Pension Reform Newsletter – July 2014

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

• Phoenix Pension Reform Act Could Save $1.6 Billion
• How to Structure a Good Defined Contribution Plan
• Public Pension Investments: Risky Chase for High Returns
• Millennials Support Private Retirement Accounts
• How Pension Reform Can Help the City of Omaha
• Survey of States Pension Debt
• The Latest Public-Sector Pension Scandal
• Lucy Burns Institute Launches Policypedia

Quotable Quotes on Pension Reform

Contact the Pension Reform Help Desk

 

Articles, Research & Spotlights

Phoenix Pension Reform Act Could Save $1.6 Billion
By Anthony Randazzo, Reason Foundation

In November, Phoenix taxpayers will be considering whether or not to adopt a proposed change to the public employee pension system (COPERS). While the system does not include police or fire employees (they have their own separate pension system), changing the structure of COPERS could have substantial fiscal rewards for Phoenix.

The proposed Phoenix Pension Reform Act would do four things:

1. All future workers would be enrolled in a defined contribution plan up to a rate of 8 percent. Employees in the defined benefit funds would remain, and the systems would naturally phase-out.
2. So-called pension “spiking” would be ended by revising the calculation of current employees’ pensions to remove unused sick time and vacation from counting toward defining the pension benefit.
3. The calculation of defined benefits would be revised from a final highest average salary of three years to five years.
4. Finally, employees would no longer be able to enroll in multiple retirement systems, such as participating in both the COPERS defined benefit system and defined contribution deferred salary programs outlined in city employee labor contracts.

We recently published an actuarial analysis of how these changes would affect the city of Phoenix, and in that report we assumed a 7 percent defined contribution rate and that the savings from ending spiking and changing the final average salary calculation would be put back into the pension fund to pay down debt.

To read more of the actuarial analysis of the proposed reform and its potential cost savings, go here and here. To read Reason Foundation’s response to opponents of reform, go here.

For more analysis see the full actuarial study.

How to Structure a Good Defined Contribution Plan
By Truong Bui, Reason Foundation

A good public pension plan should balance the interests of three major stakeholder groups: taxpayers, employers and employees. Corresponding to these interests are three criteria: fiscal sustainability, workforce productivity and retirement security. In other words, a good pension plan should not impose excessive burden on taxpayers (fiscal sustainability), should improve worker retention and recruitment (workforce productivity), and should provide some reasonable level of retirement income (retirement security).

Defined contribution (DC) plans, by definition, are fiscally sustainable because they do not create or perpetuate unfunded liabilities for government pension plans and they have predictable contribution levels. Unlike defined benefit (DB) plans, DC plans do not shift investment risks to taxpayers and produce no lag between benefit promises and payments. In terms of workforce productivity, DC plans are an attractive retirement vehicle for the modern mobile labor force due to their portability, transparency and freedom of choice. Having a three- or five-year vesting requirement for the eligibility for employer contributions may further improve the retention of quality employees.

Retirement security may not be a strong aspect of traditional DC plans, not because of any inherent feature of the DC structure, but because of workers’ financial choices.

To learn more about how properly structured DC plans can balance the interests of taxpayers, employers and employees while being fiscal sustainability, increasing workforce productivity and providing retirement security, go here.

Public Pension Investments: Risky Chase for High Returns
By Truong Bui, Reason Foundation

A recent Pew report shows a systematic shift of public pension plans away from fixed-income investments towards equities and alternative investments in the last 30 years. Using investment data on public pensions from 1952 to 2012, Pew found that public plans “significantly increased their reliance on stocks” during the 1980s and 1990s. The data reveals that fixed-income investments and cash constituted nearly 96 percent of public pension assets in 1952. The proportion decreased to 47 percent by 1992, and had dropped to 27 percent by 2012. And during the past decade, public pension funds have allocated an increasing share of their assets to alternative investments, which include private equity, hedge funds, real estate, and commodities. From 2006 to 2012, the share of pension assets in these alternatives had more than doubled, from 11 percent to 23 percent.

Unrealistically high assumed rates of return are the cause behind this shift. From 1992 to 2012, while the average annual yield on 30-year Treasury bonds declined by 4.75 percentage points, from 7.67 percent to 2.92 percent, the median pension fund’s assumed rate of return decreased by only 0.25 percentage points, from 8 percent to 7.75 percent. This means pension funds have to be much more aggressive than in the past to earn their assumed rates of return, hence the shift towards equities and alternative investments.

To read more about this report, go here.

