Public pension plans should not get into the private retirement annuity business

A recent opinion piece in Governing, “What Public Pensions Could Do for Private-Sector Retirees,” by finance columnist Girard Miller, proposes authorizing public pension systems to create a new common trust account to issue annuity-type products to private sector individuals. This new government-owned and operated enterprise could, allegedly, provide a competitive (i.e., less expensive) alternative to the annuity products issued by private sector insurance companies and help fill the gap in retirement security for private workers. The proposal, however, attributes too much of ongoing retirement savings problems on a supposed distrust of private insurance agencies, and it overestimates the abilities of governments to manage this type of state-run solution.

In Governing, Miller argues:

America needs a better system of “longevity insurance” whereby private-sector 401(k) and IRA savers can convert some of their nest eggs into annuities, providing guaranteed lifetime income with an earnings rate at least a little better than what insurance companies typically offer. There could be an important role for public pension systems in making that happen…

If your expectation is that the private sector will figure this all out and that competition will drive the economics for retirees so favorably that they can all get a maximum return on their annuity investments, then you will see no need whatsoever for a public-sector alternative. But if you harbor the average American’s distrust of insurance companies, then you might want to get behind the idea of a competitive yardstick to be provided by public pensions. The idea here is not to replace the insurance and annuity industries, just to keep them honest and price competitive.

This idea attempts to remove perceived impediments to using lifetime income products for private individuals in this country. However well-intentioned, the proposal would create new, complex, government-run enterprises in each state that would do little to improve retirement security for individuals.

Miller rightly points out that our country’s solutions supporting financial security in retirement are not working for too many people–particularly in the private sector. He notes the reality of poor retirement plan participation and savings rates, the relative absence of lifetime income products for 401(k) plans and IRAs, and the absence of retirement medical savings strategies for most private sector employees. If this situation is not fixed, there is a substantial risk that many workers will become elder-care welfare recipients, adding to the fiscal burdens of governments. 

By contrast, the piece notes that most state and local government employees receive defined benefit pension plans, which provide lifetime annuity income. Miller further acknowledges that retirement plans for educators, primarily in higher education and health care workers covered by 403(b) plans historically have long included lifetime income features through annuities issued by private sector insurance companies. The emergence of new retirement longevity insurance products, such as qualified life annuity contracts (QLACs) that provide income protection only if a person lives longer than age 85, is noted favorably.

Miller also argues that private-sector insurance companies cannot be relied on to solve this retirement income security problem for private-sector employees. The piece posits that many private sector workers elect not to use their retirement savings to buy lifetime income products because of a lack of trust in insurance companies and the cost of those products. Based on this theory, the proposed solution is to create an honest and price-competitive standard bearer deemed more trustworthy with lower costs. And in Miller’s piece, the candidate should be a public pension plan run by state governments.

But are the distrust and high annuity purchase pricing truly the core reasons for the low use of private sector insurance company annuity solutions?

Maybe this is true for individuals deciding whether to buy an individual retail annuity product. However, distrust does not explain why private-sector employers and their consultants often do not use group annuity solutions in their employer-based plans. 

Miller acknowledges the success of group annuity solutions in retirement plans when he notes that the traditional 403(b) plan market does not have these trust problems and offers price-competitive group lifetime income solutions. 

The main barriers to retirement income security in this country are actually more about poor retirement plan design than expensive annuity products and distrust of insurance companies. A great deal more could be accomplished if policymakers encouraged employers to offer good lifetime income-focused plan designs in the first place, similar to the higher education market, rather than adding another layer of government-run complexity. 

Even past the high hurdle of creating another government-run enterprise, a myriad of structural, regulatory, and public policy issues need to be examined before accepting the proposition that public pension plans should enter the private-sector lifetime-income product arena. Miller’s Governing piece touches on some. The government-run annuity enterprise would need to have a separate common trust account to manage the assets supporting the annuity products. This is critical because pension systems are fiduciary bodies and must legally keep their main business of providing pension benefits separate from this new private annuity enterprise. The new enterprise would, in effect, need to be run apart from and unsubsidized by the pension system.

Miller says he doesn’t “expect this idea to see the light of day anytime soon.” But it’s worth discussing the proposal, which is based on the premise that costs would be lower, assuming the new publicly owned and managed insurance company has no profit motive and somehow can be operated more efficiently. But will this be likely? In most cases, probably not.

Miller’s proposal would have each state creating its own new annuity trust company, which means it will not have the economies of scale to realize cost savings. Running this new government annuity trust company would not be the same as running the state pension plan. It would involve a great deal of added complexity and cost just to comply with state insurance regulatory requirements. Public pension administrative systems are not designed to handle these regulatory complexities.

The proposed new publicly-owned annuity trust could also run into financial difficulties if not managed properly–just like any other private sector insurance company. Miller argues that “who backstops any actuarial shortfalls” needs to be decided, but that backing might be less costly than letting elder-care welfare costs soar.  

The implication is that state governments and the public treasury should back this annuity enterprise managed by public pension systems. The troublesome reality is that there is no particular reason to think that the administrative bodies of public pension systems and the lawmakers overseeing these plans would be up to the task, given their track record of underfunded benefits and public pension debt. Under the oversight of state governments, unfunded pension liabilities of 118 state pension systems have exploded to an estimated $1.3 trillion by 2023. This does not inspire confidence in the government’s ability to manage additional retirement-related funds properly. 

The proposed new public annuity trust fund would be best set up to stand on its own two feet without recourse to the public taxpayer and should be subject to all the same regulatory, solvency, risk capital requirements, and state-required guaranty association membership rules as any private sector insurance company.

The idea of leveraging state public pension systems to provide lifetime annuity products to private sector individuals is interesting to explore because of the need to help protect people from outliving their retirement assets. Miller’s proposal, however, addresses only the longevity risk part of the retirement savings and security problems that too many are facing.

There are existing cost-efficient market-based annuity solutions that work but have not been widely adopted by employers. Reason Foundation’s Pension Integrity Project has proposed a retirement structure for public employees, the Personal Retirement Optimization Plan, or PRO Plan, that uses tested annuity strategies to address longevity risks, and similar options are available to the private sector.

Appropriately designed retirement plans that focus on the full range of retirement security issues: automatic participation, adequate savings levels, portability of benefits, managed investments, and prominently featured lifetime income solutions would do far more to solve retirement security issues than adding another layer of government with questionable results.