However, despite funding developments from year to year, public pension plans remain subject to an uncertain economic climate, and the next downturn can quickly widen the unfunded gap.

While there are several answers for resolving the enormous debt accrued by pension plans, the standard solution employs a systematic plan to pay off the debt over many years. Usually, UAL is not paid off as a lump sum but is “amortized” over some time.

While the two most common amortization methods are level-dollar and level-percent, only the level-dollar method ensures predictable amortization contributions from year to year. It requires lower payment in the initial years of the schedule because it creates a predictable path to solvency by ensuring that specific amounts are paid each year.

When it comes to open and closed amortization schedules, this analysis graphically illustrates that closed amortization schedules ensure a timely repayment of UAL. Open amortization schedules, on the contrary, run the risk of keeping the amortization payment continually below the interest expense. This leads to perpetual negative amortization and makes it impossible for the pension plan to pay out UAL.

It is also important to keep the amortization period short. For longer amortization horizons, like 25 years, the interest exceeds amortization, leading to wasteful spending. Keeping an amortization schedule at 15 years ensures the intergenerational equity principle, that is, to pay off UAL within the average remaining working lifetime of active members of a pension plan.

The analysis that goes into calculating the amortization schedule relies on an assumption about the payroll growth rate and discount rate to be realized. Notably, the level-dollar amortization does not rely on an assumption about payroll growth, highlighting another advantage of the method. The discount rate, however, plays a critical role in the amortization of pension debt regardless of the method chosen. Setting the proper discount rate reduces the chance that the annual payments will not earn enough returns to pay off the debt eventually.

After thoroughly evaluating these policies, best practices for amortizing pension debt call for several recommendations, these include using level-dollar amortization, a closed schedule that does not exceed 15 years and setting appropriate discount rates. Plan sponsors should adhere to these principles to ensure the pension plan is equipped to fulfill its promises to existing retirees, as well as to assure the future robust functioning of the plan.

When adopting a particular amortization policy for a public pension, policymakers must consider a number of factors and tradeoffs. Time preference and budgetary constraints may prove influential forces in selecting from among the amortization method choices.

However, from the perspective of plan solvency and intergenerational equity, there are best practices that a pension plan can follow in adopting the best possible amortization policy.

(1) The level-dollar method is better than the level-percent method. Using level-dollar avoids actuarial assumption sensitivity, the potential for negative amortization, and requires lower total contributions over time compared to level-percent.

(2) Closed amortization schedules are better than open schedules. Using a closed schedule ensures the unfunded liability will actually be paid off. The open amortization approach violates the basic principles of intergenerational equity because the unfunded liability is never paid off.

(3) The length of an amortization schedule should not exceed the average remaining service years of the plan. This practice adheres the closest to the intergenerational equity principle. Today’s taxpayers, not future ones, should fund the pension benefits of today’s government employees. A good rule of thumb is to adopt schedules that are 15 years or less.

(4) The shorter the amortization schedule, the better. Shorter amortization periods may mean a higher level of contribution rate volatility, but they save costs in the long run and allow the pension plan to better recover from a significant near-term negative experience.

(5) Discount rates should appropriately reflect the risk of the plan’s liabilities. If the discount rate is too high, the recognized value of liabilities will be too low; thus, the value of unfunded liabilities that are amortized will be too low, and the plan will risk not having enough assets to pay promised pensions.

Plans that choose to adopt alternative policies to this gold standard can still make choices that aim for long-term solvency. Specifically:

(6) If using the level-percent method, adopt a closed design with a schedule of 15 years or less. Amortization schedules should always be closed, and the shorter the schedule, the better the policy.

(7) To avoid contribution rate volatility, use a layering method. Seeking to avoid spikes in amortization payments is an understandable budgetary goal, but it is best pursued by layering closed amortization schedules, rather than by using an open schedule.

Full Policy Brief: Best Practices for Pension Debt Amortization

The post Best practices for pension debt amortization appeared first on Reason Foundation.

Last summer, the legislature adopted a set of innovative changes to its public school employee retirement system (known as MPSERS) that included offering new teachers the option of either a risk-managed defined benefit pension plan with cost-sharing, or a defined contribution plan with access to annuities. While this legislation—which became Public Act 92 of 2017—made important changes and today offers a national model for robust pension reform, it did not address all of the challenges Michigan has been facing with its statewide retirement systems. At  the time, the legislature focused on what it could put together given existing fiscal and political constraints and took several large steps forward with the intent of working collaboratively over time to keep addressing problems.

Since then, the Michigan House and Senate have been engaged in a follow up round of legislation with several bills aimed at covering some of the issues left out of the original 2017 pension reform bill. Additionally, pension fund administrators made prudent adjustments to a key assumption that drives pension accounting.

The collective set of changes to state retirement systems was recently praised by Standard & Poor’s, which cited pension reform as a key factor in its recent decision increase the state’s credit rating from -AA to AA with a stable outlook. Hence, it is worth taking a step back to look back over the landscape of recently adopted legislation to see how the underlying process has driven such a successful collective outcome.

1. Moving to “Level-Dollar” Amortization of Pension Debt

Many public pension plans spread out their pension debt payments (unfunded liability amortization payments) over time by pegging them to the expected growth in payroll, and MPSERS has historically done the same. The logic is that as payroll grows it will reflect a broader capacity to make payments towards the debt by the state. However, this also means backloading debt payments as the expected dollar amounts in the future are much greater than today if payroll is assumed to grow at a considerable rate.

Unfortunately, this backloading method has contributed to structurally underfunding MPSERS over the past few decades. Payroll has been assumed to grow at 3.5% to 4% a year since the turn of the millennium. And yet, actual payroll has been effectively flat during that time, and in some years has contracted (largely due to a declining economy and population flight out of Michigan during the first decade of the century). As a result, the dollar value of amortization payments today are millions less than was expected by previous debt schedules.

In order to address this problem, the legislature unanimously adopted a bill sponsored by Rep. Tom Albert (House Bill 5355) to gradually reduce the MPSERS payroll growth assumption until it reaches zero. This innovative ratchet-down mechanism will avoid a fiscal shock from switching the level-percent amortization method to level-dollar overnight. When the payroll growth assumption reaches zero, MPSERS will effectively have level-dollar amortization method because payments will be spread out over the same expected payroll base. And as a failsafe, should Michigan experience a population boom that warrants maintaining a higher payroll growth assumption, the legislation allows for adjustment to the phase down schedule.

Particularly noteworthy is the nature of the political debate around HB 5355, relative to the rancor and heated debate of the 2017 MPSERS reform effort. The legislation that would become P.A. 92 passed by a thin 4-vote margin in both the House and Senate. By contrast, this pension reform — enshrined as Public Act 181 of 2018 — was passed with unanimous, bipartisan support in both chambers and signed shortly thereafter by Gov. Snyder. While there was some discussion over the fiscal effects of P.A. 181 during the process, this time around both chambers clearly recognized the long-term value of the policy and acted in singular accord to embrace it.

2. Lowering Assumed Rates of Return for Major State Pension Plans

In February 2017, Gov. Snyder’s Department of Technology, Management and Budget (DTMB) and the Office of Retirement Services — which oversees Michigan’s statewide retirement systems, including MPSERS and the State Employees’ Retirement System, MSERS — proposed lowering the assumed rate of return for the systems under their purview. (Research from Reason Foundation has long pointed out the need to make this change based on historic trends and capital market forecasts.) Funding was included in the package of 2017 reforms to pay for lowering the assumed rate of return on these systems from 8% to 7.5%.

However, it was widely accepted that the 7.5% assumed return was still reflecting considerable risk. In fact, P.A. 92 created a new defined benefit plan for teachers hired as of February 2018 that uses a maximum 6% assumed rate of return when determining normal costs.

Acknowledging the need for additional, prudent adjustments to the return assumption, this past spring Michigan took steps to further lower the assumed rate of return for MPSERS to 7.05% and for MSERS to 7%. The administrative change was driven by DTMB, but the legislature still needed to approve the change via the appropriations process (which was formalized in the budget signed by the governor in June).

3. Expanding Access to Annuities (in progress)

One of the provisions of SB401 was to require that ORS provide members of the state’s defined contribution plan access to annuities, specifically, the option of at least one fixed rate annuity and one variable rate annuity. However, due to debates over specific provisions at that time any further guidance was left out of the 2017 legislation.

This spring, two bills have been introduced to expand on that section of the law created by SB401. HB5230 and HB5231 have passed the House and made it through the Senate Finance Committee (as of May 2018). Specifically, the bills would ensure DC plan members can purchase annuities while still participating in the plan (rather than just rolling their account balances into annuities at the end of their career), require a competitive bidding process for the provision of annuities, set standards for the annuity providers selected by the Treasury Department, require certain reporting standards, and require the annuity provider to offer participant-specific education and tools to understand the use of annuities as part of retirement income.