Millennials Support Private Retirement Accounts
By Emily Ekins, Reason Foundation

Reason Foundation has released a new extensive study of young Americans (18-29 year olds) finding millennials are skeptical of government efficiency and are enthusiastic for alternatives to outmoded government retirement programs.

Fully 66 percent of millennials believe government is wasteful and inefficient-up from only 42 percent in 2009. Even millennials who generally favor a broader role for government view it as wasteful – 57 percent of millennial Democrats and 52 percent of those who voted for President Obama say government is wasteful. Sixty-nine percent of independents and 81 percent of Republicans agree.

A large majority (73 percent) support private retirement accounts, and a majority (51 percent) of millennials continue to favor private retirement accounts even if doing so “required reducing Social Security benefits to current and future seniors.”

When it comes to private accounts, there are not significant differences across race/ethnicity but there are meaningful partisan differences. Sixty-three percent of Republicans and a plurality of independents (49 percent) favor private retirement accounts, even if it reduces benefits to current seniors, but a plurality (50 percent) of Democrats oppose.

To read more of this study, go here.

How Pension Reform Can Help the City of Omaha
By Victor Nava, Reason Foundation

Facing a $700 million unfunded pension liability, in September 2013 Standard & Poor’s Rating Service downgraded the City of Omaha’s bond rating from AAA to AA+ marking the first time in 30 years that Omaha has had anything less than a AAA rating. Standard & Poor’s cited “the city’s high net direct debt and underfunded pension obligations” as part of the reason for the downgrade. In a new study released by the Platte Institute for Economic Research, pension expert Andrew Biggs describes how Omaha’s deteriorating pension system is putting the fiscal stability of the city at risk, and how switching to a defined contribution system can help.

Annual required contributions to Nebraska’s Cash Balance pension system for state and county employees and the City of Omaha’s Police and Firefighters Retirement System have dramatically increased in the last 10 years. These payments are taking up a larger percentage of the city’s budget and making it more difficult for the city to fund other services. For instance, annual required contributions to the state’s cash balance plan increased from $14.2 million in 2003 to $56.7 million in 2013. Required contributions to Omaha’s civilian and uniformed (police and fire) employees’ plans have also increased from about $6 million in 2004 to $15.6 million in 2012 for the civilian plan, and from about $22 million in 2004 to $54 million in 2012 for the uniformed officials plan.

Omaha has not been able to keep up with these increasing annual required contributions (ARC), and as a result, both of the city’s defined benefit (DB) pension plans are poorly funded. Beginning in 2003 Omaha began underpaying its ARCs. The city went from making 120 percent ARC payments to the uniformed officials plan in the late 1990s and early 2000s to just 65 percent in 2013. The city also skimped on payments to its civilian plan, making just 46 percent of the ARC in 2012. As a result, both systems’ funding ratios are now dangerously low – the uniformed officials plan is 45 percent funded and the civilian employee plan is 56 percent funded.

To read about the many advantages of switching to a DC plan, go here.

Survey of States Pension Debt
By Victor Nava, Reason Foundation

In a paper released earlier this month by the Competitive Enterprise Institute, former Virginia Libertarian gubernatorial candidate Robert Sarvis explains how state governments have understated the underfunding of their pension systems for years through the use of dubious accounting methods. Namely the use of a discount rate – the interest rate used to determine the present value of future cash flows – that is too high. As a result, state pension systems are likely in even worse shape than government data suggests and without reform, state government debt could burden labor markets and worsen state’s business climate. Sarvis aggregates several estimates of states’ pension debts and ranks the states from best to worst in terms of unfunded liability compared to state GDP. Included in his composite ranking are unfunded liability estimates calculated using fair market value techniques by Naughton, Petacchi, and Weber in their recent paper “Economic Consequences of Public Pension Accounting Rules” , by Novy-Marx and Rauh in their 2011 paper “Public Pension Promises: How Big are They and What are They Worth”, by Cory Eucalitto in “Promises Made, Promises Broken-The Betrayal of Pensioners and Taxpayers”, by Moody’s Investor Service, and unfunded liability estimates based on each states official assumed rate of return.

In determining whether a pension fund’s assets are sufficient to meet future liabilities, one must compare the valuation of assets in the pension fund with the calculated net present value of future payments to retirees. The net present value of future liabilities is calculated using a discount rate that represents that represents the risk and timing of those liabilities. Sarvis argues that the discount rate used by public pension systems should be a low risk rate, ideally as low as the rate on Treasury bonds (around 2 percent), but at least as low as other government bonds (municipal bonds return about 5 percent) or high-quality corporate bonds.

To read more on how and why state pension systems regularly use overly optimistic discount rates, go here.

