Public Pensions Watch IV: the saga continues

[campbell]

NEW THREAD FOR 2013: http://www.actuarialoutpost.com/actu...d.php?t=253567

New year, new thread, and I've got the perfect link to kick it off.

First, some housekeeping:

the original thread, started in Sept 2008 - http://www.actuarialoutpost.com/actu...d.php?t=146801

Second thread - Jan 2010 - http://www.actuarialoutpost.com/actu...d.php?t=183680

Third thread - Jan 2011 -
http://www.actuarialoutpost.com/actu...d.php?t=207956

Okay, now a new post --- from Girard Miller in Governing Magazine:
http://www.governing.com/columns/pub...n-Puffery.html

One of my pet peeves in the ongoing debates over public pension reform is the way partisans on each side try to pitch half-truths and myths to support their arguments. The other side seldom believes any of these, but they help rally the allies on the speaker's side. Sometimes the press naively re-circulates these fallacies, which leaves the general public even more confused about what to believe. There's an old saying in politics that if you tell the same lie long enough, the public will eventually believe it — and that apparently is the mentality of lobbyists on both sides. In an effort to start the new year with a clean slate for public debate, I'd like to set the record straight on a dozen of the most glaring fallacies and silly slogans.

This is a lengthy column, so readers can click on to any one of these topics to jump to that subject:

1. "The pension mess was caused by greedy people (from the other side), not us."
2. "There's no crisis. The stock market will recover and then there is no problem."
3. "The solution is to replace pensions with 401(k) plans, like the private sector."
4. "Experts consider 80 percent to be a healthy pension funding ratio."
5. "Only 15 percent of pension costs is paid by employers. Investment income pays the lion's share."
6. "My pension contract is protected by the Constitution and can't be violated."
7. "States are already fixing the problem with reasonable pension reforms."
8. "The solution is collective bargaining. There is no need for drastic legislation."
9. "This is a $3 trillion problem when you measure it using honest (risk-free) math."
10. "We earned more than 8 percent in the last 25 years, and will do so again."
11. "The average public pension is $23,000."
12. The $100,000 pension club.

Go to the link for his comments on each "half-truth".

I'm just going to pull out one for this thread (others, feel free to pull out other points). We've got multiple threads on discount rates already, so let's go with the 80% funding level "half truth".

http://www.governing.com/columns/pub...ffery.html#ht4

Half-truth #4: "Experts consider 80 percent to be a healthy funding level for a public pension fund."

This urban legend has now invaded the popular press, so it's about time somebody set the record straight. No panel of experts ever made such a pronouncement. No reputable and objective expert that I can find has ever been quoted as saying this. What we have here is a classic myth. People refer to one report or another to substantiate their claim that some presumed experts actually made this assertion (including a GAO report and a Pew Center report that both cite unidentified experts), but nobody actually names these alleged "sources." Like UFOs, these "experts" are always unidentified. That's because they don't actually exist. They can't exist, because the pension math and 80 years of data from capital markets history just don't support these unsubstantiated claims.

With only one rare and fleeting exception (which occurs at the very bottom of a business cycle, similar to the green flash in a tropical sunset), 80 percent funding is not a sufficient, sound or healthy funding level for a pension fund. The only authoritative references to 80 percent funding ratios are the federal ERISA and pension protection act provisions which require private-sector pension plans below 80 percent funding to take immediate remedial action! (Remember that public plans are not even governed by these laws.) These statutes do not make funding ratios at 80 percent "healthy" or "good" or "sound" or "well-funded." Pensions funded at 80 percent are no different than a $400,000 house in a distressed neighborhood with a $500,000 mortgage — you can keep living there if you keep making the payments, but it's underwater and your balance sheet is now upside down no matter how much you try to double-talk it. The only difference is that state and local governments can't mail in the keys to the bank.

Until the last recession, respectable and world-wise actuaries would tell you privately that when a pension system gets its funding ratio above 100 percent, there is a political problem. Employees, unions and politicians suddenly become grave-robbers who invariably break into the tomb to steal enhanced benefits and pension contribution holidays. So these savvy advisors historically have tolerated modest underfunding, based on their recurring past experience with the forces of evil in this business. They figured the ideal public plan would drift between 80 to 100 percent funding over a market cycle, and nobody would be hurt if the plans were a "little bit underfunded" in normal times. Obviously that didn't work out so well in the Great Recession, which has forced us all to take a harder look at the math and this conventional wisdom.

