Wednesday, November 7, 2012

Ivory Tower Folks Continue to Misunderstand Public Employee Pensions

Last month, two academics penned an article that appeared as an op-ed in the Washington Post, with the usual ‘sky is falling’ static analysis of public employee pensions. If only the zaniness would stop.

The article, titled “The Looming Shortfall in Public Pensions” is much the same fare as what we’ve been writing about the last few years. The authors imitate so-called research from the Pew Center, the Heartland Institute, the American Enterprise Institute and the Heritage Foundation, to name but a few. Their conclusion is predictable:
Systems could consider introducing mixed defined-benefit and defined-contribution plans for all employees, not just new hires, a method used by Rhode Island. Most public workers in that state are now in hybrid plans with a smaller defined-benefit component, contributions to individual accounts and higher retirement ages. Combined with a temporary suspension of cost-of-living adjustments, Rhode Island’s reforms reduced the unfunded liability by more than 40 percent.

Of course they don’t say why that will work to balance budgets, or even if 401(k)s would offer a secure retirement to public employees. They just throw it out there, like all the rest. And as we’ve said, states like Alaska and others have no empirical proof that defined contribution plans work to achieve the goals of cities or their employees.

Nonetheless, we’re tired of beating our heads against the walls with these ‘conclusions’ and we thought you might like to hear the voice of Diane Oakley, the Executive Director of the National Institute for Retirement Security, who battles these sorts of ‘think-pieces’ when they pop up in national newspapers. Here’s what she wrote to the Washington Post editors, but we don’t think they’ve run it yet. This is the entire article she submitted:

Letters to the Editor
The Washington Post
1150 15th Street, NW
Washington, DC 20071 
To the Editor, 
The opinion piece [The looming shortfall in public pension costs; Oct 21] misinforms the public about pension funding costs. The authors' ivory tower exercise that values public pension liabilities at a "riskless" investment rate raises false alarms, and bears no relationship to real world decisions to fund retirement benefits for state and local first responders, teachers and other employees. 
Pension funds are invested by professionals in a diverse portfolio to defray costs to taxpayers. The investment return assumption matters because investment earnings account for a large portion of pension revenues. Set too low, the rate will overstate liabilities; a rate set too high will understate liabilities. An assumption that is wrong in either direction will result in a misallocation of funds. 
So, it's clear that determining funding costs based on a "riskless" rate that is far below expected investment returns would distort funding policy decisions and waste government dollars by over-funding pensions. Data show that over rolling 30 year periods between 1926 and 2010, covering multiple market downturns, public pensions have meet or exceed the eight percent investment rate of return used by most funds. 
It's also important to note that the Governmental Accounting Standards Board earlier this month indicated a "definitive separation" between financial reporting of pension liabilities and funding decisions. The responsibility for developing stable and sustainable pension funding policy sits with government officials using sound data and information. As a result of the financial crisis, forty-six states have responded by enacting changes to ensure the long-term sustainability of their pension systems. Moving to fund public pensions based on a riskless rate has not been a policy consideration. 
Finally, it's perplexing that the authors suggest that switching from pensions to 401(k) accounts is a solution. Last week, TIAA-CREF president and former vice chairman of the U.S. Federal Reserve Roger Ferguson wrote about the retirement crisis, and indicated that 401(k) accounts were intended to supplement pensions, not to serve as the primary retirement vehicle. Moreover, the median balance of such accounts is $44,000 according to recent Federal Reserve data - nowhere near what any American needs to remain self-sufficient today. Perhaps an economic analysis of the real retirement crisis facing Americans lacking pensions would better serve your readers? 
Diane Oakley
Executive Director 
Well said, Diane. And we’d like to bring your attention to one more point.

We’ve been impressed recently with the statistic that public employee pensions in Texas have increased the value of employee and employer contrbutions by 63 percent. This comes from a fact sheet created by NIRS to discuss the entire financial benefit of pension results. The NIRS Fact Sheet on Texas says this:
Between 1993 and 2009, 19.91% of Texas’ pension fund receipts came from employer contributions, 17.05% from employee contributions, and 63.04% from investment earnings.* Earnings on investments and employee contributions—not taxpayer contributions—have historically made up the bulk of pension fund receipts.
This means that Texas, its cities and its public employees are able to dedicate their funds to things other than pensions because the retirement system investors do such a great job earning money from investments. Gaining 63% on employer and employee contributions means more potholes can be filled, more crime can be fought and more fires responded to quicker. Gaining 63% on employer and employee contributions also provides a safety factor to employees foregoing opportunities in the private sector for the more mundane, lower paid jobs in the public sector, with steady retirement allowances.

There are several more points we need to raise about the op-ed in the WAPO, but this will do for now. More later. – Max Patterson

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