4. Regularizing Certain Retirement Benefits

The legislature enacted three additional bills this year that, while narrowly limited in scope, will bring additional rationality to certain benefit structures:

• Public Act 335 and Public Act 336 made adjustments to the judicial and state employees retirement systems that sync the actuarial assumptions used to calculate certain optional benefits with the assumptions used by the plan actuary today.
• Public Act 328 of 2018 cleared up certain language with respect to community college students, formally establishing that they are not required to contribute to MPSERS if they are working for their school on a part-time basis.

Conclusion

Taken as a whole, Michigan policymakers have made considerable strides towards improving the retirement security of state workers, teachers, and other public education employees over the current biennium. The state has created a new choice-based plan design for teachers, lowered the assumed rate of return in steps from 8% to 7%, put in place a phase in towards a 6% assumed return over time, adopted an effective level-dollar amortization policy, and set the stage for members of its defined contribution plan to have a stronger path towards retirement security. This impressive and sweeping set of achievements was not accomplished with one singular bill, though, and the process as a whole is a testament to making incremental change through more narrow debates so that the collective reform effort is not drowned by competing priorities.

The post Reflections on Michigan’s Ongoing Pension Reform Project appeared first on Reason Foundation.

PERA currently faces an unfunded liability of around $51 billion, with a funded ratio of 46 percent (based on GASB accounting standards). Colorado and its school districts have been facing the threat of a credit rating downgrade. And projections by the pension plan’s actuary showed that, absent reform, there was a possibility the dollars set aside for teachers could run out in the 2040s.

SB200 aims to keep promised benefits protected primarily by increasing employer, employee, and state general fund contributions. The pension legislation also reduces COLAs for existing retirees by freezing the so-called Annual Increase for this year and next year, and lowering the cap on the annual Increase to 1.5 percent beginning fiscal year 2020. The retirement age for workers hired after January 1, 2020, is increased from 60 to 64 under this legislation, and those members must satisfy a Rule of 94 (combination of age plus service years) to get a full, unreduced pension benefit.

To address structural challenges with PERA, SB200 creates a new bicameral pension oversight committee, requires that employers make the same payments towards the unfunded liability whether or not their members participate in PERAChoice, and expands access to the PERAChoice option to local government workers (previously only certain state employees could choose a defined contribution plan). Further, SB 200 allows for automatic increases in future contributions rates and decreases in the Annual Increase if necessary to keep PERA on a path towards being fully funded over 30 years.

The bill does fall short in a few areas, however:

• It does not address the plan’s problems with overly optimistic assumptions, namely the assumed rate of return.
• The definition of success for the PERA board remains targeting a 30-year funding period, which is much longer than the time horizon should be for paying off unfunded liability according to current best practice standards established by the actuarial profession.
• The legislature missed an opportunity to reduce risk by expanding access to a choice of retirement plans to teachers — instead allowing only state and local employees to decide whether they want the more personal PERAChoice defined contribution retirement plan instead of the pension benefit. Opening the DC option to all workers would provide more flexibility to a wider variety of workers — less than 5 percent of teachers earn a full, unreduced pension benefit and many would be much better off with a DC plan — while simultaneously reducing the financial risks faced by PERA and state government.

Despite its shortfalls, SB200 remains a major step in the right direction. It institutes much-needed increases to contributions and adjusts the retirement age to better match a population that is living longer than before. Additionally, the formation of the new pension oversight committee leaves the door open for further incremental reform down the road.

The Pension Integrity Project at Reason Foundation worked with a wide range of PERA stakeholders over the past year, providing technical assistance to Colorado policymakers, education groups, business community groups, and a Denver Metro Chamber of Commerce pension reform working group as the reform discussions—and ultimately SB200—took shape. In addition, we conducted an extensive legislative outreach effort and provided advanced analysis and actuarial modeling to legislators as various options for reform were considered throughout the legislative process.

1. The Problem

PERA is an association of five separate defined benefit plans and an optional defined contribution plan, known as PERAChoice. The five pension plans are known as the State Division (covering employees at state agencies and in state-wide ‘hazardous duty’ roles), the Schools Division (covering all teachers and public school employees outside of Denver), the Denver Public Schools (DPS) Division, the Judicial Division, and the Local Division (covering most municipally employed workers who are not police or firefighters).

PERA was last fully funded in 2001. Like many other pension funds across the country, PERA has seen a consistent expansion in unfunded liabilities over the last fifteen years. By 2016—the latest reported year—the unfunded liability had grown to a stated $32 billion, with assets covering only 58 percent of the benefits promised to public workers. Given that that figure is based on PERA’s overly optimistic investment return assumption, the problem is likely more severe. According to PERA, the 2016 unfunded liability is actually $51 billion with a funded ratio of just 46 percent when calculated using methods prescribed by the Governmental Accounting Standards Board (GASB).

With its PERA pension liability growing faster than government revenues, Colorado has begun to feel the pressures in their budget, making it more difficult to allocate for other critical services. Chronic underpayment of required contributions—an artifact of a statutorily-mandated employer contribution rate that has proven much too low relative to actuarial funding standards—has resulted in a darkening outlook for Colorado’s credit rating. More importantly, the growing funding gap has become a major threat to the financial security of all workers and retirees under PERA, which accounts for around 10 percent of Colorado’s population.

While some observers may assume that PERA’s current unfunded liability is primarily the result of underperforming market returns, the Pension Integrity Project’s analysis of PERA’s valuation reports—available in this interactive visualization—shows that the growing pension liability stems from several different factors.

As shown in the figure below, the largest contributor to the unfunded liability has been underperforming investments, which has added $8.4 billion since 1996. Over that period of time, PERA’s assets have consistently returned less than the assumed rates.

Other actuarial factors such as the withdrawal rate and the age at retirement have differed from assumptions, leading to another $7.7 billion added to the unfunded liability from 1996. These factors along with recognizing additional pension debt through assumption changes account for more than two-thirds of the final $32 billion in estimated unfunded benefits payments.

The other third of the unfunded liability is the result of Colorado’s underpayment of actuarially required contributions. Since 2003, Colorado has paid below the amount required to prevent a decrease in the funded ratio. Much of this is the result of Colorado establishing fixed contribution rates in statute, as opposed to using the actuarially determined contribution rate in any given year. This faulty approach is structurally underfunding the plan, which hasn’t been able to keep up with rapidly growing pension obligations. As a result, PERA has added $4.6 billion to the funding gap since 1996. Another $6.5 billion can be attributed to interest on the pension debt, meaning that the state is having to pay interest on the unfunded liabilities.

Using independent actuarial modeling, Reason’s forecast shows that without changes to PERA, the unfunded liability will nearly double over the next 30 years. And that assumes that actual returns will match current PERA assumptions, which recent history demonstrates is not a sure thing.

2. The Changes

Efforts to overhaul PERA began in 2017 after a stress test analysis (known as the “PERA Signal Light” study) showed it was possible that the State and School divisions could run out of money by the 2040s without a meaningful set of changes. The executive leadership at PERA went on a tour around the state to communicate to employees, retirees, and other stakeholders about the problems the system was facing. Around the same time, the Denver Metro Chamber of Commerce formed a working group (including members of the legislature, the business community, and subject matter experts) to discuss what should be done. And concurrent with this activity was ongoing work by education community groups (primarily Secure Futures Colorado) to encourage rational, needed changes.

By March 2018, House Majority Leader K.C. Becker (D) and Sen. Jack Tate (R)—both members of the Chamber working group—agreed to jointly champion a bipartisan pension reform bill to be introduced starting in the Senate. Additional co-authors on the bill included Sen. Kevin Priola (R) and Rep. Dan Pabon (D).

The elements of SB200 as introduced were grounded in a set of recommended changes by the PERA board from late 2017 and supplemented with ideas developed by the Chamber of Commerce working group and best practice policies recently adopted in various state-level reform efforts.

The final version of SB200 as enacted was the result of two months of vigorous debate on the various aspects and components of the bill and included a number of compromise positions such that it could be collaboratively embraced by the Republican-controlled Senate (passed 24-11), Democrat-controlled House (passed 34-29), as well as the Governor’s office, employer groups, and PERA itself.

SB200, as adopted by the Colorado legislature in 2018, makes the following changes:

Contribution Changes

• Employees will contribute more of their pay towards PERA. Increases will begin in 2019 and will gradually ramp up to an increase of 2 percent of pay by 2021. The employee contribution rate will at that time total 10 percent for most PERA workers.
• All employers besides those in the Local Division will chip in an additional 0.25 percent of their payroll towards PERA, putting the contribution rates for the State, Schools, DPS, and Judicial Divisions at 10.4 percent.
• Future contributions will be based on gross compensation instead of net compensation (because benefits are based on gross compensation).
  • It is noteworthy that no one has a clear sense of how much the shift from “net-to-gross” compensation as the basis for determining contributions will generate for PERA. Estimates range from a 1 percent increase in total contributions to a 5 percent increase — both relatively small amounts on an annual basis, but that could add up to a considerable amount in the long-run.

