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Friday, June 22, 2012

Carrot and Stick Treatments of Pension Sponsors Not Working, Analyst Says

We have been contending that many of the pension systems in an underfunded condition are so because their city or state sponsor did not make their contributions in a complete and timely fashion. Their sponsor’s delays have reached their day of reckoning in many places.

The State of Texas has been pretty good at setting aside enough money to fund its employees’ pensions, but not perfect. For example, over the last six years Texas has fully funded the actuarial required contributions (ARC) for its Teacher’s Retirement Systems twice, and contributed 85% of its requirement in the other four years. Clearly, this puts the pension in jeopardy of achieving comfortable rates for its funded status, but it’s much better than other states that tend to only contribute half – or less. Other states’ pensions with funded status in the 20-40 range are increasingly becoming a national wake-up call for make-up contributions that need to be made diligently, and fast. The sad thing is that the politicians who had engineered the shortfalls don’t suffer because of it. They used the money that was available to them to pay for other constituency services, the type that gets them re-elected. But the retirees who contributed their life to public service and promises of a secure retirement (many without Social Security) suffer anxiety in seeing the topics of their retirement benefits get bandied about as a political football.

Well, it’s time the engineers of the shortfalls had their comeuppance too, according to an actuary who follows these matters closely.

Pension analyst Chris Tobes has an interesting take on the reasons that public pensions have experienced underfunding, as well as the serious shortcoming of the current systems of “checks and balances” as they could be said to exist in the pension world. Here’s a couple of paragraphs from his most recent paper, “Did the SEC and S&P let 14 states destroy their Pensions?”:
14 States have broken balanced budget clauses of their own constitutions in addition to defying the rules of pension mathematics. According to data from the Center for Retirement Studies at Boston College: Illinois, Kentucky, Oklahoma, Rhode Island, Connecticut, Colorado, Alaska, Minnesota, New Jersey, Kansas, New Mexico, Pennsylvania, Maryland, and Missouri have made partial payments over the past 7 years. In my attachment you will see how they have made the equivalent of half the mortgage payment for 10 years which has been the main driver taking their funding ratios into the 20,30s and 40s, and proves these are self-inflicted wounds. Even in bull markets some of these funds shrink in assets because of negative cash flows.

I contend that ratings agencies (S&P and Moody’s and Fitch) and the SEC are enablers by allowing this partial payment culture to exist and not punishing states and localities enough for not making their ARC. If States had paid half their municipal coupons the rating agencies would have downgraded them, but they looked the other way with pensions. The SEC caught New Jersey red-handed in 2010 but only gave them a slap on the wrist.
First, note that Texas is not among the states Tobes mentions.

Next, note that Tobes makes the case that those other states’ credit agency assigned ratings should have suffered when the state sponsors put their pension obligations on a non-existent credit card – and didn’t disclose that to investors. If a state only pays half of what is needed to keep a system sound, there will be a day of reckoning, and those half-payments weren’t appropriately calculated into the rating that affects a state’s ability to borrow money. Credit ratings affect borrowing costs. If the credit agencies had done their job in adjusting their ratings to the unfunded liabilities, the sponsors may have more diligently balanced their pension obligations with expenditures for current services. If the credit ratings had been downgraded appropriately, the markets would have been able to send signals to investors about the risks involved and appropriate bond pricing that continues to go higher may have likely woken sleeping taxpayers.

Tobes’ analysis is interesting because it demonstrates the disparities between private and public sector pensions. Private sector pension sponsors would have suffered immensely under ERISA laws designed to monitor their ongoing funding. No such monitoring exists for public sector sponsors, except through the credit rating agencies. They need to do their job so that more responsible behavior can be achieved throughout the system, even by politicians. – Max Patterson

Wednesday, June 13, 2012

NCPERS Confirms: Change Happens at Public Sector Employee Pensions

A few weeks back we received a phone call from a Texas newspaper journalist doing his work on a budget battle kicking up on his city council beat. The city had notified its public employees’ pension that it would be tinkering around the edges with a few changes needed to help its budget balance. The changes would mostly affect the benefits of future employees who might receive slightly less of a promised benefit. It seemed apparent to us that the reporter was sensing a dust-up that could get ugly. The uglier the better of course, so that the story might gain front page billing.

We felt bad about it, but we felt that we rained on his parade a bit when we told him that the situation in his city is not uncommon. This type of city budget balancing dance occurs in one form or another, in one city or another, at different times of every year across the state of Texas.

From our statewide viewpoint, as the representative of pensions across Texas, we see these sorts of processes happen all the time. Fundamentally they are all the same: the system is set up so that all cities in Texas collaborate in one way or another with their public employee pensions to make things work from a budget balancing viewpoint. The only thing that makes them different is the degree of acrimony that one or two people typically bring to that process.

This is the Texas system, where decisions about cities’ abilities to fund their employees retirement are continually adjusted at the local level so that they don’t break the budget, or absorb funding for other city services. We don’t want to appear Pollyannaish here though: some cities do get out of balance for different reasons and that causes acrimony. But by and large cities try to buy the highest quality employees they can afford, with differing levels of current and future benefits, within their budgets and workable, collaborative processes. That’s the Texas system.

Which brings us to the main point of this blog. The same thing seems to be happening across the United States according to a recent study conducted by the National Conference on Public Employee Retirement Systems and Cobalt Community Research. The NCPERS 2012 Fund Membership Study tabulated responses from 146 state and local pensions administering 7.5 million retired memberships and managing assets of more than $1.2 trillion.

The study’s respondents indicate that they are continuing to respond to a slow economy with changes that seek “to ensure long-term sustainability for their stakeholders,” meaning the retirees and the cities that sponsor their retirements. Here’s the tell-tale paragraph:
Several areas that showed increased activity over the 2011 study include: increased employee contributions, increased age/service requirements, reduced wage inflation assumption, tightened use of overtime in the calculation of a benefit, made benefit enhancements more difficult, reduced the multiplier, shortened the amortization period...
If you believe the critics of defined benefit plans, and you shouldn’t, you would think that public employees are hell-bent on keeping their current levels of benefits at all costs, even if they drive their city to the poorhouse.

Sure, there may be a few places in the country and in Texas where certain dynamics have evolved to put cities and their employees at odds over expected benefits. But those are the exceptions and not the rule. They get the headlines.

Most plans seek mutually beneficial ground to mete out benefits according to a city’s ability to pay them – and to allow a city’s residents to enjoy the longevity of qualified, experiences professionals working mostly thankless jobs. – Max Patterson