Pension Reform Newsletter – January 2014

This newsletter seeks to shine a light on articles, research, opinion, reformers and other information related to public pension problems across the country at the state and municipal levels. As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to lance.christensen@reason.org. You can also follow the discussion on pensions and other governmental reforms at Reason Foundation’s website or on Twitter @ReasonReform.

Articles

• The Hidden Danger in Public Pension Funds – Truong Bui
• Oregon’s Tepid Pension Reforms Leave $11 Billion Unfunded Liability – Sal Rodriguez
• Pennsylvania Enacts Anti-Pension Spiking Provisions – Sal Rodriguez

Research

• Rhode Island Pension Reform Case Study – Reason Foundation
• Public Pension Reform: Benefit Design as the Key to Sustainability – Manhattan Institute
• Pension Reform Glossary – Institute for Local Government

Quotes on Pension Reform

Contact the Pension Reform Help Desk – Get assistance for your pension reform needs

 

Articles

The Hidden Danger in Public Pension Funds
By Truong Bui, Reason Foundation

Public pension expert Andrew G. Biggs, a resident scholar at the American Enterprise Institute, offers a great insight into the risk level of current public pensions in a recent study, “The Multiplying Risks of Public Employee Pensions to State and Local Government Budgets,” which he summarizes in an article at the Wall Street Journal. According to his research, public pensions today “pose roughly 10 times more risk to taxpayers and government budgets than in 1975.” Why? Biggs explains that large increases in pension sizes and flawed assumptions about risk and returns are the culprit through “public pensions’ decades-long shift from safe bonds to risky stocks, along with the recent growth of ‘alternative investments’ such as hedge funds and private equity.”

Basic finance dictates that an asset’s volatility is correlated with its risk. More volatile assets can generate higher returns, but at the same time have higher chances of incurring losses. In the past, public pensions could achieve 8% expected returns with relatively low volatility (measured by the standard deviation of returns). In particular, a portfolio in 1975 could earn an annual expected return of 8% with a standard deviation of 3.7%, losing money on average only once every 65 years. By contrast, a portfolio today must have a standard deviation of 14% to get the same expected return, suffering losses about once every four years.

As many public pensions still assume an 8% rate of return, this implies that pension managers must invest more in riskier assets than in the past, creating a substantial threat to state and local budgets. To show how big the threat is, Biggs indicates that the standard deviation of public pension investments only amounted to 1.8% of state and local budgets in 1975, while it reached a whopping 19.8% today due to the dramatically larger pension obligations. In short, the risk imposed by public pensions on state and local budgets has increased tenfold over the past four decades.

The implications of Biggs’ analysis are two-fold: 1) public pensions’ sizes need to be reduced, and 2) pension managers must adjust their return expectations to properly match assets with liabilities.

To read Biggs’ study, “The Multiplying Risks of Public Employee Pensions to State and Local Government Budgets,” go here.

Oregon’s Tepid Pension Reforms Still Leave $11 Billion Unfunded Liability
By Sal Rodriguez, Reason Foundation

Last year, Oregon’s Public Employee Retirement System (PERS), which provides retirement benefits to all public employees in Oregon, faced an unfunded liability of nearly $14 billion. Unlike most other pension systems, only 30% of public employees actually contribute towards their pensions. Approximately 70% of public employees enrolled in PERS receive a perk known as a “pension pickup,” whereby taxpayers make contributions on behalf of employees in addition to the annual contribution the state of Oregon and local government agencies must contribute towards PERS. As a result, rising pension costs in Oregon come to the detriment of spending on services taxpayers think they’re paying for.

Read the full column here.

Pennsylvania Enacts Anti-Pension Spiking Provisions
By Sal Rodriguez, Reason Foundation

On December 23rd, Pennsylvania Governor Tom Corbett signed legislation reigning in the costly practice of pension spiking, potentially saving taxpayers $1.1 billion over the next fifty years ($22 million annually). Pension spiking, also known as pension padding, is the practice of inflating pension benefits by manipulating the factors used in pension calculations. Typically, it results in more pension benefits than the contributions made over an employee’s career are designed to cover, thereby contributing to the pension plan’s system-wide unfunded liability.

Read the full column here.

