Pension Reform Newsletter – April 2015

This newsletter highlights articles, research, opinion, and other information related to public pension problems and reform efforts across the nation. To find previous editions, please visit https://reason.org/newsletters/pension-newsletter/.

Articles, Research & Spotlights

• Governance & Decision-Making in Underfunding of Public Sector Pension Plans
• Testimony on Nevada Assembly Bill 190
• A Response to the Defense of Status Quo for Failing Pension Systems
• Unions Need to Make a Deal on Retirement Benefits
• California Crowd-Out
• Reforming Alabama’s Retirement System
• GASB Changes Hit Public Pension Plans
• Why Pre-fund? Why Fully Fund?
• Website for Government Workers to Learn about 401(k)s
• Updated Pension Gimmicks List

Quotable Quotes on Pension Reform

Pension Reform Handbook

Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Governance & Decision-Making in Underfunding of Public Sector Pension Plans
By Pete Constant, Reason Foundation

Cities and states throughout our country are struggling to meet the financial demands of skyrocketing public employee pension contributions. Forward-looking projections of contribution rates reveal little to no relief for many years to come. And while this crisis has prompted government agencies at all levels to call for reform of the public pension systems, the question remains – will these proposed reforms fix the problem?

Recent research suggests that investment returns played only a minor role in the current underfunding and that behavioral issues might be more significant than previously thought. Reformers may want to look at the roots of structural governance issues in the traditional make-up of pension boards that approve the assumptions that are used to create their forecasts.

To read the full commentary on the impact of pension boards in investment projections and funding decisions, go here.

Testimony on Nevada Assembly Bill 190
By Anthony Randazzo, Reason Foundation

The state of Nevada is considering a substantive change to its public sector pension system. Assembly Bill 190, by Assemblyman Randy Kirner, a bill currently being considered in the state assembly, would introduce for new employees a hybrid pension plan while leaving current employees alone.

In consultation with The Terry Group , Reason developed a forecast for how the legislation would change Nevada’s fiscal position, taxpayer risks, and member benefits. We presented our findings in a hearing on April 15, 2015 before the Nevada Assembly Committee on Ways and Means.

Our actuarial model of Public Employees’ Retirement System of Nevada, and forecasting of how AB 190 would change the baseline, yielded three key findings:

1. AB 190 will create savings for total employer cost, $14 million in year one and around $2.4 billion over 20 years;
2. AB 190 will mitigate risks to taxpayers by replacing part of the defined-benefit liabilities with a fixed employer cost defined-contribution benefit; and
3. AB 190 will provide comparable benefits to the status quo, assuming the DC accounts and DB plan earn the assumed 8 percent return.

To read the complete testimony and see accompanying graphs, go here.

A Response to the Defense of Status Quo for Failing Pension Systems
By Lance Christensen and Truong Bui, Reason Foundation

Opponents of pension reform in Nevada seem unwilling to admit that the system is broken and that its significant unfunded liabilities will impair state and local governments’ ability to provide basic programs and essential services for citizens. Rather than engage in constructive dialogue about the appropriate reform steps to take, they would rather deflect discussion and hope for some economic miracle or tax increase that will put billions of dollars more into a system that is critically ill. Here are some responses to a sampling of statements made by Teresa Ghilarducci, a national advocate of defined benefit pensions, in a recent Las Vegas Review-Journal op-ed.

In the end, both the taxpayers and those who have served Nevada in local and state government jobs deserve to understand the full context of the debate before them so that they are better informed about the needs and pathways to pension reform. Reform proposals before the legislature keep the promises made to those already in the system without increasing the debt on future generations. Further, policymakers acknowledge that Nevada needs a retirement system that is transparent, affordable, sustainable and secure for a changing workforce and future generations.

To read the full commentary, go here.

Unions Need to Make a Deal on Retirement Benefits
By Lance Christensen, Reason Foundation

California taxpayers are saddled with unfunded public pension liabilities estimated to be as high as $583 billion, but often overlook that they’re also on the hook for billions more in retiree health care benefits. In his January 2015 budget proposal, Gov. Jerry Brown acknowledged that unfunded liabilities for retiree health care costs for state employees now stand at $72 billion and will increase to $90 billion if nothing is done.

The tab for taxpayers is higher when factoring in health care benefits for local government retirees. In estimating the costs for both state and local government workers, the nonprofit California Common Sense found an unfunded retiree health care liability of $157.7 billion.

Annual spending from the state’s general fund to pay down this debt has more than quadrupled, from $458 million in 2001 to $1.9 billion this fiscal year, but that is still not enough to meet the costs. And, with the average Californian’s life expectancy now exceeding 80 years, the cost of health care benefits for public retirees will continue to grow.

So what’s the solution? To read more about the issue, go here.

