Thursday, May 17, 2012

Analysts at American Enterprise Institute, Heritage Foundation Still Selling Skewed Statistics

We’ve written previously about Andrew Biggs, an analyst at the American Enterprise Institute, and Jason Richwine, an analyst at the Heritage Foundation, who cover public employee pension issues. Their position is basically this: if taxpayers can’t have defined benefit plans from their private sector employers, then public employees shouldn’t either, damn the consequences of having employees in both sectors retiring without adequate nest eggs.

Our previous blog focused on how they used the historic market tumult in 2008-09 to negatively position pension systems’ funded status. Their “sky is falling” approach to public policy issues is unbecoming and counter-productive to good-faith debate, to say the least. But nonetheless they were back at it recently, utilizing their “pension envy” tactic in this way:
For example, a typical Illinois school teacher who worked for 30 to 34 years would retire with a guaranteed pension benefit of $60,756 a year, an income higher than 95 percent of Illinois retirees. To achieve the same level of guaranteed retirement benefits, a private sector worker with the same salary would need to save roughly 45 percent of his salary in a 401(k). The difference in pension benefits is more than enough to push public sector compensation above private levels.
For one thing, the example they use is Illinois, not Texas. Average defined benefit plans for Texas’ retired teachers, like most other public employees, is more typically in the $20-30,000 range. Illinois is Illinois. National analysts need to keep that in perspective. But they like to use the anomaly and the exception as example of the rule.

Then, in the next paragraph, they point out exactly what we have been saying, in the bold emphasis:
Our own work simply points out that a guaranteed benefit is more valuable than a risky one. Public employees with traditional pensions receive guaranteed benefits. Private sector workers with 401(k) plans, if they wish to receive benefits at around the same dollar level as public employees, have to take significant investment risk.
We agree with Biggs and Richwine on this point: private employees should not have to be their own investment managers in 401(k)s. It’s too risky and it’s not working for them. We disagree with them on the point that if 401(k)s are bad fror private sector employees then they should be forced onto public sector employees.

The correct policy debate would be one that addresses the causes of that situation, that defined benefit plans have become impractical for private sector employers to use. The wrong policy debate is the one that Biggs and Richwine want, to force public employees into bad retirement vehicles that already exist for private sector employees.

Biggs and Richwine really fly off the handle with this paragraph:
Public sector pensions generally assume 8 percent returns on investments, and they calculate pension contributions based on that assumption. However, benefits to public employees are guaranteed even if the plan's investments fall short of 8 percent. What this means is that public employees as a group effectively are guaranteed 8 percent annual returns on both their own contributions and those made by their employer -- at a time when the guaranteed return on Treasury securities available to workers with 401(k) plans is only 2 percent to 3 percent. The difference in benefits payable at retirement can be huge.
This may be news to them, but public employees are not “guaranteed” 8 percent annual returns on contributions to their pension plan.

Instead, the actuaries for a pension system might use an 8 percent return to calculate the amounts that both the employer and employees would need to contribute to achieve a certain defined benefit once they retire.

Obviously that’s considerably different from a “guaranteed” amount. It’s telling that they don’t seem to draw this distinction.

Many systems aren’t generating 8 percent returns right now due to sluggish economies and difficult investing environments. As such, in Texas at least, it is increasingly common to see plan sponsors, their actuaries, and employees going back to the drawing board and define what makes the most sense for an assumed rate of return for a certain level of benefits. That is happening nearly everyday somewhere in Texas at local and state pensions for public employees. Together, the pension system participants work to agree on some level of benefit that is achievable and attractive for every one involved.This is the way things are supposed to work.

Once again, we’d ask you to view any analysis that come from Mr. Biggs and Mr. Richwine with a high degree of skepticism as they are often wrong on facts, or they skew sitautions to create a false sense of alarm to make their arguments. Regardless, they continue to fail to address or encourage discussion around the more meaningful reforms that should be occuring in private sector employees pensions. – Max Patterson

1 comment:

  1. Max Patterson’s attention to my work with Jason Richwine of the Heritage Foundation is flattering, but his attention to detail leaves something to be desired.

    First, he claims, we exaggerate the generosity of public pensions by illustrating using Illinois teachers. A full-career Illinois teacher receives an average pension of $62,280 based on final earnings of $86,636, for a replacement rate of 72 percent. A full-career Texas teacher (meaning, at least 30 years of work) receives an average pension – not of $20,000 to $30,000, as Mr. Patterson claims – but of $45,204, against final earnings of $64,929, for a replacement rate of 72 percent. Texas teacher pensions are really no less generous than in Illinois, it’s merely that wages and the cost of living in Texas – for teachers and everyone else – are lower. But a Texas private sector worker would need to save just as large a share of his salary in a 401(k) to match a teacher pension as we illustrate for Illinois.

    Next, in response to our calculation showing that public employees receive average guaranteed returns on their pension contributions of 8 percent, while private sector workers with 401(k)s can receive guaranteed returns of only around 3 percent by investing in U.S. Treasury securities, Mr. Patterson snidely points out “This may be news to them, but public employees are not ‘guaranteed’ 8 percent annual returns on contributions to their pension plan.” We’re well aware of how DB pensions function, which is why our article stated that public employees “as a group” receive 8 percent guaranteed returns. Public pensions discount future benefits at an 8 percent interest rate, then use the resulting “present values” to determine contributions. This is mathematically equivalent to taking total contributions and paying a guaranteed 8 percent return. Some public employees receive higher returns – mostly those with long careers – while some do less well, but our point is that in judging the generosity of public pensions you must look not only at the contribution level but the return on contributions, which is far higher for public than private plans.

    But, of course, guaranteeing 8 percent returns regardless of actual market outcomes isn’t free, much though public pension advocates wish it were. The government, meaning the taxpayer, bears the risk. At the federal Bureau of Economic Analysis has stated, “if the assets of defined-benefit plan are insufficient to pay promised benefits, the plan sponsor must cover the shortfall. This obligation represents an additional source of pension wealth for participants in underfunded plan.” Other non-partisan agencies, such as the Congressional Budget Office and the Federal Reserve, not to mention the vast majority of academic economists, hold the same view. Our approach captures the extra value to public employees and the extra cost to taxpayers of these guarantees. Beginning in 2013, the National Income and Product Accounts of the United States – the official ledger for the country -- will calculate defined-benefit pension liabilities, and the income flowing to employees in those plans, on a basis similar to what we advocate. By ignoring all this evidence, which we have amply cited in our work, Mr. Patterson portrays our conclusions as a wily trick rather than representative of the majority of analysts working on these issues.

    Andrew G. Biggs
    Resident Scholar, American Enterprise Institute