Independent Company Study Contrasts with Pew Research

We have noted in the past how the Pew Center on the States has used worst-case numbers from the 2008-09 market collapse to inflate anxieties in its series of Widening Gap reports on pension funding. The Pew Center sometimes has its own political agenda for the factoring included in its studies.

Now comes another study from a private sector actuarial firm, ostensibly one without a political agenda. The study, from Milliman, is worth a look.

First, you should know that Milliman is very different from Pew, a think tank. Milliman is among the world’s largest providers of actuarial and related products and services. They offer consulting services for employee benefits, healthcare, investment, life insurance and financial services. The firm does not get into political debates about the types of pension plans that public employers should use, and therefore provide another view of pensions.

In Milliman’s recently released “2012 Public Pension Funding Study,” the company measured the aggregate funded status of the 100 largest U.S. Public Pension plans using basic actuarial principles and reported plan liabilities and assets. Milliman used a uniform approach to accrued liabilities with respect to interest rate assumptions, an approach that Milliman believes unique among studies.

What it found was that the plans, in aggregate, have a funded ratio of 67.8% and typically have very conservative interest rate assumptions:

On the whole, we conclude that there are only a small number of plans whose interest rate assumptions are causing a sizeable underreporting of liability relative to what would be calculated based on current forecasts of future investment returns. 

What does this mean?

Simply that some plans have overly optimistic assessments of what they can earn through investments. This is a significant problem because investment returns achieve as much as 60% of a retiree’s eventual monthly income. Overly optimistic assumptions mean that future benefits will need to be made up by employer’s, e.g. taxpayers’, contributions. From an actuarial standpoint, it’s better to have more conservative, less optimistic assumptions baked in. And, the good news according to the study is that:

…in fact, there are a surprising number of plans whose interest rate assumptions and accrued liability reporting are conservative in light of current forecasts. 

That means most plans are continuing to make adjustments that will narrow the new market norms with future expectations for benefits that will need to be funded.

Milliman poses that we can get a clearer picture of future liabilities by using a single inflation rate across all the systems. They used a 2.75% inflation rate figure and determined that, using that rate, the actuarially determined interest rate for the aggregate assets of all the plans in their study is 7.32%. This is nearly a full 3/4s percentage point below the 8% return used by Pew. Using that rate, the systems in the Milliman study would have a 65.9% funded ratio.

This ratio continues to be well within shooting distance of the 80% funded ratio to which most plans aspire. And we should note that funded ratios are only one indicator of system health. As long as the trend of funded ratios continues to be positive over time, this ratio should be considered to be healthy. The problem occurs when funded status takes a hit, say due to downward market fluctuations, and continues downward. As long as the trend reverses to an upward or stabilized course, systems with this level of ratio are in good shape. – Max Patterson

San Antonio Newspaper Article Focuses on Sizzle, Misses Steak about TEXPERS Educational Conference

We here at TEXPERS know that the media live on controversy, confrontation, and schism wherever they can find it. It’s called “making headlines” and that is how they create a product that sells to an audience, that then can be turned into advertising dollars.

We understand that dynamic and we appreciate the work that the media does in bringing issues and events to our attention. We, as free citizens, need the media telling us all what is going on around us. And we realize that, without the sizzle of a sexy headline, people wouldn’t read the newspaper and so there wouldn’t be any newspaper. The headline “20,000 planes took off and landed again safely today” would get boring day after day, which is why the media only focuses on the one that might, unfortunately, crash every year and a half or so.

Such is the case with a story that featured TEXPERS’ activities on its members’ behalf at our summer conference which concluded this week.

The story, “Groups defend public pensions,” provided a summary of my and another TEXPERS’ member comments about special interest groups – all with funding coming from outside of Texas – who have as their defining purpose the dissolution of defined benefit plans for public employees. There’s no ‘give’ in their position: No matter how well DB plans perform in Texas for police, firefighters and municipal employees and the cities they work in, they must be replaced by DC plans, they say. There’s no rational debate or discussion about the matter. Just because some systems have not fared well in other parts of the country, they must be dismantled here, our opponents say.

So, yes, we advised our members about these threats and the reporter dutifully came to the one presentation where some hint of controversy drew him to our conference. We’re not blaming him for doing that. It is his line of work.

But what you should know is that, for the previous three days, more than 500 trustees of pension systems from around the state came to San Antonio to further their education about investments and pension administration so that the burdens on taxpayers for their employees pensions would be as low as possible. They heard from money managers, lawyers, and other pensions, to learn how to operate the best possible pension, on their city’s taxpayers behalf. Dedicated men and women took time from their personal lives to devote their efforts to their colleagues at fire houses, police stations and city halls across our great state. They came to invest their and their fellow’s money as best they can so that after 20 or 30 years of service, at very minimal rates of pay, the public employee could retire securely at least possible burden to their fellow taxpayer.

