Pension Reform Newsletter – February 2016

This newsletter from Reason’s Pension Integrity Project highlights articles, research, opinion, and other information related to public pension problems and reform efforts across the nation. You can find previous editions here.

Articles, Research & Spotlights

• How Will GASB 68 Affect Cities’ Reported Funded Status?
• An Examination of Connecticut State Employees Retirement System
• State and Local Government Pensions: Problems and a Solution
• Milliman Annual Study on Public Pension Funding
• State and Local Government Pension Debts Rise by $268 billion in the Third Quarter of 2015
• Video Clip Explaining Teacher Pensions in Less than 3 Minutes

Quotable Quotes on Pension Reform

Pension Reform Handbook

Contact the Pension Reform Help Desk

Articles, Research & Spotlights

How Will GASB 68 Affect Cities’ Reported Funded Status?
By Truong Bui, Reason Foundation

In a recent paper at the Center for Retirement Research at Boston College (CRR), Alicia Munnell and Jean-Pierre Aubry examine how the new provisions of the Governmental Accounting Standards Board (GASB) regarding public pension financial disclosure affects major cities’ reported funded status. Specifically, the paper looks at the GASB 68 rule that requires localities that participate in cost-sharing state plans to report their share of that plan’s unfunded liability on their books.

The paper is based on an analysis of 173 major cities, with a focus on 92 cities that are participating in cost-sharing state plans. To estimate a city’s share of assets and liabilities, the authors use the city’s contribution to a given state plan as a percentage of the plan’s total annual required contribution (ARC). In case the ARC information is not available, the ratio of the city’s actual contributions to the state plan’s total actual contributions is used instead.

The paper estimates that, for the 92 cities affected, the GASB 68 rule raises their unfunded liability as a percentage of revenue from 37 percent to 70 percent. The impact on the 173 cities is much smaller (only about 9 percentage points increase in the ratio) because the 92 cities are small in terms of revenue. One should note however that GASB 68 does not actually increase pension burdens on these cities, but merely makes them recognize these burdens on their books. The rule therefore may encourage local governments to fund their pensions more responsibly.

To read the paper, go here.

An Examination of Connecticut State Employees Retirement System
By Truong Bui, Reason Foundation

The Center for Retirement Research at Boston College (CRR) recently provided an assessment of Connecticut’s two largest pension plans: the State Employees Retirement System (SERS) and the Teachers’ Retirement System (TRS).

The brief shows that the state’s SERS is heavily underfunded, with a funded ratio of only 42 percent in 2014, among the lowest in the nation. The pay-as-you-go structure during the 1939-1971 period was a major cause of the plan’s current low funded status. Even after the state started to pre-fund the plan in 1971, the unfunded liability has kept growing due to in inadequate contributions, insufficient investment returns, and negative actuarial experience, all of which are commonly present in poorly funded public plans. Among those factors, inadequate contributions have contributed the most to the rise in SERS’s unfunded liability since 1985. The substantial pension debt has been translating to high pension costs, which are expected to steadily increase in years to come and may skyrocket if the assumed investment returns do not materialize.

The brief offers a two-pronged approach to improving the system’s finances: 1) a separate, more flexible funding scheme for liabilities associated with members hired before pre-funding; and 2) stricter funding of the ongoing plan, including switching to a level-dollar amortization method and reducing the assumed rate of return.

To read the brief, go here.

State and Local Government Pensions: Problems and a Solution
By Truong Bui, Reason Foundation

A new study from the Mercatus Center at George Mason University examines the trends and differences between public and private pension plans, the financial condition surrounding state and local plans, and the legal impediments to reform.

The study starts by noting that while defined benefit plans’ popularity has declined significantly in the private sector, they remain prominent in the public sector. When pensions and other benefits are taken into account, government workers enjoy higher compensation than their private counterparts with similar skill levels. In addition, public pensions follow accounting standards that are much looser than those governing private defined benefit plans.

The financial conditions of public pensions are not promising. Under a fair market valuation approach, 21 states had funded ratios below 40 percent in 2009. On average, state and local governments would need to contribute 14 percent of annual revenue to fully fund their pension plans. Roughly a third of state pension plans are expected to run out of money within the next two decades.

This bleak financial picture however is not easy to deal with, thanks to rigid legal protections granted to pension benefits. This means pension reforms will have to rely on voluntary choice by plan participants. The study’s reform proposal focuses on two features:

• Requiring governments to disclose the financials of their pension plans to beneficiaries in plain language, using standardized conservative accounting assumptions
• Allowing governments to offer beneficiaries a choice to receive a lump-sum buyout of their pension benefits, adjusted by the funded ratio.