Benefit Design Changes

• Cost of Living Adjustments (COLAs) — known as the Annual Increase — will be suspended for two years and reinstated in 2020 at a reduced rate. PERA members who are eligible for an Annual Increase will have that adjustment capped at 1.5 percent, down from the up to 2 percent increase before.
• New hires starting January 1, 2020, will have an increased retirement eligibility age, up to 64 from the previous age of 60 for state workers and 58 for teachers.
  • New members will also have to satisfy a “Rule of 94” — the combination of age plus years of service should equal at least 94 — in order to receive unreduced benefits.
• The option to take part in the PERAChoice plan — a defined contribution retirement plan with 10.25 percent employer contributions and 10 percent required employee contributions — will be expanded to employees in the Local Division and to the non-professor staff at colleges and universities
  • This option was previously only available to employees in the State Division (such as staff at state agencies, district attorneys, and members of the legislatures).
  • Professors at colleges and universities already have access to DC plans if desired — managed separate from PERA — but non-teaching staff did not.
  • PERAChoice will still be unavailable to the Denver Public Schools Division and the Schools Division, which together comprise the largest group of public employees in the state.

Structural Changes

• PERA will adopt an “Automatic Adjustment” feature for future contribution increases, should the above changes to contributions and the COLA not be enough to keep PERA on a trajectory towards being fully funded in 30 years.
  • When total contributions are less than 98 percent of the total Actuarially Determined Contribution (ADC) the employee and employer contribution rates will increase (by up to 0.5 percent of pay a year) and COLAs will decrease incrementally (by no more than 0.25 percent a year).
  • The maximum increase in the employer and employee rates is an additional 2 percent of payroll.
  • The COLA can never drop below 0.5 percent.
• The funding policy for unfunded liabilities will be adjusted so that pension debt payments are paid on total payroll of PERA. This allows for expansion of the DC option without reducing crucial debt payments to the pension fund.
• The Legislature will establish a bicameral PERA oversight committee, which can request reports, propose legislation and make recommendations to PERA.
• The Legislature established an objectives statement for the optional DC plan that emphasized the role of PERAChoice as being a retirement plan intended to build retirement income for members.
  • Many DC plans fall short of meeting this objective because they are only focused on general wealth accumulation in a supplementary capacity, and not designed to explicitly target the production of retirement income for the participant.

3. Grading the Changes

Grading the changes in SB200 according to the Pension Integrity Project’s seven objectives of good pension reform provides a useful evaluation of the enacted legislation. Judging the changes to PERA according to this grading method shows that the bill falls short in achieving a full remedy in some instances but manages to accomplish—at the very least—slight improvement in all of the seven objective categories.

Keeping Promises: The adopted legislation will improve the solvency of PERA through increased contributions with automatic adjustments and a reasonable adjustment to the supplementary Annual Increase. The increased retirement age for new hires establishes a more realistic and achievable promise and also improves the plan’s ability to reach solvency. All of these changes are made without cutting any earned pension benefits already made to members and retirees.

Without the adopted changes, PERA was forecast to have perpetual growth in unfunded liabilities, as shown in the figure below. With the adopted changes — particularly the automatic adjustment feature — there is a path to fully fund PERA as long as actuarial assumptions are reasonably accurate. If investment returns average less than 5 percent over the next few years and decades, the state will need to come back to the drawing board.

Retirement Security: Expanding PERAChoice to the local government division will mean a slight expansion of the availability of retirement security, but this option remains unavailable to the schools and DPS divisions. The PERAChoice Defined Contribution (DC) Retirement Plan has a generous employer match that provides a path to retirement income security. The back-loaded pension plan works best for full-career workers, and it remains available to all future hires.

Predictability: The current political practice in Colorado favors the near-term illusion of predictability in contribution rates by putting them in statute, while dealing with the need to increase contributions every few years because actuarial assumptions used by the plan have not matched positively with actual experience. This was not changed with SB200, meaning the annual contributions will continue to be slow to adjust, which was a major source of growth in the unfunded liability over the past two decades.

One small improvement in favor of long-term predictability was the expansion of access to the PERAChoice DC Retirement Plan, whose contribution rates are wholly predictable, to the local government division.  However, continuing to use fixed contribution rates in statute that are dependent on an unrealistic 7.25 percent assumed rate of return means that long-term rates are not as predictable as if more conservative assumptions were used for the new tier of pension benefits (which would avoid repeating the primary cause of today’s problems).

The chart below shows that it is still reasonable to expect a range of possibilities for contribution rates. A lot depends on the timing of investment returns when the assumed return itself has only around a 50 percent probability of being right. Actual volatility could look more wild than this analysis using the same average return for each year.

It is worth emphasizing that in a scenario where investment returns average 6 percent, reductions in the Annual Increase to as low as 0.5 percent in cost-of-living adjustments will be required to maintain the contribution rate trajectory shown. Year-to-year changes in contribution rates will depend on how exactly the PERA board decides to put the automatic adjustments into practice.

Risk Reduction: The pension plan will continue to be exposed to market volatility with PERA’s 7.25 percent assumed rate of return, which has only about a 50 percent probability of success. The expansion of PERAChoice provides a slight reduction in risk, as it will reduce PERA’s overall exposure to market risk and volatility.

Affordability: SB 200 will have enough additional contributions to ensure there is a path to pay down the unfunded liability in a reasonable time only if experience meets PERA’s actuarial assumptions. A lower return rate will prevent this plan from reducing the total amount paid into PERA in the long-run, and interest costs will continue to be a problem. The automatic adjustments help mitigate this risk, but the limits on the adjustments could render them insufficient within a few years — even if investment performance is strong over the long run.

For example, when we look at the forecast for the actuarially determined contribution rate in the chart below, it is clear that the long-term trajectory is growth in required employer dollars, even after SB200. To be clear, a huge improvement from SB200 is that the total contributions for an underperforming market scenario will be less than if the status quo had been preserved. But SB200 still leaves PERA exposed to risk and the potential for an expensive future.

Attractive Benefits: Expansion of the PERAChoice DC Retirement Plan option gives the local division access to a competitive and attractive retirement plan for 21st Century employees, but this option still isn’t available to teachers in the schools and DPS divisions (Colorado’s largest category of workers).

Good Governance: The bill establishes a new Public Pension Legislative Oversight Committee to create a more robust framework for legislative oversight of PERA. The committee will ensure greater transparency, accountability, and the long-term sustainability of a secure and affordable retirement system.

4. Conclusion & Next Steps

SB200 made positive steps in most of the categories of good pension reform, but several key areas saw only slight or incremental improvements. In some ways, the bill falls into similar traps that eventually made the 2010 law known as SB1 a failure in retrospect.

The adopted bill doesn’t do enough to reduce risk. As is evidenced by the previous twenty years and projections going forward, PERA has a problem with investment returns not meeting the assumed rate of return. Previous reductions in the assumed rate have curtailed the risk for the fund, but our analysis shows that even more reductions are necessary.

Without a major change to the current assumption policy, PERA is likely to still have unexpected growth in liabilities resulting in yet another pension quagmire in the future. In the following years, Colorado policymakers (including the new Pension Oversight Committee) ought to consider a reform that reduces the assumed rate of return for the entire plan or for just the incoming hires of the newly established DB plan.

The expansion of the DC option does help with reducing risk, but this round of reforms still fell short of expanding this choice to the largest group of public employers in Colorado—teachers. By restricting access to the program, PERA is missing on an opportunity to reduce future risk in a way that is mutually beneficial to both the employer and the employee.

By limiting the expansion of PERAChoice from teachers, the reform also limits PERA’s ability to fulfill the important objective of providing attractive benefits. The defined benefit plan is an excellent option for many Colorado workers but lacks the flexibility and portability that some workers—i.e. the more than half employees who do not plan on staying for the rest of their career—may value. Future reform efforts in Colorado should prioritize making this program available to teachers as it is already for the rest of the state’s public workers. Expanding the DC plan is, after all, a positive step in two ways. It provides an additional option to those who would like to choose a DC and it reduces the risk carried by the government and its taxpayers.

In SB200, the Colorado Legislature has enacted meaningful improvements to the state’s pension system, which will lead PERA to a considerably improved long-term position. By improving policies in a way that is focused on keeping promises, retirement security, affordability, and good governance, policymakers of the Centennial State have greatly improved the post-employment security of their workers as well as the fiscal security of the state. Slight improvements in the objectives of predictability, risk reduction, and attractive benefits suffer from some unfortunately missed opportunities, but will also improve the overall security of the plan for all stakeholders. After a grueling legislative process filled with difficult decisions, Colorado lawmakers deserve credit for adopting effective, bipartisan pension reform.