As I have explained in one of my very first Governing columns in late 2007 (when the last business cycle was peaking), a fully funded pension plan must today have market-value assets of 125 percent of current accrued actuarial liabilities near the peak of an average business cycle — in order to offset the near-certain loss of stock market values in the following recession. Historically, that is because the 14 recessions since 1926 (including the most recent) have shrunk equity values by 30 percent on average, and equity investments represent about two-thirds of the average public pension funds' portfolio. Real-time pension funding ratios will therefore likely decline by about 20 percent in the average recession, depending on how much the bond portfolio offsets the stock losses and mounting liabilities. So there is not a major public pension plan in the United States today that can be described as "overfunded."

A pension plan that is 100 percent funded at the end of a business expansion will likely lose 20 percent of its value in an average recession, so 80 percent is the bare-minimum "healthy" funding level at the bottom of a recession — and only then. Once the economy begins to recover, it is mathematically necessary for a reasonable funding ratio to be higher than 80 percent and rising on a clear path to full funding. Otherwise, the plan is doomed to be chronically underfunded with current taxpayers supporting retirees who didn't ever work for them. A plan funded at 80 percent going into a recession will likely find itself funded at 65 percent at the cyclical trough — and that's a toxic recipe calling for huge increases in employer contributions to thereafter pay off the unfunded liabilities. That's why today's 70 percent funding ratios are a legitimate concern and a financial burden on younger generations who will inherit this problem that their elders keep sidestepping.
Just think for one minute about what would happen if Europe unravels or China lands hard and we suffer another average recession from today's levels. That would take most pension funding ratios well below 60 percent percent and trigger a more horrendous multi-year budgetary catastrophe for public employers nationwide. Pension trustees and plan administrators with funding ratios at or below today's national average should be asking that question on the record in formal board sessions — if they understand how fiduciaries are expected to perform their duties.

One can argue that a pension plan with 80 percent funding today can be deemed prudently funded if it adopts a more aggressive amortization schedule that defrays its unfunded liabilities over the average remaining service period of incumbent employees. That's essentially what the GASB's proposed service-life amortization guidelines would ultimately imply. Anything less should invite suspicion and deserves serious reconsideration of the plan's funding policies and benefits levels. And if employees put skin in the game by agreeing to hereafter bear one-half the cost of paying down the plan's unfunded liabilities during their working years, we can then talk about 80 percent funding as a logically "healthy" or "sustainable" number.

[Aluan]

I half-hoped that you'd find something positive for once and subtitle the thread IV: A New Hope...oh well!

[campbell]

I have no new hope currently, but come back next year, and we'll see where things stand.

[MountainHawk]

Originally Posted by campbell

I have no new hope currently, but come back next year, and we'll see where things stand.

Public Pension Watch V: The Pensions strike back!

[campbell]

(SHHHHH)

[awriter]

Some states are looking/have looked at switching to defined contribution plans as a way to "stop the bleeding" so to speak. If all the contributions required for the current DB plan are channeled into a new DC plan, doesn't that hurt the existing DB plan? In fact, doesn't that accelerate plan maturity and argue for a lower discount rate to measure the present value of the liabilities? What are the pros and cons of this move toward DC plans for public pension plans?

One of my concerns about the huge shift away from DB plans to DC plans in general is that it may provide a benefit to the plan sponsor, but it may (probably will) increase the likelihood that retirees don't have enough savings/income to live on after they retire or otherwise become unable to work (unemployment, ill health, etc.). This would be particularly true for employees at the lower end of the pay scale. Has anyone seen studies projecting the degree of preparedness/unpreparedness of future retirees coming out of DC plans?

Thanks for your thoughts about these questions!

[campbell]

Originally Posted by awriter

Some states are looking/have looked at switching to defined contribution plans as a way to "stop the bleeding" so to speak. If all the contributions required for the current DB plan are channeled into a new DC plan, doesn't that hurt the existing DB plan? In fact, doesn't that accelerate plan maturity and argue for a lower discount rate to measure the present value of the liabilities? What are the pros and cons of this move toward DC plans for public pension plans?

One of my concerns about the huge shift away from DB plans to DC plans in general is that it may provide a benefit to the plan sponsor, but it may (probably will) increase the likelihood that retirees don't have enough savings/income to live on after they retire or otherwise become unable to work (unemployment, ill health, etc.). This would be particularly true for employees at the lower end of the pay scale. Has anyone seen studies projecting the degree of preparedness/unpreparedness of future retirees coming out of DC plans?