To read the full study, go here.

Milliman Annual Study on Public Pension Funding
By Truong Bui, Reason Foundation

The actuarial and consulting firm Milliman has recently released its annual study exploring the funded status of the 100 largest US public pension plans. Besides using the plan sponsor’s own assessment of the funded status, the study also recalibrates each plan’s assets and liability based on Milliman’s own independent evaluation of the plan’s expected investment return.

The study finds that the aggregate funded ratio increased from 70.7% to 75% through 2014, due to strong investment returns. However, the weak market performance in 2015 will bring down funded ratios, but the effect has not been yet fully recognized because of the time lag in reporting. Overall, the assessed plans have sufficient assets to cover 100% of the reported accrued liability for retirees and inactive members, but have only 39% of the required assets to cover the reported accrued liability for active members.

During the 2012-2015 period, the median reported investment return assumption decreased from 8.00 percent to 7.65 percent, reflecting the continued decline in long-term expected investment returns. However, the reported return assumption may still overestimate the expected returns. Milliman’s independently determined investment return assumption is 7.25 percent, which is 40 basis points lower than the reported 7.65 percent in 2015. As a result, the recalibrated unfunded liability is $1.20 billion (compared with the reported $1.02 billion) and the recalibrated funded ratio is 71.7 percent (compared with the reported 75 percent).

The study also finds that for the first time, retired and inactive members outnumber active members.

To read the full study, go here.

State and Local Government Pension Debts Rise by $268 billion in the Third Quarter of 2015
By Truong Bui, Reason Foundation

A recent brief at the Rockefeller Institute of Government revealed that state and local government unfunded pension liabilities increased by $268 billion in the third quarter of 2015, owing to poor investment returns. That increase was equivalent to 1.4 percent of the US GDP, raising the unfunded liabilities to 9.5 percent of GDP.

The brief also offers an interesting observation: over the last 25 years, unfunded liabilities have increased by 1.4 percent or more of GDP in thirteen quarters, while they have decreased by 1.4 percent or more in only two quarters.

To read the brief, go here.

Video Clip Explaining Teacher Pensions in Less than 3 Minutes
By Truong Bui, Reason Foundation

This short video clip created by TeacherPensions.org tackles the popular notion that public teacher pensions are good for teachers in general.

Using simple examples, the clip explains how the heavily back-loaded structure of most teacher pensions primarily benefits long-career teachers, at the expense of short- and mid-career ones, and of teachers who do not stick to one state for their whole-career. The clip then shows that alternative retirement structures could bring about more equitable and inclusive distributions of retirement benefits.

Watch the video clip here.

Quotable Quotes on Pension Reform

“Because California’s UAAL’s accrue interest at a high rate (7.5%, which is twice the current yield on CA General Obligation Bonds (GO’s) for the same maturity), $24 billion of additional UAAL’s will translate into well over $50 billion of service cuts and/or tax increases over the next three decades. To put the single-year addition of $24 billion of debt obligations into perspective, that amount is nearly one-third of the total amount of outstanding GO’s. GO’s are voter-approved. UAAL’s are not.”
– David Crane, Lecturer, Stanford University

“Most pension portfolios have a long-term investment return target between 7 and 8 percent a year. Historically, plans achieved that with relative ease. But a lot has changed in the past 20 years. In 1992, the median pension fund’s assumed rate of return was 8 percent, and U.S. Treasury securities paid out 7.67 percent, according to an analysis by the Pew Charitable Trusts and the Arnold Foundation. That means a pension portfolio’s overall investments only had to perform slightly better than the bond market — not a very big gamble. By 2012, pension plans had lowered their return assumptions to a median 7.75 percent, but the 30-year Treasury bond returns had plummeted to just under 3 percent. The pressure on pensions to boost investment returns intensified tenfold.”
– Liz Farmer, Staff Writer, Governing magazine

“Every year we delay serious pension reform, public employers make more unsustainable promises to new employees, and public retirement debts grow. We need pension reform to protect our education system and vital public services from these fast-growing burdens.”
– Chuck Reed, former Mayor of San Jose, and Carl DeMaio, former Member of San Diego City Council

“At the root of the problem is a change in the financial structure of public pension funds. Whereas in the early days of government pensions governments expected more than half the money to pay benefits would come from taxpayer and worker contributions, pension systems increasingly came to rely on risky investments to pay retirees.”
– Steven Malanga, senior editor of City Journal and senior fellow at the Manhattan Institute

Pension Reform Handbook

For those interested in the process and mechanics of pension reform, Reason Foundation 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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Adrian Moore
Vice President, Policy
Reason Foundation