practice as it does put extra burden on the plans. But that’s another blog for the future!

But finally, our readers should know that there is increasing concern – among private sector employer themselves – about the ability of defined contribution plans to provide retirement security.

As Stanek and Lehrer note about defined contribution plans, “the risk is on the workers.” Increasingly, private sector employers are seeing that their employees are not up to the task of taking on this risk, whether it’s their voluntary levels of contribution or their ability to see investment results that would lead to retirement security.

A 2009 study of 401(k)s by Deloitte – available to Stanek and Lehrer but not cited, if it was reviewed at all – indicated that only 14 percent of private sector employers feel that ‘most’ employees will be adequately prepared to retire, while 19 percent cite “very few” and 67 percent feel “some” will be prepared. All the numbers show increasing concerns about 401(k)s ability to deliver retirement security. Granted, the $20,000-$30,000 average yearly public sector benefit (depending on the system and years of service in Texas) is not much better in terms of providing retirement security. But let’s stick with Stanek-Lehrer's point that public employees should be moved to an even worse system.
There’s no doubt that private and public sector employers are concerned about the state of their employees’ pensions. The Deloitte study finds that 37 percent of private sector employers are considering conducting a retirement readiness assessment in response to their concerns. And many public pensions in Texas have financial counselors dedicated to helping their system retirees with the financial situations.
These are our top-line observations of the Stanek-Lehrer report card. Based on that, we don’t feel that digging deeper into their details of their report will amount to any more than wasted time. – Max Patterson

Bios for Stanek and Lehrer as Provided in their Report

Eli Lehrer is senior fellow at The Heartland Institute and national director of its Center on Finance, Insurance, and Real Estate. Lehrer played a major role in founding the coalition, a coalition of taxpayer, environmental, insurance, and free-market groups dedicated to risk-based insurance rates, mitigation, and environmental protection.

Prior to joining Heartland, Lehrer worked as speechwriter to United States Senate Majority Leader Bill Frist (R.-Tenn.). He has previously worked as a manager in the Unisys Corporation’s Homeland Security Practice, senior editor of The American Enterprise magazine, and as a fellow for The Heritage Foundation. He has spoken at Yale and George Washington Universities.

Steve Stanek is a research fellow for The Heartland Institute and managing editor of Budget & Tax News. He has been a freelance writer and editor since 1997, producing marketing materials and business articles for corporate clients, as well as feature articles and news stories for Chicago-area newspapers, magazines, and business publications. Before becoming a freelance writer, Stanek worked nearly 11 years in corporate communications. He also has worked as a newspaper reporter and editor at weekly and daily newspapers in Illinois.

Friday, October 22, 2010

When 401(k) Is Not OK – Why Defined Contribution Plans Aren’t a Good Idea

It’s increasingly common these days for members of city councils to consider changing police, fire and municipal employee pension plans from Defined Benefits (DB) to Defined Contributions (DC), those similar to private sector 401(k)s.

The council members – usually the newer ones making a name for themselves early in their political career – offer many reasons for proposing this change but key among them is that most taxpayers don’t have defined benefit plans themselves. It’s a ‘level the playing field’ sort of politically-charged approach.

It’s also rash and ill-advised. There’s a significant body of evidence that show DC plans aren’t a good idea for employees, for many reasons. Key among the concerns right now is the fact that 401(k)s aren’t working out very well for private sector employees. If the goal of private and sector employers is to improve retirement security for all workers, 401(k)s aren’t getting the job done.

Take for instance the findings of a recent study on 401(k)s and the real-life evidence from a state that tried such a switch in 1991.

A Deloitte study, the “Annual 401(k) Benchmarking Survey: 2009 Edition,” reported that 19% (up 2 percentage points from the previous year) of private sector plan sponsors believe "very few" of their employees will be financially prepared to retire. As a result, more than 60% of the employers are considering adding features such as re-enrollment to help increase deferral rates while others plan to conduct a retirement readiness assessment. If the 401(k) is the way to go, then why are employers taking such strident measures to make it work?

In West Virginia, the Teachers' Retirement System (TRS) closed their DB plan to new members in 1991. All new hires were offered a DC plan. This decision resulted in the loss of new members, making it more difficult to finance their unfunded obligations. Because the DC plan was not reducing employer costs nor providing an adequate level of retirement income, West Virginia Legislature reopened the DB plan for public school teachers. In June 2008, when given the choice to return to the DB plan, 78% of those in the DC plan chose to switch.

As the issues of converting to a DC plan continue to surface, hopefully more public employers will realize that a DC plan may not be the solution. We’re going to touch on this issue in many future blogs, but 401(k)s aren’t okay for public employee retirement security.