Thanks for your thoughts about these questions!

Well, this isn't exactly the thread for this, but there are indeed several studies out there re: DC vs. DB plans. There may be some threads on it in this subforum, or in Political.


I am not going to get into the measurement of the liabilities right now. I know we have other threads on that.

Ultimately, all the contributions actually come from taxpayers (except perhaps in the case of buying airtime, but there's still a bunch of stuff there.... so let me add that!)

http://www.usatoday.com/news/nation/...sts/52247140/1

Government workers in 21 states are using an obscure perk to retire early or to boost their annual pensions by thousands of dollars, which can cost taxpayers millions more in payments to retirement funds, a USA TODAY analysis shows.

The practice, called buying "air time," lets state, municipal and school employees pay to add up to five years to their work history so they are eligible to retire and collect a lifetime pension. Workers already eligible for retirement can buy extra years to boost a pension by up to 25%.

It's called "air time" because workers buy credit for non-existent work, in contrast to policies that let workers buy credit for military service or government jobs in a different state.
....
In California, where 34,202 people have bought air time since 2005, Democratic Gov. Jerry Brown recently proposed barring the practice. Kentucky, New Hampshire and Texas stopped or restricted air-time purchases after finding they weren't charging enough for the extra years, which was costing taxpayers money.

Legislatures have allowed air-time purchases as both a perk to workers and an inducement for early retirement. Some states try to make air time cost-neutral to their retirement funds by charging an up-front sum equal to a worker's projected extra lifetime pension payments.
But nine states set the price in ways that could cost taxpayers money. Michigan, Indiana, Montana and Nevada let workers buy air time years before they retire and pay a sum based on their salary at the time. If a worker's salary is higher at retirement, his pension will be based on the higher salary and the state may not have charged enough to break even, says David Driscoll of pension adviser Buck Consultants.

So one can discuss the theory and models, and then you can look at what actually happens in real life.

http://www.usatoday.com/news/nation/...ion/52246538/1

States, though, are finding that air time can be costly even when they set a price that is expected to cover the higher pension benefits.

That's because when workers such as Weiss buy "air time" — credit for work they never did — states make an educated guess about how much to charge. The guess is based on projections about when a worker will retire and die, what her pension will be and how successfully a retirement fund will invest its money.

Any of those can turn out wrong.

"It's been our experience that air time ends up costing the system money," says Kentucky state Rep. Mike Cherry, who heads the House committee that oversees the state pension systems. The Legislature limited teachers hired after July 2008 to buying only 10 months and barred other workers hired after July 2002 from buying air time.

"Individuals live longer than anticipated. Health care costs go up more than we anticipate. People retire earlier than we would estimate they retire," Cherry says.

"The problem is that occasionally — actually, quite often — actuarial assumptions are not realized," says David Driscoll, head of public-sector consulting at pension adviser Buck Consultants. "In years like 2008, when you have big downturns in the market, for people who had bought air time, the state retirement systems lost money."

....

Critics such as Dan Pellissier see no reason to expose retirement systems to the risk that goes along with air time policies.

"Taxpayers should not be on the hook for a supplemental benefit like air time," says Pellissier, president of California Pension Reform, which is pushing to cut the state's retirement costs.

Pellissier, who was an aide to the state's previous governor, Arnold Schwarzenegger, bought five years of air time in 2004. He says the system "made a bad bet on me, because I got a substantial raise after I bought my air time."

Love that last bit.

[Chilango]

Senator Hatch issued a report stating that defined benefit plans are inappropriate for state and local governments.

http://hatch.senate.gov/public/_cach...%20America.pdf

From page 9: "Many of the legislative proposals and enactments at the state and federal level are good ideas that would improve the defined benefit pension structure. However, it is becoming increasingly apparent that defined benefit pension plans will never be financially sound enough over the long term for use by state and local governments. The financial risk associated with the defined benefit pension structure may be appropriate in the corporate setting, but it is inherently flawed in the state and local government setting. When defined benefit pension liabilities explode unexpectedly for a private corporation, the harm is usually limited to the corporation’s shareholders, employees and customers. In the public sector, by contrast, the harm goes beyond the public employer and employee, and is inflicted directly on taxpayers either through higher taxes, additional borrowing or reduced services. For this reason, the financial risks associated with the defined benefit pension structure are uniquely inappropriate for state and local governments."

