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

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

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

Sky Continues Not To Fall on Public Employee Pensions Around the Nation

The typical newspaper headline over the last few years has been about the failure of public employee pensions in certain cities and states to match their assets with their liabilities, meaning the benefits due to retirees. The doom-and-gloom headline would likely focus on one or two city or state plans that weren’t disciplined in funding their pensions on yearly basis, only to find themselves at some point potentially owing huge amounts for future retirement obligations they had made to people who’d dedicated their life to providing a public service.

The good news today is that we may see fewer of those sorts of headlines as cities and states do what they should to balance their books. And we are likely to see even fewer.

This week the Center for State & Local Government Excellence released a new report, “The Funding of State and Local Pensions: 2011-2015,” showing that public pension plans funded ratios slipped a modest 1 percent in 2011, to 75%, reflecting actuarial smoothing caused by a reduction in the growth rate of liabilities. In other words, as cities and states have cut back on hiring, and reformulated their plans to match income with outlays, the decline in funded ratio has declined at systems around the nation.

They didn’t say this, but I will: the system is working in terms of people across the nation coming to the realization that adjustments needed to be made to reflect a slow growth economy.

The study projects continued steadiness, and then improvements in funded status, as the economy and stock markets return to more ‘normal’ growth. Here’s the conclusion from their report:

The funded status of state and local pensions has been front page news since the collapse of financial markets in 2008. At the time, it was clear that the funded ratios of public plans would continue to decline as actuaries gradually averaged in the losses. Indeed, the funded status for 2011 was 75 percent compared to 76 percent in 2010. The decline was mitigated somewhat by much slower liability growth.

The reason that the growth in liabilities has slowed is that states and localities have laid off some workers, frozen salaries, and reduced or suspended COLAs. Because many of these changes are one-shot, liability growth is likely to pick up somewhat in coming years. Even if the liability growth rate picks up, however, phasing out years of low returns in the actuarial averaging process should lead to an increase in assets under our “most likely” stock market scenario. Specifically, if the stock market increases at about its historical rate over the next four years, the funded ratio for state and local plans should increase gradually to 82 percent in 2015.

The critics of defined benefit plans like to use scare tactics in their campaigns against public employee pensions, but the general public should see this report as continuing evidence that the “crisis” is whipped up and manufactured. Leave the system to work itself out. 

The chart below shows the funded status of Texas’ biggest state pension systems, and is available on page 12 of the report. --- Max Patterson