Pension Reform Newsletter – June 2014

This newsletter highlights articles, research, opinion, and other information related to public pension problems and reform efforts across the nation. Previous editions are archived at https://reason.org/newsletters/pension-newsletter/.

Articles, Research & Spotlights

• Addressing Common Objections to Defined-Contribution Retirement Plans
• The Public Employee Pension Crisis Explained
• Phoenix Reform Eliminates Taxpayer Risks, Could Save Hundreds of Millions
• Oklahoma Pension Reform – A Defined Contribution Conversion
• Pension Reform in Alabama – A Case for Economic Accounting
• State Fiscal Constitutions and the Law and Politics of Public Pensions
• Stopping the Sinkhole – Lessons for Pension Reform in Pennsylvania
• Illustrating Pennsylvania’s Pension Problems
• Truth in Accounting: Educating and Empowering Citizens through Transparency

Quotable Quotes on Pension Reform

Contact the Pension Reform Help Desk

 

Articles, Research & Spotlights

Addressing Common Objections to Defined-Contribution Retirement Plans
By Lance Christensen, Truong Bui & Len Gilroy, Reason Foundation

Reason Foundation has just released a post responding to a number of frequently raised objections to pension reform involving defined contribution (DC) plans. These arguments range from the usual complaint that DC plans are inadequate to deliver retirement security compared to defined benefit (DB) plans to the absurd claim that switching to DC plans would increase rather than decrease government’s costs and debt. Most of the objections stem from a misunderstanding of pension funding or a lack of awareness of the critical difference between DC and DB plans. What truly sets DC plans apart from DB plans lies in who bears the investment risks and in the timing of benefit promises and payouts. Recognizing these two defining features of DC systems is the key to understanding pension reform.

To read the responses, go here .

The Public Employee Pension Crisis Explained
By Kristen Kelley, Anthony Randazzo, Truong Bui, Reason Foundation

While public pensions have an enormous impact on government fiscal health, and thus should receive special attention from taxpayers, the topic at times may sound too complicated and technical for the ordinary voter. A recent article at Reason Foundation sets out to demystify the subject matter in layman’s terms.

The article starts by describing the fundamental structure of a pension and explaining the difference between a defined benefit system and a defined contribution system. It explains the mechanism of pension funding and, through simple examples, shows the significant divergence between how public pensions work in a “perfect world” compared to reality, showing implications for taxpayers. Clear, straightforward, and to the point, the post serves as a good primer for non-experts to learn the basics of the public pension crisis.

To read the article, go here.

Phoenix Reform Eliminates Taxpayer Risks, Could Save Hundreds of Millions
By Anthony Randazzo, Reason Foundation

This November taxpayers will be asked to vote on whether or not to approve the Phoenix Pension Reform Act. The ballot initiative would recalculate benefits for current public employees, primarily by ending a troublesome practice known as pension “spiking,” and put future government workers in 401(k)-style retirement accounts instead of the current defined benefit pensions. The Act would also end the practice of allowing public sector workers to dual enroll in a second, City operated retirement plan.

The initiative represents a concrete idea in what has otherwise been a vague discussion about how to address the $1.5 billion in unfunded liabilities and pending recruitment troubles Phoenix faces. The question, however, is whether the proposed Act would ultimately benefit taxpayers or not.

To read more of the analysis, go here .

Oklahoma Pension Reform – A Defined Contribution Conversion
By Lance Christensen, Reason Foundation

Last month, Oklahoma’s Governor Mary Fallin signed House Bill 2630 , The Retirement Freedom Act, establishing a defined contribution (DC) system for all new state employees hired after November 1, 2015, except for public safety workers and teachers. The passed bill is “likely to be the most significant state reform in 2014”, according to Reason Foundation.

Oklahoma’s pension plans were only 65% funded in 2012 and currently have $11 billion in unfunded liabilities. The system is not financially sustainable. The new DC plan will not only reduce the fiscal burden on taxpayers and the state thanks to its cost predictability, but also gives state workers more choice and flexibility in pension investment and career planning. However, some are concerned that the reform does not go far enough to address the existing pension debt, even though it will prevent the unfunded liabilities from growing for new workers.

To read more about the reform, go here .

Pension Reform in Alabama – A Case for Economic Accounting
By Truong Bui, Reason Foundation

A recent study by Eileen Norcross at the Mercatus Center looks at Alabama’s public pension systems and shows how flawed accounting of pension liability obscures the true debt picture and creates perverse incentives for pension plan managers.