Does Colorado’s 2018 Legislation Meet Objectives for Good Pension Reform? A Final Grade

The post Colorado Adopts Significant Pension Changes for All Public Employees appeared first on Reason Foundation.

Austin’s largest municipal retirement system is mired in financial trouble, even by its own standard.

Based on a discount rate of 7.5 percent, the City of Austin Employees’ Retirement System’s (COAERS) unfunded liability was $1.3 billion in 2016, an increase of more than $875 million over a 10-year period. The system’s funded ratio hovered at 64 percent in 2016, a decrease from its 80 percent mark in 2007. When more realistic actuarial assumptions are applied, the system appears even more distressed. Based on a discount rate of 6.5 percent, COAERS’s unfunded liability amounts to $1.8 billion and its funded ratio is only 57 percent. Using a discount rate of 5.5 percent, the system’s unfunded liability totals $2.4 billion and its funded ratio declines to 50 percent.

COAERS’s fiscal deterioration is evident, and the causes are many, such as subpar investment returns, failing to properly anticipate how long workers would stay in the system, and mortality assumptions. And while the city has taken certain steps to shore up the plan’s finances, such as creating the Supplemental Funding Plan, those actions have proven insufficient.

As such, COAERS remains a troubled plan and questions persist about its longterm sustainability and stability. To calm these concerns and ensure that the plan remains solvent well into the future, state and local policymakers need to take decisive action that may include:

• Moving away from funding the plan based on a statutory contribution rate and adopting an actuarially determined contribution rate policy;

• Using more conservative assumptions, particularly with regard to a lower rate of return; and

• Creating a primary retirement defined contribution plan and allowing new employees the option to participate, such that there would be slower growth in liabilities exposed to unrealistic assumptions.

In combination, these reforms have the potential to significantly improve the fiscal condition of the COAERS system, especially if reality exceeds expectations. Resolving COAERS’s fiscal issues may not be easy or painless, but implementing the proper policy prescriptions now means a better tomorrow for retirees and taxpayers alike.

Full Report: Evaluating Solutions for Austin’s Billion Dollar Pension Crisis

The post Evaluating Solutions for Austin’s Billion Dollar Pension Crisis appeared first on Reason Foundation.

The funding policy improvements of SB151 will be important for preventing the state employees pension plan— currently, around 15 percent funded — from sliding into insolvency. And the prospective cash balance plan that will be offered to future teachers represents a step forward in terms of risk reduction (albeit it an insufficient step that leaves open the need to improve teacher pension funding policy).

These pension plan positives for Kentucky may only become clearer to protestors once the perception of benefit cuts fades. In the end, ironically, the policy prompting protest and rancor in Frankfort these days did not cut a single dollar of an active teacher or retiree benefits or cost-of-living-adjustments (COLAs), and it still preserves a guaranteed “no loss” retirement benefit for newly hired teachers.

Legislation Summary

The Pension Integrity Project at Reason Foundation provided technical assistance on policy concepts presented by Gov. Bevin and legislative leaders as they crafted various reform proposals over the past year. Ultimately, Gov. Bevin and legislative leaders explored a wide range of policy designs, and SB151 was the final product of an iterative process that saw several different versions of reform legislation that dialed back the scope of reform along the way.

Nonetheless, Senate Bill 151 constitutes a significant improvement overall, with meaningful risk reduction and better funding policy across Kentucky’s various retirement plans. Major policy elements of the legislation include:

• Teachers’ Retirement System (TRS):
  • New members of TRS will be offered a cash balance plan that guarantees against any principal losses and credits employee accounts with 85 percent of investment returns over 0 percent.
  • The only change to affect existing members is that their accrual of sick leave that can be cashed into spike a pension at the end of a career is being capped — a provision in SB151 applicable to public sector employees across the state.
    • Note: There were no changes to employee contribution rates, COLA reductions, or benefit changes for current members of the TRS defined benefit pension plan.

• Kentucky Retirement System (KRS):
  • Members of most plans will be offered an optional defined contribution plan that would serve as a primary retirement income benefit, including:
    • Kentucky Employees Retirement System (KERS)
    • County Employees Retirement System (CERS)
    • Legislators’ Retirement Plan (LRP)
    • Judicial Retirement Plan (JRP)
  • The bill creates a statutory funding policy that will be one of the most effectively risk-managed in the nation, with amortization payments based on a level-dollar schedule and 5.25 percent discount rate for KERS and the state police plan, and 6.25 percent discount rate for CERS. The years in the amortization schedule were re-set to 30 years in order to make the shift to level-dollar more manageable for state and local budgets.
    • Note: These changes effectively codify the same practices adopted by the KRS board during the summer of 2017, ensuring that future KRS boards won’t be tempted to reverse course on conservative practices to ensure retirement system sustainability.
  • The design of the cash balance plan available to current members will change from offering a 4 percent rate of return guarantee, with 75% of returns above that minimum, to being credited with 85 percent of returns above 0 percent. Over the past 10 years, there has been no 10-year period with a geometric average return less than 0 percent (even accounting for the financial crisis), reflecting the minimal risk associated with this kind of plan design.

• Legislators’ Retirement Plan (LRP):
  • Benefits for current members were adjusted for this plan—with a slightly lower accrual rate adopted for prospectively earned service. No existing accrued benefits were cut.

While these are significant and prudent policy changes, many other ideas that could have helped improve pension solvency and retirement security were considered, but jettisoned, along the way:

• Cost saving measures for TRS — such as temporary COLA freezes and reductions—were proposed, negotiated down, and then eliminated from the bill. While changes to COLA benefits can be uncomfortable, making permanent or temporary changes can have an outsized effect on the overall affordability of existing pension debt. In the case of Kentucky, for example, several years of unpaid for COLA increases have created their own share of unfunded liabilities that has grown exponentially.
• Freezing defined benefit service accrual at normal retirement age was proposed, but dropped from the bill. This approach would have helped reduce overall contribution rates (while allowing employees in defined benefit plans to continue accruing benefits as they might have expected).
• A defined contribution retirement plan—first mandatory, then optional—was proposed for TRS and then dropped. Allowing teachers access to a DC plan built to provide primary retirement benefits would have given a wider range of future teachers access to a retirement benefit with a path towards retirement income security.

Further, funding policy changes for TRS are still necessary for the legacy defined benefit plan. The teacher plan is currently 56 percent funded, but that is using an unrealistic 7.75 percent assumed rate of return. Assumptions for TRS need to be improved, and the methods of paying off the debt need to be adjusted along similar lines as what has just been adopted for KRS. Thus, there remains a need for additional pension reforms in upcoming legislative sessions to continue chipping away at changes needed to advance the goal of pension solvency.

Process Critique

Politics is often messy, something exemplified in Kentucky on the issue of pensions the last year. The legislative effort that culminated in SB151 was a moving target since the fall of 2017, when Gov. Bevin and legislative leaders jointly announced a plan and related legislation to place all newly hired teachers and public employees in a pure defined contribution plan, among other aggressive policy proposals designed to improve solvency.

That plan was quickly beset by political obstacles. In addition to an abrupt, scandal-driven change in House leadership, TRS’s actuaries and board muddied the waters by releasing misleading actuarial analysis to the press regarding the original Bevin/leadership bill draft. (Specifically, the analysis measured the status quo forecast for TRS and the proposed changes using different underlying assumptions.) That started to pressure legislators to start backing away from the original reform concept.

This was succeeded by a wave of various legislative proposals around different plan design concepts, slowly chipping away at the more aggressive policy proposal in the original bill in an attempt to win over sufficient political and labor support (the latter of which never materialized, as is evident from recent labor protests and school closings).

And just when it seemed as if all chances of movement on pension reform were dead for the legislative session, a negotiated plan by legislative leaders to rush a sequence of pension reform, tax reform, and budget bills hastily through both chambers in a matter of days delivered SB151 to Bevin’s desk in short order at the end of the regular 2018 legislative session.

The language included in SB151 was pieced together from a range of previously introduced or drafted bills that had been considered and analyzed, such that the final text reflected a patchwork of ideas that had been debated in various forums since the Fall of 2017.

The passage triggered several waves of protests by teacher unions—part of a larger narrative emerging in several states around teacher compensation issues—and a lawsuit filed by Kentucky Attorney General Steve Beshear and two labor associations challenging the passage of SB151 on both procedural and constitutional grounds.

It may be fitting that such a convoluted process culminated with the terrible optics of pushing a pension reform bill through the legislature in the dead of night as a “gut and replace” amendment to a piece of unrelated legislation on wastewater issues. But it is not true, as some have asserted, that the bill hadn’t been read by members — every provision was in some version of the reform bills presented over the previous six months. All components had been discussed and debated ad nauseam—it was only the particular combination of ideas that were new. Still, it is always unfortunate when sound policy is tainted by poor politics and poor messaging.

