This newsletter from Reason Foundation’s Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions here.
In This Issue:
- How CalPERS’ Lowered Investment Return Assumption Impacts Taxpayers
- Court Upholds California’s Ban on Airtime Purchases
- New Reports Examine Omaha, Lincoln Pension Liabilities and Risks
- Simulation Models Illuminate Risks Faced by Public Pension Plans
- The Role of Governance in the Dallas Police and Fire Pension Crisis
The board of the California Public Employees Retirement System (CalPERS) sent shockwaves through the Golden State last month when it approved lowering its investment returns assumption from 7.5% to 7.0% over the coming years, a move that revealed the pension plan is billions more in debt than was previously recognized. In the short term, this change is going to mean increased pension contributions for the state and most local governments, which could potentially impact taxpayers through service cuts or tax increases. But as Reason’s Leonard Gilroy writes in a recent Orange County Register column, there is a silver lining for taxpayers in the long term.
» FULL ARTICLE
A California appellate court upheld the provisions of a state pension reform law enacted in 2011 that eliminated so-called “airtime purchases,” where public workers were able to boost their pensions by purchasing an additional five years of service time without having to actually work for those years. Taken together with a separate ruling last year upholding Marin County’s elimination of pension spiking, Reason.com reporter Eric Boehm writes that the new ruling can be seen as part of a developing trend of courts taking a skeptical look at the so-called “California Rule.”
» FULL ARTICLE
Nebraska’s municipalities are somewhat of an outlier nationally as most cities and counties across the state offer either a cash balance plan or defined contribution plan to public sector workers. Two striking exceptions to this are the cities of Omaha and Lincoln, each of which offers defined benefit retirement plans for public safety workers. Omaha runs a defined benefit plan for its civilian employees too (though new hires for the next few years are being offered a cash balance plan as a part of a collective bargaining agreement).
Unfortunately, Omaha and Lincoln are not exceptions when it comes to the accumulation of unfunded pension liabilities. Combined, the two cities report about $920 million in unfunded liabilities—but, using more realistic assumptions, they are likely facing around $2.2 billion in pension debt. This is one of the findings from two policy studies that Reason co-published this month with the Nebraska-based Platte Institute. Using actuarial analysis, the Lincoln report also shows that unfunded liabilities in the city’s public safety pension fund are likely to quadruple over the next 20 years if there are no changes to plan assumptions and recent patterns persist. The Omaha report also includes a forecast that shows within the next two decades the city will probably be paying more than 50 cents for every dollar in salary to cover increasing unfunded liability amortization payments.
» STUDY: Pension Debt: The Billion Dollar Problem Still Threatening Omaha
» STUDY: Pension Debt: The Still Unsolved Problem Threatening Lincoln
Last year, the Rockefeller Institute of Government released a paper showing how underfunding risks are significantly increased through funding practices commonly employed by public pension plans, such as high discount rates and long open amortization periods. Rockefeller is back with a new report that, according to Reason’s Truong Bui, helps answer how investment risks translate to volatility in funded ratios and contribution rates, and how specific assumed return rates and investment practices are related to this process of investment risk and volatility.
» FULL ARTICLE
There are several factors influencing the declining solvency of the Dallas Police & Fire Pension System (DPFP), including risky investments, generous DROP returns, and large lump-sum withdrawals. Further complicating the situation, Dallas Mayor Mike Rawlings recently requested an investigation of potential unspecified criminal activities conducted by previous DPFP administrators. In a new blog post, Reason’s Anil Niraula writes that the actual causes behind the plan’s misfortunes apparently go far deeper than any possible past criminality and point directly to the way the retirement system is governed.
» FULL BLOG POST
“In an overall portfolio context, the return for a simple 60% world equity and 40% U.S. aggregate bond portfolio [in 2017] is expected to be in the neighborhood of 5.5% to 6.0%, roughly 75 basis points below our 2016 assumptions. Volatility forecasts are also marginally higher.”
—Anne Lester, head of retirement solutions for J.P. Morgan’s global investment management solutions group, quoted in John Manganaro, “Long-Term Return Assumptions Reduced Again for 2017,” Plansponsor.com, January 10, 2017.
“All models developed in 2016 indicated a likelihood of 35 percent or less of actual long-term future average returns meeting or exceeding 7.6 percent.”
—Florida Department of Management Services’ annual report on the financial status of the state pension system (which lowered its assumed rate of return to 7.6 percent in October 2016), quoted in News Service of Florida, “Projected pension returns could be too rosy, report says,” Orlando Sentinel, January 5, 2017.
“It was an unsustainable feature. […] What they turned it into was an investment strategy and guaranteed themselves a return that is unheard of.”
—Dallas, TX City Manager A.C. Gonzalez on the Dallas Police & Fire Pension System’s historical policy of guaranteeing 8-10% annual interest on the balances in individuals’ deferred retirement option plans (DROP), quoted in Tanya Eiserer, “Dallas Police and Fire pension members may have to pay back funds,” WFAA.com, January 5, 2017.
“We’re not on the brink of running out of money. But what we are is at a much higher risk profile than we’re comfortable with. That’s not just a risk for members. That’s a risk for employers, that’s a risk for taxpayers, that’s a risk for Colorado communities.”
—Greg Smith, Colorado Public Employee Retirement Association executive director, quoted in, Brian Eason, “PERA at risk of insolvency if another recession comes, director says,” The Denver Post, January 20, 2017.
“Providing DB benefits is expensive, and any time you backload pay (for you or someone else), it is tempting to not put enough money aside. The combination of high cost and bad incentives is what killed the pension plan. Or, it was ERISA, which forced pension plans to account for the cost and fund pensions properly. It is telling that the only industry where [pensions] are still common is the one not subject to ERISA, state and municipalities. Don’t blame the 401(k) for the fact you don’t have a DB plan!
And DB plans are risky. Risk is one reason why they are so expensive for employers. Moving a stream of income from today into the future is expensive to insure.”
—Allison Schrager, “If liking 401(k) accounts is wrong, I don’t want to be right,” Allison’s Ode to the Second Moment (e-newsletter), January 9, 2017.
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Senior Managing Director, Pension Integrity Project
Managing Director, Pension Integrity Project
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Reason Foundation’s Pension Integrity Project has helped policymakers in states like Arizona, Colorado, Michigan, and Montana implement substantive pension reforms. Our monthly newsletter highlights the latest actuarial analysis and policy insights from our team.