Most public pensions, following the Government Accounting Standards Board guidelines, use the expected return on pension assets as the discount rate to value pension liabilities. According to the study, this practice is faulty. Economic theory holds that the discount rate must reflect the risk of the liability, not the expected return of the assets that finance the liability.

To read more on the study, go here.

State Fiscal Constitutions and the Law and Politics of Public Pensions
By Truong Bui, Reason Foundation

In a new paper on the law and politics of public pensions, Amy B. Monahan at University of Minnesota offers an in-depth analysis of the political incentives behind pension funding and how even explicit constitutional funding requirements fail to discipline public pension plans. The major reason why so many governments fail to properly fund public pensions comes straight from Public Choice 101: politicians are not benevolent and altruistic, but self-interested people who care more about getting votes in short-term horizons than doing the right thing. This incentive structure encourages allocating scarce budgetary dollars towards current constituents and away from long-term obligations such as pensions. Since pension debt is not reflected on the balance sheet, pension underfunding is an attractive means of off-balance-sheet borrowing to politicians.

To read more about the paper, go here.

Stopping the Sinkhole – Lessons for Pension Reform in Pennsylvania
By Truong Bui, Reason Foundation

A new report by the Commonwealth Foundation shows the desperate need for public pension reform in Pennsylvania and how a shift to defined contribution plans is a viable solution. The state currently faces more than $50 billion in public pension debt, thanks to large unfunded liabilities of the two major state pension systems, the State Employees’ Retirement System and the Public School Employees’ System. The two systems are only 60% funded, with funding ratios having steadily declined for 12 years. Full funding of the state’s public pensions in 30 years requires an estimated $7.5 billion increase in annual contribution, equivalent to $1,550 per household . In five years, pension costs as a share of General Fund expenditures will almost double (from 5% to 9.8%), crowding out important government services.

To read more about the report, go here .

Illustrating Pennsylvania’s Pension Problems
By Truong Bui, Reason Foundation

As part of the Fix the Numbers campaign designed by the Pennsylvania Municipal League (PML), fixthenumbers.com has some notable data and illustrative graphics on the state of Pennsylvania’s public safety employee pensions. Some “quick facts” from the website:

• “Half of Pennsylvania’s municipal public safety pension plans are experiencing some level of pension distress.”
• “66 of Pennsylvania’s 67 counties have at least one municipality with a pension plan under a high level of financial stress.”
• “41% of Pennsylvanians live in a financially distressed municipality.”

To learn more about the data, go here.

Truth in Accounting: Educating and Empowering Citizens through Transparency
By Lance Christensen, Reason Foundation

Truth in Accounting (TIA) announced the beta version of its new website June 11, 2014. Consistent with TIA’s mission – to educate and empower citizens with understandable, reliable, and transparent government financial information – the website offers easy access to TIA’s analysis, weekly featured charts and relevant press information. It also provides incisive analysis on government accounting data from each of the 50 states.

Read more about TIA’s resources here.

 

Quotable Quotes on Pension Reform

“God help us if medical technology has some breakthroughs, and these people who are retiring don’t live to 80, but they live to 100.”
–California Governor Jerry Brown

“Although the systems have been underfunded for many years, their underfunding now greatly exceeds the state’s annual budget for all categories of expenditure, including, without limitation, public education, public health and safety, medical coverage for the poor and for current and retired public employees, road construction, repair and maintenance, and all other public services provided by state employees.”
–Illinois Attorney General Lisa Madigan

“The riskiness of a pension obligation depends on state law. If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate. Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability: specifically, the Treasury zero-coupon yield curve. This would result in a discount rate in the low 3% range…This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees, or not to make the promises in the first place.”
–Securities and Exchange Commission member Daniel M. Gallagher

“Just like Illinois, the commonwealth has pushed out the date for paying off unfunded pension liabilities, which reduces current annual payments to the fund, but dramatically increases the amount Massachusetts residents must ultimately pay back. This is yet another classic example of politicians kicking the can down the road, shifting the burden to our children and the tough decisions to future state officials. Recent agreements to pull the deadline back to 2036 from 2040 are little more than an empty promise because the serious payments are still deferred for the remote future. And Massachusetts’s real pension picture is probably worse than it appears. Our projections are based on the state pension fund earning 8.25 percent in interest each year, a very aggressive – some would say unrealistic – assumption. Moreover, the state and its municipalities are not even required to fund tens of billions of dollars in retiree health care obligations, which will balloon into ever-larger payments as they come due.”
–Iliya Atanasov is Senior Fellow on Finance at Pioneer Institute for Public Policy Research in Boston

 

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