In our view, this was the equivalent of the 20,000 planes that cross our skies safely each day. It won’t make headlines, but it’s the truth of what really happens with local pensions in Texas. -- Max Patterson

Where’s Texas?

The doom-and-gloom naysayers of public employee pensions got more ink last week in the Wall Street Journal.  The story was “Hard Times Spread for Cities: Rising health, pension costs top the list as municipalities struggle to recover from the recession,” and was written by three WSJ staffers, Kris Maher, Bobby White and Valerie Bauerlein.

Do a search for the word “Texas” and once again you’ll find our great state is nowhere mentioned in the story.

Now, we have no doubt the journalists did their job in thoroughly investigating situations they recount in California, Pennsylvania, Michigan, North Carolina, Illinois, Rhode Island, Massachusetts, Ohio, and Missouri, where cities are struggling with pension costs or looking to raise taxes to support other services.

But these trouble cases have been all the media rage over the last few years. They usually follow mismanagement by politicians over years and decades. And they seem to be more the exception the rule.

It’s been our wish over the years that every story like this would include a quote from someone that knew about the overall health of the public employee pension system in Texas. If they would, the story might include a paragraph that would say something like “‘We’re not having the same problems in Texas, where a system of checks and balances tend to keep pension contributions in balance over time,’ said Max Patterson, the executive director of an association of local pensions across Texas.”

Somehow, I don’t think we ever will, but it is the truth, and it would add some fairness and balance to every story like the one that appeared in the WSJ. – Max Patterson

Policy Observers Starting to Address Core Causes of Pension Envy

We have for several years now been noting the “pension envy” phenomenon, where people in the private sector want the same defined benefit plans that public sector employees have. We have said that we agree with them completely – that ERISA laws placing onerous burdens on private sector companies need some revision. We agree that new thinking is in order. We don’t agree with their position that because most private sector employees don’t have DB plans, then public sector employees can’t have them either. Public policy should be guided by what works, not some sense of class fairness determined by where you work.

This pension envy, in our view, also has its origins in the failure of 401(k) plans to adequately generate the returns most Americans need for retirement. There is some irony in this development, as we remember how, in the 1990s when stock markets were booming, we would read about the imminent death of antiquated defined benefit plans. Why would anyone in the public sector agree to meager 5 percent returns when mutual funds in the 401(k)s were making 20 percent each year? That was the argument then. 

The 401(k) disaster is beginning to be recognized. We’ve noted how the annual Deloitte study of 401(k) plans shows increasing discomfort on the part of employers for the retirement status of their employees. We’ve seen studies from the Center for Retirement Research indicating severe funding shortages for retirees.

Now we have another academic making some of the same observations, that 401(k)s aren’t getting the job done. Here’s a few paragraphs from a story, “Our Ridiculous Approach to Retirement,” appearing recently in the New York Times, by economics professor Teresa Ghilarducci:

The current model for retirement savings, which forces individuals to figure out a plan for their retirement years, whether through a “guy” or by individual decision making, will always fall short. My friends are afraid, and they are not alone. In March, according to the Employee Benefit Research Institute, only 52 percent of Americans expressed confidence that they will be comfortable in retirement. Twenty years ago, that number was close to 75 percent.

I hope that fear can make us all get real. The coming retirement income security crisis is a shared problem; it is not caused by a set of isolated individual behaviors. My plan calls for a way out that would create guaranteed retirement accounts on top of Social Security. These accounts would be required, professionally managed, come with a guaranteed rate of return and pay out annuities. This is a sensible way to get people to prepare for the future. You don’t like mandates? Get real. Just as a voluntary Social Security system would have been a disaster, a voluntary retirement account plan is a disaster.

It is now more than 30 years since the 401(k)/Individual Retirement Account model appeared on the scene. This do-it-yourself pension system has failed. It has failed because it expects individuals without investment expertise to reap the same results as professional investors and money managers. What results would you expect if you were asked to pull your own teeth or do your own electrical wiring?

Defined benefit plans work in part because employees are required to make contributions to their individual retirement account, and they sacrifice some of their current income for future, delayed gratification. They rely on the professional decision making of their Board and the money managers they hire. The same dynamic does not exist with 401(k)s and it is a serious flaw. We don’t like mandates either, but there needs to be some fundamental change in how all policy makers view individuals savings capabilities.

You might also want to see Ms. Ghilarducci interviewed on this subject on a Web interview, available here. – Max Patterson