Conclusion

Untangling Kentucky’s 2018 pension reform requires reconciling some tricky contradictions. First, it’s true that SB151 was watered down and did not go far enough to solve all of Kentucky’s pension crisis. But no one reform ever does, and the fact remains that it makes some major policy changes that will de-risk and improve the long-run solvency of the KERS and TRS plans speaks to its merits. Second, the legislation did not cut a single dollar of teacher benefits or COLAs and will create a still-very-attractive retirement plan for new hires. But activists and labor associations are still decrying the reforms as “pension cuts” in the local and national media, distorting the intent and reality of the situation. Third, the bill passed through an unfortunate political process (as did Kentucky’s recent tax reform and budget bills). But Kentucky’s recent experience in pension reform serves as a good reminder that an ugly political process can still occasionally result in good public policy.

Hopefully, the needed follow-on reform work in Kentucky will tread a more conciliatory and collaborative path.

The post Despite Poor Process, Kentucky Enacts Meaningful Pension Plan Design, Funding Policy Reforms appeared first on Reason Foundation.

1. A one-time window in which select eligible employers (mostly health systems and local universities) could opt to leave KRS with interest-free installment payments on their buyout priced using the plan’s discount rate.
2. A phase-in of a separately determined contribution rate increase for local employers within the County Employees Retirement System — which is a subdivision of KRS.

The latter provision would likely be a positive for municipalities seeking budgetary stability, though it only accomplishes this by punting some costs down the road. Local employers are facing a large (and needed, from the pension plan’s perspective) contribution rate increase due to the adoption of a more accurate discount rate last summer. HB 362 effectively would have reduced the step up in contribution rates for the first two years, and then ramped up the contribution rate to larger than needed for the third year, before having contribution rates settle back to their projected amounts as actuarially determined.

By contrast, the former provision, allowing for interest-free installment payments is a more complicated and fiscally problematic element of the bill.

Approaches for Opting-Out

Gov. Bevin cited the first provision for his veto, and the reasoning is sound. Allowing employers the option to leave a pension plan is certainly acceptable policy for a legislature in general, but only if it is executed in a way that ensures the sustainability of plan after they leave.

One way to accomplish this is to allow an employer to prospectively leave the DB plan (any future employees would join a retirement plan of the employer’s choice), while stipulating that they continue to make a normal cost payment for their employees who remain in the plan, plus the same unfunded liability amortization payment rate as a percentage of their actual or projected payroll. This is the simplest option, but it does not provide employers with the kind of budgetary certainty they are likely seeking with the buyout option.

Another way to accomplish this would be to calculate the present value of unfunded liabilities for an employer and requiring this amount in a full lump sum (as is currently required under Kentucky law) or partial lump sum with stipulated installment payments. The liability value should also be calculated using a market rate (such as a long-term treasury yield) to ensure that the lump sum and/or installment payments are sufficient to cover future benefit payments that are likely undervalued by the use of a discount rate linked to the DB plan’s assumed return on assets. Under this overall approach the system would have the full value of their accrued benefits and various arrangement could be made for employees already in the system.

Problems with the Opt-Out Specifics

HB362 attempts to get at the latter approach by adding the capacity for installment payments, but does not require interest be made on those installment payments. As a result the present value of the contributions into KRS that would be made from any employer that opts out is significantly less than if the installment payments were priced such that the amount transferred has the same present value, whether paid all today or spread out over time.

While the Bevin veto cites the lack of interest on the installments as a problem, the more critical weakness is the lack of a requirement that a market valued discount rate be sued to price the liabilities. The current KRS discount rates (5.25% for state employee benefits, and 6.25% for county employee benefits) are certainly among the more conservative in the country, but may still be overstating the value of existing unfunded liabilities.

Was the Veto the Right Choice Given the Trade-Offs?

There are clearly some trade-offs with this bill. The fiscal stress reduction provided by the phase-in of contribution rate increases would likely be an overall positive since the language does require that counties catch back up on the phased in payments. But the interest-free buyout clause at a non-market valuation of liabilities would create a significant net negative for the remaining employers in KRS. Collectively, this trade-off is likely to lead individuals towards a favorable or critical view of the veto based on specific preferences that they have within this mix of policy goals. But from the perspective of equity within the KRS pension plans and the fact that the near-term budgetary phase-in was going to come at the cost of future contribution rate increases even larger than currently projected, the veto probably the right decision.

The post Bevin’s Veto of Interest-Free Pension Buyout Probably the Right Decision appeared first on Reason Foundation.

My name is Anthony Randazzo, I am a Senior Fellow the Pension Integrity Project at Reason Foundation, a 501(c)3 nonprofit, think tank. The Pension Integrity Project works with policymakers, labor associations, and other interested stakeholders around the country by offering data-driven analysis and policy concepts designed to improve the overall solvency of public-sector retirement systems.

Over the past several months we have had the opportunity to work with a range of stakeholders here in Colorado to provide technical assistance in understanding the causes and scope of PERA’s sustainability challenges. In that capacity we have developed robust actuarial models of PERA’s Schools and State divisions to perform various solvency and stress tests.

The unfortunate reality is that PERA does face a solvency crisis. In virtually every plausible scenario, the State and Schools divisions will either run out of money in the next few decades or come very close with funded ratios below 10%. Without an increase in the contributions into PERA, there is a very real likelihood that several divisions will run out of funds around 2040.

It is valuable to have a robust debate about where contribution rates should come from — employer or employee, or both — and how such increases might be mitigated with changes to the Annual Increase or prospective benefit design. However, these political and policy debates must start with the underlying premise that the additional dollars are needed.

The primary factor driving unfunded liabilities for PERA is that assumptions about the future have not matched actual experience. In particular, investment returns and withdraw rate assumptions. This has also been the primary reason that SB1 from 2010 has not fully solved the problems facing Colorado PERA — while the changes provided then were a positive change, the entire plan for solvency was based on assumptions that were quickly shown to be unrealistic.

Thus, this committee and the legislature would be wise to ensure that any reform bills adopted address in some way the methods and assumptions used to forecast and ensure plan solvency. To the degree that such changes are not affordable under the status quo budget and revenue structure, at the very least more realistic assumptions and best practice methods should be adopted prospectively.

In addition to our solvency analysis of PERA’s pension funds, we have also analyzed the PERA investment portfolio and its underlying capital market expectations against independent capital market forecasts.

PERA’s investment expectations today are that there is around a 50% chance of earning a 7.25% return. Some of our independent analysis suggests that the probability is probably closer to 30% that PERA will return 7.25% over the next couple of decades. But in either case this is a fairly significant amount of risk.

A very conservative investment outlook would suggest that if Colorado wanted close to a 75% probability of success on the existing portfolio, the assumed return should be closer to 5% to 6% (depending on the capital market expectations).

Ultimately, the risk tolerance of Colorado is a decision the state and its pension board trustees need to make for themselves. However, the given the high degree of risk for the current assumptions it is worth bearing in mind how that might change the future funding of PERA — if the investment returns are just 5.25% (reasonably likely) over the next 20 years instead of 7.25% (at best 50-50 chance), then in less than 25 years the State and Schools division will run out of cash.

The Pension Integrity Project does not take a position any specific piece of legislation, but we do have seven objectives we think all good pension reform legislation should adhere to. We have put together an analysis of SB200 and how it stacks up against these benchmarks and with the Chairman’s permission I will distribute a copy to the committee and would be happy to walk through the details in Q&A should any Senator wish to further discussion.

Thank you again for allowing me to present and I am happy to take any questions you may have.

Note: the distributed analysis available here: PERA_TestimonyTable

The post Colorado PERA’s Defined Benefit Pension Funds are Facing Insolvency appeared first on Reason Foundation.

In December, the Michigan House and Senate passed a package of 16 bills establishing the clearest and most comprehensive set of reporting standards for municipal pension and retiree healthcare nationally. The legislative package, which passed almost unanimously and was signed by Michigan Gov. Snyder shortly thereafter, also established a Municipal Stability Board (MSB) to provide funding standards and a state-level solvency evaluation process for local government pension systems and retiree healthcare plans. The MSB, operating within the state Treasury Department, will mandate “corrective action plans” for local government units whose retirement benefit systems are in danger of insolvency, or whose budgetary outlays toward retirement benefits exceed certain thresholds.

Reason Foundation’s Pension Integrity Project team was engaged with a range of stakeholders throughout the process of developing the local government reporting standards and evaluation system. We provided technical assistance and policy design advice to legislative leadership, governor’s office, treasurer’s office, and Michigan Municipal League, including the creation of UnfundedMichigan.org, an interactive website reporting pension and retiree healthcare data that we collected from over 2,700 local comprehensive annual financial reports and pension or health care plan valuation reports.

In the landscape of reporting standards, Michigan’s new legislative changes stands out in its scope. Other states have reporting requirements for municipal pension and/or retiree healthcare benefits that provide certain centralized information. But Michigan will require all local governments to annually submit pension and retiree healthcare plan summary reports to Treasury using a standardized set of assumptions and methods that will allow the MSB to more accurately measure financial solvency and fiscal stress.