California Crowd-Out
By Lance Christensen, Reason Foundation

When pension costs increase, absent tax increases, significant changes to actuarial assumptions, prudent fiscal decisions or even substantive reform, other core governmental services are often negatively impacted through “crowd-out.” In a recent in-depth study, “California Crowd-Out: How Rising Retirement Benefit Costs Threaten Municipal Services,” Manhattan Institute senior fellow Stephen D. Eide writes, “Balanced budget requirements mandate that when costs grow more rapidly than revenues, something must give. All too often, this has meant reductions in core government services, most of which-police, fire, libraries, parks, and street and sidewalk maintenance-are delivered at the local level in California.”

While there are many causes of crowd-out such as structural problems found during economic downturns and increasing costs for employee benefits, unfunded pension liabilities have also play a major role. Eide notes that “between 2004 and 2012, growth in pension costs for California local governments outpaced spending on core services, such as police and fire, and quality-of-life services, such as parks and libraries.” Inasmuch as governments try to protect their personnel, staffing for various departments continues to lag behind growth in the private sector. Additionally, it is difficult to maintain major capital investments and infrastructure when money is diverted to pay down hefty unfunded liabilities. Eide writes, “But local services are not improving at a rate proportionate to economic growth. When the next recession hits, more municipal bankruptcies will come. For the moment, the greatest threat is mediocrity, not insolvency.”

To read the full report and see recommendations for improving the situation, click here.

Reforming Alabama’s Retirement System
By Truong Bui, Reason Foundation

A recent report by the Alabama Policy Institute examines the public retirement system in Alabama and recommends substantive reforms to bring about fiscal sustainability. As a whole, Alabama’s pension system is unfunded by $15.2 billion, with a funded ratio of only 66 percent. This year alone, the state is expected to spend nearly $1 billion on pension contributions, which have increased annually by 11.9 percent on average since 2004. The pension cost accounts for 12 percent of the entire state budget (excluding federal funding), and is the second-largest outlay in all of state government, behind only education.

Alabama attempted to bring down pension costs with two bills in 2011 and 2012, which raised the employee contribution rate and created a new tier for new employees with a more affordable benefit formula. These changes are estimated to save the state about $162 million annually on average over the next 30 years. The measures, however, still left some fundamental problems unaddressed. The report’s recommendations aim at fixing these problems:

• Cash balance pension plan: a switch to a cash balance plan would provide more portability for employees through individual accounts, and reduce taxpayers’ contingent liability by allowing mutual risk sharing between the public employer and the employees.
• Judicial pension reform: the current benefit formula for judges is excessive and should be made more consistent with those of other state employees.
• Eliminate piggyback agency participation: the definition of “teacher” for eligibility to participate in the state pension system is too broad, allowing a private lobbying group to benefit from taxpayers’ money. Fixing the definition would narrow the pension benefits to the intended workers.

To read the report, go here.

GASB Changes Hit Public Pension Plans
By Truong Bui, Reason Foundation

Public retirement systems in the US have experienced the first wave of change in the Governmental Accounting Standards Board (GASB) rules . Rolled out in 2014, GASB 67 requires a different treatment of the discount rate, making public plans use a market discount rate to value the pension liabilities that are not covered by projected performance. The resulting blended discount rate, for many plans, is often lower than previously assumed.

According to a recent analysis by Governing , 28 out of the 80 surveyed pension plans decreased their discount rates in fiscal year 2014. However, the average funded status rose from 70 percent in 2013 to 74 percent in 2014, thanks to the new accounting rule requiring plans to report the market value of assets, which have recently seen large gains, instead of the smoothed value. Some plans did see a significant drop in their funded status. For example, the Kentucky Teachers’ Retirement System had its funded ratio fall by 6 percentage points in 2014 after reducing its discount rate by two points to 5.23 percent. Similarly, the funded status of New Jersey’s state employee retirement plan sank to 28 percent from the previous 46 percent due to the plan’s discount rate adjustment.

The second wave of change will come later this year, with the new rule GASB 68 requiring cost-sharing employers to record their share of unfunded liability on their balance sheet. The rule is expected to force governments to recognize the role pension obligations play in their overall finances.

Despite these positive changes, the new GASB standards still have serious limitations , and only structural reforms would bring long-term sustainability to government pension systems.

To read the Governing analysis, go here.

Why Pre-fund? Why Fully Fund?
By Lance Christensen, Reason Foundation

The Terry Group, actuaries and experts on pension plan funding, are developing a series of commentaries to advance the discussion on retirement solvency. In their most recent column, “Why Pre-fund? Why Fully Fund,?” they address the challenges to pre-funding public pension plans and whether full funding will be a result. They ask the question, “Should immediate full funding of current liabilities be the ‘norm?'”

Putting the situation in a more relatable context for the average citizen, they set up a construct where “it may be useful to think of the pool of current taxpayers in a public entity as analogous to the current stockholders of a private sector entity. And future taxpayers-those who will ultimately have to pay the deferred funding cost-as analogous to the future investors of a private sector entity. Those future taxpayers (like future investors) may ‘discount the value of the municipality,’ e.g., through reduced property values, to reflect the deferred funding obligation.”