[campbell]

Thanks for the link, Chilango. Somebody had sent me a news article on Hatch's comments, but not a link to the "report".


In other news, we have the Governor of Illinois, Pat Quinn, saying that this time, they really mean it, they'll do some pension reform this year:
http://www.sj-r.com/top-stories/x207...-pension-panel

Gov. Pat Quinn said Tuesday he will jump into the fight over how to reform Illinois’ pension system.

“Our rendezvous with pension reality will come this year,” Quinn told reporters at a Chicago news conference. “This is a major mountain to climb, and I’m willing to lead the expedition. We’re going to get this done once and for all.”

The governor pledged that pension reform would be done in a “fair and constitutional manner.”

Quinn's statement echoes those made in recent weeks by Senate President John Cullerton, indicating the two Democrats want an alternative to a proposal sponsored last year by House Minority Leader Tom Cross, R-Oswego, and House Speaker Michael Madigan, D-Chicago.

Cross’ proposal, which is backed by Chicago’s top business leaders, would create a three-tiered pension system and sharply increase contribution rates for public workers who want to stay in the first tier, a defined benefit plan that covers the vast majority of state workers today.

Quinn said he would model his working group after a panel convened by Senate Democrats last year that produced a bill that streamlined the process for firing teachers and made changes to other education laws. That group included teachers’ unions, principals, education reform groups, lawmakers and others in the education community. It produced a nationally praised law signed by Quinn earlier this year.
....
Anders Lindall, spokesman for the American Federation of State County and Municipal Employees, said the union welcomes the governor’s plan “if it is focused on the real problem,” which is successive governors and legislatures failing to fund the systems properly.

“Our union and our partners in the One Illinois coalition have been urging a collaborative process for a very long time,” Lindall said. “It’s critical to understand ... the real problem in Illinois public pensions is not benefits but funding.”

[campbell]

Start spreading the news....

http://webfarm.bloomberg.com/news/20...7-from-8-.html

New York’s chief actuary is recommending that the city’s $115.2 billion pension plans lower their assumed annual rate of return on assets to 7 percent from 8 percent, which would open a funding gap of at least $2 billion next year, according to two people familiar with the proposal.

Robert North, the actuary, is presenting his plan to overseers of funds for police, firefighters, teachers, civilian employees and school administrators, the people said. They spoke on the condition of anonymity because the proposal hasn’t been made public. The New York Post reported on the plan yesterday.

The city has already set aside $1 billion for the fiscal year beginning July 1 to cover an increase in its annual pension contribution.
....
Higher Cost
Spreading the increased pension costs spurred by lower return assumptions over time, rather than making the full payment all at once, will cost taxpayers more, Brainard said.
“It’s like shorting your mortgage payment,” he said.

“If you take a holiday on your mortgage you’ll have to catch up later on,” Brainard said. “At the same time these plan sponsors and policy makers are weighing competing objectives, which include maintaining some predictability and stability in the budget process.”

Actuaries look at a number of factors in coming up with an assumed return including inflation, historical and projected returns of various asset classes, the pension fund’s historical returns and employee demographics, Brainard said.

Matthew Sweeney, a spokesman for New York City Comptroller John Liu, declined to comment citing the draft nature of the recommendation.

Comment by John Bury:
http://burypensions.wordpress.com/20...guy/#more-1710

For that we turn to the New York Post which reports that, in addition to revising the rate of return, North is also recommending a change in key accounting practices which would allow the city to pass some of the costs to Bloomberg’s successors citing sources involved in the pension analysis who said North’s staff was concerned that too big a hit all at once could cause a budget catastrophe at City Hall. “The impact would be too great,” said one analyst involved in the discussions between the actuary and the administration. “You have to look at the [city’s] ability to pay.”

No you don’t!

The actuary should be able to to determine the cost of a promised defined benefit based on his professional judgment. If a government is unable or unwilling to make that payment they have options since there is no authority forcing them to put in that money. The problem with this scenario for a lot of stakeholders in the system is that the government would get the bill for $10.5 billion, put in the $9.5 billion they have, and the deliberate underfunding of the plan would become obvious and might prompt calls to reduce benefits.

However, if they get the actuary to change ‘key accounting practices’* to lower their contribution requirement they can cash in on the good name of the actuarial profession and claim that they met their funding obligations (as determined by their paid flunky).