The process established is a model that other states should consider adopting in coming years in order to better manage the threat of pension and retiree health care insolvency at the local level.

1. The Problem for Michigan Local Governments

Statewide, local governments have over $18 billion in unfunded liabilities for pension and retiree healthcare benefits. This pension and retiree health care debt is spread across the state, not isolated to one geographic part of Michigan or specific to just poor communities or particular types of government agencies.

The majority of counties and cities in Michigan provide some retirement benefits through a defined benefit pension plan and/or retiree healthcare insurance package (often referred to as “other post-employment benefits,” or OPEB). Many other local government units also provide the same kind of retirement benefits.

Unfortunately, 81 of 83 counties in Michigan have at least one local unit of government with a pension system or retiree healthcare plan less than 60 percent funded, a level typically considered critically underfunded. In fact, a total of 245 of Michigan’s cities, counties, townships and other municipal units have saved less than 1 percent of what is necessary to pay for retiree healthcare benefits.

The widespread problem with unfunded liabilities carries two key problems:

• First, financial insolvency for pension benefits and OPEB puts retirees themselves at risk, particularly those dependent on the benefits.
• Second, the growth of unfunded liabilities means rising costs to provide pension benefits and OPEB, requiring an increasing amount of revenue from today’s taxpayers to finance these retiree benefits. The growing costs of pension systems and retiree health care have been crowding out the ability for local governments to fund basic services, road improvements, libraries, parks, and fully staffed police and fire departments.

2.  The Solution

The adopted legislation creates a new, uniform set of reporting standards to improve transparency, along with a 4-phase process for assessing and addressing pension or retiree healthcare benefit insolvency and a new state board designed to help local government units tackle their underfunding challenges.

New Reporting and Funding Standards

All local units of government — including counties, cities, towns, villages, and other independently managed governmental units such as commissions, districts, hospitals, etc. — will report their pension system and retiree health care plan funded status to the state using a uniform set of actuarial and funding assumptions to be determined by the treasurer’s office:

• These assumptions do not have to be adopted for funding purposes by the municipalities; they are for reporting purposes, intended to ensure that the solvency of a retirement benefit is being accurately determined and measured using consistent standards.
• The uniform set of assumptions will include, at a minimum, the assumed rate of return, the discount rate, payroll growth rate, salary growth rate, inflation rate, health care cost inflation rate, amortization method, and mortality tables.

The legislation also requires that local units providing retiree healthcare benefits must at least pay the annual retiree health care premiums on their plans, as well as the full normal cost for any retiree healthcare plan offered to new hires as of 2018.

Municipal Stability Board

The Treasury Department will create a Municipal Stability Board to provide oversight of local government pension and retiree healthcare solvency and corrective action plans. The MSB will consist of three members appointed by the governor, representing state officials, local officials, and employees/retirees, respectively. The appointed members will generally serve four-year terms and must have relevant experience and skills to perform the duties of an MSB board member.

The MSB will be tasked with developing strategies, plans, methods, and best practices that local governments can implement as part of a corrective action plan that will improve financial solvency and reduce fiscal stress. In addition, the MSB will monitor compliance with corrective action plans (as outlined in Phase 4 below).

Phase 1: Annual Transparency Reporting from Local Units of Government

All local units of government offering pension or retiree healthcare benefits will annually report various funding metrics for those systems and plans to the treasurer using the pre-determined actuarial standards. Those reports will be posted online to a Local Government Dashboard.

Phase 2: Solvency Assessment by Treasury

Treasury will undertake a solvency assessment for all pension systems and retiree healthcare plans:

• Any pension system with a funded ratio less than 60% and with pension contributions exceeding 10% of local government operating revenues will be deemed “underfunded.”
• Any retiree healthcare plan with a funded ratio less than 40% and with OPEB contributions exceeding 12% of local government operating revenues will be deemed “underfunded.”

Retirement benefits that pass the solvency assessment will not require any further action until the following fiscal year. Any system or plan determined to be underfunded will move on to the next phase.

(It is important to note that there is no magic to the 60% and 40% thresholds adopted by this legislation. As noted below in “Next Steps,” these rates were the result of negotiation in the legislative process. A more robust threshold would gradually rise over time until 100% funded becomes the standard to meet.)

Phase 3: Fiscal Stress Assessment by the Treasurer’s Office

Generally speaking, any pension system or retiree healthcare plan that is “underfunded” should be a cause for concern. However, there are several mitigating factors that may reasonably suggest that no action be taken on an underfunded retirement benefit. For example, a plan may be poorly funded, but also very small relative to the size of a municipality and its operating budget, making it unlikely to create fiscal stress. Alternatively, a municipality might have recently adopted a set of benefit or funding policy changes that are projected to improve solvency over time.

Given these concerns, any municipal unit with a pension system or retiree healthcare plan deemed underfunded will subject to a fiscal review by the treasurer’s office to determine whether a one-year waiver should be granted (based on the lack of fiscal stress caused by the underfunding or a pre-existing plan to correct insolvency being in place), or whether the municipal unit and its underfunded retirement benefit(s) should be placed into phase 4 for corrective action.

Phase 4: Corrective Action for Insolvency and Fiscal Stress

All local units of government that are not granted a waiver in Phase 3 will be required to meet with the MSB and develop a corrective action plan within 180 days of the determination of underfunded status.

Corrective action plans can include changes to contribution rate policy (such as increased payments or cost-sharing requirements), changes to assumptions and methods, changes to the actual benefits offered, closing existing defined benefit plans and providing new kinds of retirement benefits, increases in revenue, or other strategies and practices.

These corrective action plans must be submitted within 180 days of being declared underfunded, and the MSB will have 45 days to review and approve the plan or reject it. If a corrective action plan is rejected, the local government unit will have 60 days to provide a revised strategy.

Once a corrective action plan is approved, the MSB will monitor the local government for compliance and implementation. The MSB is also authorized to adjust the corrective action plan over time as necessary to ensure the goals of financial solvency and fiscal stability are met.

3.  Areas for Future Improvement

Applying More Robust Funding Requirements

The majority of the new standards Michigan adopted are related to reporting requirements. The primary substantive funding requirement provided for in the legislation is related to retiree healthcare plans, but only requires that minimum payments be made for existing OPEB. The could be improved by setting funding requirements broadly, including a requirement that all pension and OPEB normal costs be paid annually. Limits on the length of amortization schedules allowed for pension systems should also be considered, along with a cap on the assumed rate of return that local governments are allowed to use.

Gradually Increasing Definitions of Solvency

The definition of “underfunded” in the adopted legislation makes sense for the state’s current political climate, but is not designed to be effective in the long run. The thresholds of 60% funded for pension systems and 40% funded for retiree healthcare plans should gradually rise over time, for two reasons:

• In the interest of both retirement security and fiscal responsibility, corrective action plans should be designed to bring retirement benefits to 100% funding – i.e. full funding. But in this case, all that a pension system or retiree healthcare plan will technically need to do is cross the static 60%/40% thresholds, with no expectation of subsequent continuous improvement.
• Over time it would be prudent to place pressure on systems and plans that today are considered acceptably funded to improve themselves. Ultimately, being 60% or even 80% funded is not adequate — retirement systems and plans should always consider anything less than 100% funded to be underfunded and thus unacceptable.

Avoiding the Implicit Phase 5: Municipal Bankruptcy

A weakness in the whole process is that while the MSB can only promulgate corrective action plans, it cannot enforce them. Local government units will theoretically be allowed to ignore any corrective action plan approved by the MSB.

As a result, the only “teeth” in the evaluation process is the threat of the appointment of an emergency manager and potentially even municipal bankruptcy. In effect, municipal bankruptcy is the unstated Phase 5 for local governments who do not appropriately address the financial challenges of their pension systems and retiree healthcare plans and ignore the MSB.

The overall process in Michigan would be improved by providing the MSB with some kind of enforcement mechanism, such as the ability to require a corrective action plan under the authority of the judiciary, or by granting the MSB with certain authority currently provided to emergency managers. Another solution would be to allow the MSB or treasurer to remand a local government to an emergency manager or emergency manager panel if they are not cooperative with the MSB or do not implement a corrective action plan. Whatever the policy approach, the ultimate area for improvement is providing greater capacity for enforcement of approved corrective action plans.

4.  Pension Integrity Project’s Role and Reform Objectives

Our Pension Integrity Project team provided technical assistance to many stakeholders throughout the process of developing reforms to local government pension and retiree healthcare reporting and evaluation. We also collected data for every local government pension system and retiree health care plan—drawing data from over 2,700 comprehensive annual financial reports and valuation reports—and made this data available to the public on the interactive website, UnfundedMichigan.org. We also provided legislators with independent fiscal analysis of how various proposed provisions would address the existing problems, as well as policy design advice to legislative leadership, governor’s office, treasurer’s office, and the Michigan Municipal League.