 

Research

Pension Reform Case Study: Rhode Island
By Anthony Randazzo, Reason Foundation

In 2011, Rhode Island State Treasurer Gina Raimondo commissioned an independent actuarial assessment of the pension system because of the threat it posed to the state’s finances. This assessment showed an unfunded pension liability of $6.8 billion, implying that the system was less than 50 percent funded relative to its obligations.

Rhode Island Governor Lincoln Chafee and Treasurer Raimondo engaged the state’s various communities and key stakeholders before making detailed proposed reforms and then worked with leaders in the state legislature to highlight the problem and make the case for reform. The subsequent Rhode Island Retirement Security Act of 2011 (RIRSA) combined conventional methods for adjusting labor contracts with some innovative approaches, including a suspension of cost-of-living-adjustments for retirees, increasing the retirement age and introducing a hybrid defined-benefit/defined-contribution funding system.

While Rhode Island still faces challenges in the wake of its historic reform effort, the reform effort offers lessons for other states and municipalities facing significant unfunded pension liabilities, such as:

• Policymakers must be determined to drive reform.

• Policymakers must realistically assess liabilities.

• Coalitions can reduce the complexity of legislative debate.

• Educating the public matters.

• There are many roads to $0 unfunded liability.

• Pension reform is more than defined-benefit reform.

Though it remains to be seen whether the reform effort will achieve the full savings projected under the RIRSA plan, Rhode Island appears likely to experience some benefits from its significant reforms as long as its future leaders do not return to past practices. Read the study here.

Public Pension Reform: Benefit Design as the Key to Sustainability
By Truong Bui, Reason Foundation

A recent paper released by Carl A. Hess, Thomas J. Healey and Kevin Nicholson at Manhattan Institute describes how pension reform can achieve significant cost reduction. Using a sensitivity analysis based on a hypothetical worker model, the paper indicates that annual pension costs could be cut by as much as 62% compared to a baseline model if the following measures are adopted: 1) an increased retirement age, 2) a broader final average compensation, and 3) no cost of living adjustment. Implementing even only one of the three measures can save anywhere from 23.5% to 32.8% of pension costs, with the final average compensation adjustment bringing the most impact.

The paper also proposes other design modifications and reforms, which most notably include increasing employees’ contributions, reducing loopholes for pension padding, matching assets and liabilities with appropriate discount rates, making the annual required contribution a legal requirement and controlling the funding ratio with stress-testing in actuarial valuations. While the paper acknowledges the great difficulty in persuading jurisdictions to adopt these measures, it emphasizes that these changes will not only benefit only taxpayers and future generations, but also the public employees themselves.

To read more of the paper, go here.

Pension Reform Glossary

To aid those who engage in discussions and negotiations on pension reform, “and to offer a level of transparency to the pension process,” the Institute for Local Government has put together a plain language glossary to better understand public pension systems. This glossary uses California as its contextual model. The glossary can be found here.

 

Quotes

“While the California Rule protects pension benefits in perpetuity, it doesn’t protect the employee’s salary, health care, or the job itself. It’s easier to fire someone than to change her pension formula.”
Chad Aldeman, associate partner at Bellwether Education Partners

“The pension moves on the part of the state of Illinois (are) a positive after many years of gridlock. It’s a first step. There’s more work to be done there.”
Greg Brown, CEO of Motorola Solutions, Inc.

“Perhaps the media have drummed up a crisis…We don’t have the data to make conclusions, and we don’t know that it’s a crisis.”
Minnesota State Auditor, Rebecca Otto, commenting on a recommendation by the Public Employees Retirement Association Board of Trustees – of which she is a board member – for legislative action requiring all employers in its system to break out overtime amounts from salaries to determine if there is any spiking of pensions.

“Those states that have sort of said, ‘We’ll worry about it when the place is on fire.’ Those states are in serious trouble because they’re draining funds away from other critical needs at the city or state or county level to deal with pensions.”
Florida Senate President Don Gaetz commenting on the poor fiscal condition of other states’ pension plans and why preemptive action would serve Florida well, while the retirement fund is in good condition.

“In other words, either our generation starts paying $4.5 billion per year towards promises we made for services we received or we force the next generation to pay ten times as much for promises they didn’t make and services they won’t receive.”
David Crane, President of Govern for California, in an open letter to Governor Jerry Brown on the real need for reforming the California State Teachers Retirement System.

 

Contact the Pension Reform Help Desk

Reason Foundation has 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.

Lance Christensen
Director, Reason Pension Reform Project
Editor