For a plain language guide on unfunded pension liabilities, see Reason’s piece, “The Public Employee Pension Crisis Explained.”

The Latest Public-Sector Pension Scandal
By Ira Stoll, via Reason.com

“By the end of approximately 2007, Villalobos had made, and I had accepted, bribes totaling approximately $200,000 in cash, all of which was delivered directly to me in the Hyatt Hotel in downtown Sacramento across from the Capitol. Villalobos delivered the first two payments of approximately $50,000 each in a paper bag, while the last installment of approximately $100,000 was delivered in a shoebox.” – Plea Agreement, United States of America v. Fred Buenrostro , U.S. District Court, Northern District of California, filed July 11, 2014.

The government official who pleaded guilty here, Fred Buenrostro, wasn’t some city council member or state senator, but rather, from December 2002 to May 2008, the CEO of the California Public Employees Retirement System. CalPERS, the largest public pension fund in the country, managed assets of as much as $250 billion during that period.

The bribing of Buenrostro was part of a successful effort by a New York money management firm (which claims it had no knowledge of the bribe and has not been charged with any wrongdoing) to win $3 billion in business managing pension money for California state employees and retirees.

Crooked government officials come along often enough that there’s a tendency to tune them out, but this case is worth pausing to analyze further for a number of reasons.

To read more, go here.

Lucy Burns Institute Launches Policypedia
By Lance Christensen, Reason Foundation

At the end of June 2014, the Lucy Burns Institute, a nonpartisan and nonprofit organization dedicated to fairness and openness in politics headquartered in Madison, Wisconsin, launched Policypedia. Under the auspices of Ballotpedia, the popular wiki-source for state and local election information with the goal of eventually covering over 507,000 elected officials across the country, Policypedia will be a series of encyclopedia entries consisting of hundreds of articles to inform voters on major policy issues at the national, state and local level. Karen Danford, Policypedia Director, reaffirms their interest in making government transparent and accessible to the public. “Policy decisions made in government affect citizens in many ways, especially economically, legally, and socially. We aim to enlighten voters by focusing on the tradeoffs involved so that they can participate in the public discussion of policy issues, and vote for candidates and initiatives aligned with their beliefs and interests.”

One of Policypedia’s four main policy areas will be public pensions and will have articles describing the status of public pensions in each of the 50 states. Readers can find detailed information such as pension funding history, proposed reforms, rate of return, and unfunded liabilities. These pages will provide non-experts and regular voters with a road map into what the pension situation is along with some comparative figures.

Geoff Pallay, Director of Strategic Projects at the Lucy Burns Institute comments, “Policy is a complicated subject. White papers and long studies are a necessary aspect of the policy discussion, but the vast majority of voters want things in plain English in an easy-to-digest format. Our wikis are a proven mechanism for delivering high-quality information to a large audience of voters.”

With all the projects that the Lucy Burns Institute is taking on to bring transparency and accessibility to government and politicians, they look forward to collaborating on bringing comprehensive, detailed research to their audience.

To learn more about their organization, visit the website for the Lucy Burns Institute. Link to this story here.

 

Quotable Quotes on Pension Reform

“We have wrestled with pension. We have wrestled with trying to do something and there’s a number of us, including myself, that believe we need to make the first step.”
–Joe Scarnati, Senate President Pro Tempore, Pennsylvania State Legislature

“This is America. Who in America isn’t overworked? Who’s not tired? Look, the overtime is there, it’s available. People take it because we provide a service to the public that people need to get around. That’s the way it is.”
–Nucion Avent, BART senior foreman (California)

“It’s important that Maine be able to keep promises made to civil servants and retirees. Unfortunately, our ability to keep those promises is jeopardized by an unsustainable pension system. Maine’s government workers union wanted to block all pension reforms, which would effectively turn Maine into Detroit and leave pensioners high and dry. This ruling protects the smart reforms made to Maine’s unsustainable pension system under Governor LePage, thereby helping Maine keep its promises.”
–Peter V. Anania , Chairman, Maine Heritage Policy Center

“With $50 billion in pension debt and warnings from three major bond rating agencies, our state pension crisis will take a major toll on taxpayers and teachers alike. Yet, despite the threat of higher taxes, lower bond ratings, and more teacher layoffs, government union executives continue to fight any and every reform proposal.”
–Nathan Benefield, Vice President of Policy Analysis, Commonwealth Foundation

“The court cannot rewrite the pension clause to include restrictions and limitations that the drafters did not express and the citizens of Illinois did not approve,” he said. “If the court’s decision is predictive, the challenge of reforming our pension systems will remain.”
–John Cullerton, Illinois Senate President

 

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.

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