Whenever we evaluate a proposed set of changes to a public sector pension system or retiree healthcare plan we always compare it to our objectives for good retirement system reform. Ultimately, the effort to reform reporting and evaluation standards for Michigan municipal pension and retiree healthcare plans compared very favorably to our matrix:

• Keeping Promises: The adopted legislation does not impose a state mandate to make any specific changes to existing benefits. The Michigan Constitution protects all earned pension benefits from being impaired. Any prospective changes to pension benefits or changes to retiree healthcare benefits will be made at the local level in a collectively determined process with input from employees, retirees, and local officials.
• Provide Retirement Security: The evaluation process is designed to promote retirement security by avoiding sweeping state-level changes to benefits and setting goals for financial solvency. The MSB and local governments will still need to take care when designing corrective action plans that any changes made do not impair retirement security.
• Stabilize Contribution Rates: The definition of an underfunded plan in the legislation explicitly puts a cap on the size of employer contribution rates as a percentage of operating budgets, thus providing a clear ceiling on the growth of rates in the future.
• Reduce Risk: The funding requirements in the legislation, albeit as minimal as they are, will provide minor risk reduction that new hire retiree healthcare benefits will become severely underfunded. The actual degree of risk reduction provided by the legislation will be dependent on the nature of corrective action plans, and whether they are designed to get pension systems and retiree healthcare plans to 100% funded or just over the threshold of underfunded as defined in the new statutes.
• Reduce Long-term Costs: All corrective action plans will provide for cost reduction, either directly through changes to benefits or in the long-run by adopting contribution rate changes and revenue increases that will reduce the growth of unfunded liability payments, saving taxpayers money in the long-run.
• Ensure Ability to Recruit/Retain: The legislation explicitly leaves to local units of government how to best recruit and retain for their specific functions and communities.

The Michigan Legislature, governor, and treasurer should be commended for adopting nation-leading local government reporting standards and a robust evaluation system that will support improvements in pension and retiree healthcare solvency and financial transparency. Other states should look carefully at the design of these standards and the corrective action process for inspiration in addressing widespread local pension and retiree healthcare underfunding.

The post Michigan Enacts Nation-Leading Pension, Retiree Health Care Funding and Transparency Standards for Local Governments appeared first on Reason Foundation.

But this not only a problem for Port Huron, Grand Rapids, or Lansing. Communities in every corner of the state facing the same crisis.

Of Michigan’s 83 counties, 81 have at least one local retiree benefit system less than 60% funded. Though some localities are deeper in retirement debt than others, few Michiganders are unaffected. Cumulatively, local governments face more than $18.6 billion in unfunded healthcare and pension benefits and have only 60 cents saved for every dollar in benefits promised to government retirees.

A full list of state Treasury department data on unfunded liabilities by county, city, and special district can be found at unfundedmichigan.org.

The central problem is that the cost of providing previously promised benefits has grown larger than anticipated. More than $18.6 billion more than anticipated in fact. The additional required contributions to fund this municipal debt have begun eating away at other programs.

Promising guaranteed pensions and retiree healthcare benefits are perfectly acceptable forms of deferred compensation — but if their cost has been underestimated, it is future generations that ultimately wind up getting stuck with the bill.

That larger than expected bill is the number one fiscal challenge for Michigan’s local governments today, where nearly 430 local pension systems have saved less than 70 cents for each dollar in benefit checks promised to police officers, firefighters, and other municipal servants. Another 75 pension systems are less than 50% funded.

Even worse off is the $9.5 billion in unfunded retiree healthcare benefits for former government employees. Almost 250 local governments have virtually nothing set aside to cover retiree insurance premiums or prescription drug programs. In fact, the majority of county governments have less than 10% of the assets required to fully fund them, while cities and townships have collectively funded just 20% of their retiree healthcare benefit.

As the costs continue to grow beyond previous projections, there is only going to be so much that the occasional millage increase will be able to provide towards covering the payments. Every tax dollar needed to cover public employee retirement benefits is another dollar that doesn’t go to infrastructure, public safety, parks, libraries—or that doesn’t stay in the taxpayers’ wallets.

The unfunded liabilities that localities face not only threaten their residents, but they also threaten the retirement security of their employees.

Pensions and retiree healthcare benefits are deferred compensation—payments for services previously rendered. These benefits are supposed to be financed as they are earned, and to not fully fund benefits is the same as not paying employees in the first place.

So what should be done? There are no cookie-cutter solutions. In any jurisdiction, reform should be a collaborative effort between elected officials, labor, and taxpayers to reach a compromise that sustains public services while ensuring that retiree benefits are paid.

In some cases, spending more out of the existing budget—and cutting elsewhere—to properly pay for benefits may ultimately be sufficient. In other cases, benefits for new employees may need to be changed. In others, some combination of solutions will be needed.

Any discussion about what changes need to be made in any given community is, at this point, purely speculative. Improved reporting and introducing funding standards policies are a necessary first step—any informed discussion of what retiree benefits should look like (and how much they should cost) is impossible if the information isn’t available.

The only unacceptable response to this crisis is inaction. At some point, the music will stop and localities will be unable to afford retiree benefits, basic government services for their residents, or both.

Reform is difficult and the corrections necessary to finance benefits will be painful, but this crisis will get worse before it gets better. Like the mythical Sword of Damocles, fiscal insolvency looms over all governments with unfunded retiree obligations. It is far better to forge a path out now rather than wait for it to fall and bring governments’ finances down with it.

The post Michigan Municipalities Face a Retirement Benefit Crisis appeared first on Reason Foundation.

To this end, my colleagues Zach Christensen and Anil Niraula have helped to create a new visualization of the funded ratio for the 50 states and their pension plans over the past 15 years. The 2001 to 2016 data provides a dynamic way to watch trends for pension plans.

One of the most notable trends is the sharp drop in funded ratios during the financial crisis, largely reflected in 2008 and 2009 data. While several states enjoyed full funding in previous years, all states had fallen below 100% by 2009 and only two states (Washington and Wisconsin) could claim funding above 90%.

Another trend is a brief improvement in funded status following 2009, but a general leveling out of funded ratios since then and even a general decline into 2016. This reflects the slow rate of recovery since the financial crisis and the underlying fact that more is going on with pension underfunding than just the financial crisis hit on assets. The vast majority of pension plans have reported strong investment returns for fiscal year end dates in 2017, suggesting there will be a slight uptick with these ratios for next year.

A final trend of note is how states have recovered better than others after 2009. Oklahoma, Nebraska, West Virginia, Maine, South Dakota and Tennessee all saw improvements of over 20 percentage points in their funding from 2009 to 2016. Other states saw little to no improvements over that timeframe. A few states (Illinois, Washington, Massachusetts, Wyoming, Kentucky, Connecticut, Colorado, and Pennsylvania) actually have lower funded ratios in 2016 than they had in 2009. Pennsylvania’s ratio dropped the most, going from 61% in 2009 to 52% in 2016. A decreasing funded ratio amidst recovering market conditions ought to raise alarms for those states’ policymakers and taxpayers alike.

See the full methodology on the data visualization here.

The post Evolution of State Pension Funded Ratios appeared first on Reason Foundation.

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The map above shows how the funded status of defined benefit pension plans have evolved over the past 15 years. Each state’s funded ratio is a weighted average for the largest state-administrated pension plans in that particular state. A funded ratio is simply a measurement of how much a pension plan has saved relative to the benefits it has promised, the percentage is calculated by dividing the market value of assets by the actuarial value liabilities (i.e., the net present value of promised pension checks).

States that report fully funded pension plans (100% or more) are depicted in shades of green. Funding ratios ranging from 70% to 99% are displayed in shades of yellow/orange, while any state that falls below a 70% funded ratio appears in shades of red.

We determined each state’s funded ratio by totaling up the reported actuarially accrued liabilities and market valued assets and then calculating the funded ratio (as opposed to taking the average of funded ratios in the state). This allows for weighted average results based on each plan’s liabilities.

The post State Funded Ratios Over Time appeared first on Reason Foundation.

• • Kentucky Pension Reform Framework Released
  • Examining Michigan’s Local Government Pension, Retiree Healthcare Debt
  • Pension Reform Should Consider Employee Needs, Workforce Objectives
  • Which States Are Hiding the Most Pension Debt?