Working upon the assumptions that any and all pension promises will have to be made at some point in the future (except in the case of a default), that the costs of most pension plans continue to increase and many are oversubscribed, and that aggressive pre-funding in private sector plans is required by law, perhaps state and/or federal law should find a way to require fully funded systems so that all public pension plans can actually pay out benefits promised years in the past without crippling future generations of taxpayers. As it stands now, governmental accounting standards are just that, standards and guidelines, and it is largely up to pension boards to make the final funding decisions.

Reason Foundation’s director of economic research, Anthony Randazzo, has also explored the issue of full funding at some length here. He concluded that “there are various fiscal, political, and institutional factors at work, and no one-size-fits-all answer.”

To read The Terry Group’s full analysis, go here.

Website for Government Workers to Learn about 401(k)s
By Truong Bui, Reason Foundation

At workerfreedom.com , the Illinois Policy Institute provides an interactive tool for government workers to explore what 401(k)-style pension reform could mean to them. At the website, a government employee in Illinois can input his/her age, occupation, number of working years, and current salary to calculate the annual retirement benefit he or she would receive under the new 401(k) plan. The site demonstrates the viability of a 401(k) plan in delivering retirement security, compared to the heavily unfunded defined-benefit counterparts.

The website also supplies key facts and arguments about 401(k) plans. One can find a video explaining the workings of a 401(k) plan and a dedicated section that debunks several major myths about defined contribution systems.

To use the tool and access the website, go here.

Updated Pension Gimmicks List
By Lance Christensen, Reason Foundation

State Budget Solutions put out its most recent list of tricks used to hide the true cost of public pensions. It builds upon their list from 2013 . Policymakers and key advisors use many of the tactics they identified to confuse or hide the unsound fiscal problems of government sponsored retirement systems reform. Indeed, while investment strategies and returns are often blamed for underfunded systems, other assumptions and models often have just as much (or more) bearing on whether a pension fund will be able to provide a secure retirement to all its employees for decades to come. Some of the examples include:

• Outdated Life Expectancy Assumptions
• Inflated Discount Rates
• Overly Aggressive Investment Assumptions
• Underfunding Pension Contributions

Authors Joe Luppino-Esposito and Bob Williams write, “Those who control the levels of benefits are politicians who must worry about re-election. This is not a system that rewards future planning over present results. If politicians were divorced from the process and employees and retirees had control over their retirement, a good number of these gimmicks would not be necessary to have a sustainable system.”

Read the complete list here.

Quotable Quotes on Pension Reform

“We are fortunate that we are in this position to pay down this unfunded liability. Although our revenues have improved, we have kept our costs down, set aside reserves for a rainy day and for these opportunities to reduce our debt. The early payment will save the city hundreds of thousands of dollars – money that can be put back into the community.”
– Shelly Higginbotham, Mayor of Pismo Beach City

“Before California builds a funding model to pay for [a retiree health care] benefit for decades to come, the Legislature should consider whether this benefit should continue to be a part of the state employee compensation package for new hires. If prospective employees do not value this benefit as much as it costs, the state and the new employee might be better off if the state offered future employees an alternative form of compensation.”
– California Legislative Analyst’s Office

“Once they get into the next budget, next year, we realize the need for more pension funds is going to be in competition with a lot of other state services. That’s why we wanted to get it sorted out now, and before this gets to a truly catastrophic level.”
– Paul Guffey, president of Kentucky Public Retirees

“The worst outcome for Illinois citizens would be a Supreme Court finding that all public workers in Illinois are entitled until death to the benefits in place the first day they started their jobs – and that no disaster, epidemic or other public finance catastrophe permits governments to divert pension funds to that emergency.”
– Chicago Tribune Editorial Board

“People appreciate services: They want cops and firefighters, they want teachers and all that stuff. But if you’re a politician in a budget crunch, the one way to not raise taxes is to just not pay your pension bill. In the states and cities where there’s a big problem, it’s not because they underestimated cost. They simply didn’t pay the bill.”
– Monique Morrissey, researcher at Economic Policy Institute

Pension Reform Handbook

For those interested in the process and mechanics of pension reform, Lance Christensen and Adrian Moore published a comprehensive starter guide for state and local reformers. This handbook aims to capture the experience of policymakers in those jurisdictions that have paved the way for substantive reform, and bring together the best practices that have emerged from their reform efforts, as well as the important lessons learned.

To access the handbook, go here.

Contact the Pension Reform Help Desk

Reason Foundation set up a Pension Reform Help Desk to provide information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

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Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website or on Twitter @ReasonReform . As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to lance.christensen@reason.org.

Lance Christensen
Director, Reason Pension Reform Project
Editor