News Notes Quotable Quotes on Pension Reform Contact the Pension Reform Help Desk

Articles, Research & Spotlights Kentucky Governor, Legislative Leaders Release Comprehensive Pension Reform Framework In recent weeks, Kentucky Governor Matt Bevin, Senate President Robert Stivers and House Speaker Jeff Hoover released a long-awaited framework for a comprehensive pension reform effort aimed at restoring pension solvency in a state recognized for having among the worst underfunding and the highest pension-related burden among the states. The reform framework includes shifting to a level-dollar amortization policy for all state pension systems; placing future teachers and state/local non-hazardous workers into defined contribution retirement plans; leaving defined benefit pensions in place for active workers until they reach elgibility for a full, unreduced pension benefit; leaving current retiree benefits and retirement ages untouched; eliminating sick leave credit from pension benefit calculations; and freezing pension benefit accruals for legislators moving them into a new defined contribution retirement plan. Gov. Bevin and legislative leaders are reportedly considering a special legislative session in November to tackle the issue. » Kentucky Pension Reform Framework, Draft Legislation, and Plan-by-Plan Summaries» PFM Group reports on Kentucky’s pension performance & reform recommendations» return to top

New Interactive Website Details Michigan’s Local Government Pension, Retiree Healthcare Debt The Pension Integrity Project at Reason Foundation has released a new interactive website—UnfundedMichigan.org—that pulls together data from over 2,700 financial reports by counties, cities, townships, villages, commissions, and authorities across Michigan to give taxpayers a simple, clear way to find and compare the unfunded pension and health care liabilities owed by their local governments at all levels. The website reveals unfunded local government retirement benefits totaling over $18 billion statewide. UnfundedMichigan.org reveals that 81 of 83 counties in Michigan have at least one local unit of government with a pension or retiree health plan that is less than 60 percent funded, the level typically considered critically underfunded. In fact, a total of 245 of Michigan’s cities, counties, townships and other municipal units have saved less than 1 percent of what is necessary to pay for retirees healthcare benefits. » INTERACTIVE WEBSITE: UnfundedMichigan.org» PRESS RELEASE» return to top

Pension Reform Should Consider Employee Needs, Workforce Objectives A key element missing from many national pension reform discussions is consideration of what is best for employees in the long run and how plan design meets employer workplace goals, writes Pension Integrity Project senior fellow Richard Hiller in a new column. Recognizing the reality of employment patterns today is critical in designing a retirement plan that meets employee retirement goals as well as employer workforce objectives, including recruiting and retaining 21st century employees. Accordingly, employers should reject outdated thinking regarding optimal plan design and instead focus on offering retirement plans that balance employer workforce goals with the reality of employee needs. While traditional defined benefit pensions may be a great option for long-tenured workers, Hiller writes that today there are also defined contribution retirement plan designs that are focused on lifetime income, like pensions, but recognize the mobility of the modern workforce. » FULL ARTICLE» return to top

Which States Are Hiding the Most Pension Debt? Every state pension plan gets to decide what kind of accounting practices it wants to follow when reporting the value of its assets and size of its unfunded liability. As a result, states have adopted a range of different approaches, leading to inconsistencies in the reported amount of pension debt compared to more accurate methods of measuring the promises made to teachers, police officers, firefighters, and other public-sector workers. And it should not be a surprise that some states are using practices that significantly understate the amount of their promised pensions. In a new article and inforgraphic, Reason’s Zachary Christensen analyzed the actuarial valuations of the top 649 pension plans in the country to compare their reported value of unfunded liabilities versus the value of this pension debt using a “market value of liabilities.” Arizona, Georgia, South Dakota, Washington State and Nevada top the list of worst offenders. » FULL ARTICLE & INFOGRAPHIC» RELATED: How Much Do Reported Pension Obligations Increase When Using a Market Valuation of the Promised Benefits?» return to top

News Notes Report Examines Rising Pension Contributions, Crowd-Out Effects For California State & Local Governments A new Stanford Institute for Economic Policy Research working paper by Stanford professor and former state assemblyman Joe Nation examines the magnitude of employer pension contribution rate increases and explores crowd-out effects in 14 particular California jurisdictions—the state, sample cities, counties, special districts and school districts. Among the findings: total employer pension contributions expanded by an average of 400% between 2002-03 to 2017-18, and employer contributions are projected to increase an additional 76%-117% on average from 2017-18 to 2029-30. The full report is available here. New Report Finds Relationship Between Unfunded Pension Liabilities and Government Borrowing Costs A new study by the Center for Retirement Research at Boston College examines the impact of pension finances and pension reforms on governmental borrowing costs from 2009 to 2014. The study finds that while higher ratios of unfunded pension liability to government revenue are associated with higher borrowing costs, the impact of reforms on borrowing costs were not statistically significant, a finding the authors suggest may be because those governments pursuing reform also tended to have poor general finances. The full report is available here. GAO Recommends Overhaul of National Approach to Financing Retirement A new report by the Government Accountability Office finds that the current piecemeal approach to tackling U.S. retirement issues is ineffective given the interrelated nature of challenges facing the system today. It also recommends that Congress establish an independent commission to comprehensively examine the U.S. retirement system and make recommendations to clarify key policy goals for the system and improve how the nation promotes retirement security. The full report is available here, and the highlights are available here. » return to top

Quotable Quotes on Pension Reform “We, as a Commonwealth, have a moral and legal obligation to fulfill the promises that have been made to our public employees. This is not just about fixing our present underfunding problem. It is also about ensuring that we leave a better, financially stable Kentucky to our children. The right thing to do is rarely the easiest, but we are determined to address this crisis with the most fiscally responsible public pension reform plan in the history of the United States. I am confident that the rest of the country will pay close attention to this excellent work by our legislature and for good reason. For those retired, for those still working, and for those yet to come: we are truly fixing our broken pension systems. United we stand. Divided we fall.”
—Kentucky Gov. Matt Bevin, quoted in, “Gov. Bevin, Senate President Stivers and House Speaker Hoover Unveil Plan to Save Kentucky’s Pension Systems (press release),” October 18, 2017.

“[Pension] returns haven’t been good enough and that is why there is a big pension hole in the US; a hole that would look even bigger if the schemes used the same form of accounting as companies have to. And that creates a further problem; the current accounting approach assumes it is cheaper to fund a public pension than to fund a private one. And that makes no sense.”
—Buttonwood (blog), “Can you afford to retire?,” The Economist, October 5, 2017.

“It’s not sustainable. These costs are going to make things incredibly challenging.”
—City of Sacramento, CA finance director Leyne Milstein on a projected doubling of Sacramento’s pension contributions over the next seven years, quoted in Brad Branan, “California cities get next year’s pension bill,” Sacramento Bee, October 13, 2017.

“By not addressing the pension problem [Los Angeles’] officials are setting the table for civil conflict. Retired public employees did not cause the pension problem but neither did the citizens, taxpayers and new or un-hired public employees suffering the consequences. By not acting, uncourageous elected officials are effectively throwing those innocent parties into a boxing ring to fight over declining dollars for jobs, benefits and services they prize and expect. They will unfairly blame each other when the real culprits are the elected officials who created the problem and those who neglected to act in time to defuse the consequences.”
—David Crane, “While LA Sleeps,” Medium.com (blog), October 22, 2017. » return to top

Contact the Pension Reform Help Desk The Pension Integrity Project’s Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org. » return to top

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 leonard.gilroy@reason.org. Leonard Gilroy
Senior Managing Director, Pension Integrity Project
Reason Foundation

Anthony Randazzo
Managing Director, Pension Integrity Project
Reason Foundation

The post Pension Reform Newsletter – October 2017 appeared first on Reason Foundation.

My colleague Zach Christensen puts forward an answer to this question in a new commentary and infographic that breaks down the top public sector pension plans for each state and re-discounts the value of their liabilities using a market value of liabilities. The results create a fascinating list that singles out not only poorly funded plans, but also well funded plans that are using particularly high discount rates (thus exposing that their reported health may not be as strong as intimated).

Zach ranks states by how much the estimated value of pension obligations would increase when adopting a market valuation of liabilities practice. The top 10 worst states in Zach’s list based on FY2015 numbers are:

1. Arizona (83% increase)
2. Georgia (63% increase)
3. South Dakota (61% increase)
4. Washington (60% increase)
5. Nevada (59.4% increase)
6. Alabama (59.3% increase)
7. Mississippi (58.9% increase)
8. Minnesota (58.4% increase)
9. Connecticut (57.8% increase)
10. North Dakota 57.1% increase)

One thing that is interesting is that this contains reportedly well funded and poorly funded plans. For example, South Dakota is typically one of the top five plans in the county, while North Dakota’s teachers and public employee plans were both less than 70% funded last year. The reason the list includes such a range of plans by funded status is that they share in common a single trait — the use of a high discount rate. The average discount rate used by the 10 best states the ranking is 6.9% while the average discount rate for the 10 worst states was 7.8%. Thus, for those on the top of this list there is just a larger delta between their current practices and the use of market discount rates.

As Zach writes:

Every state pension plan gets to decide what kind of accounting practices it wants to follow when reporting the value of its assets and size of its unfunded liability. As a result, states have adopted a range of different approaches, leading to inconsistencies in the reported amount of pension debt compared to more accurate methods of measuring the promises made to teachers, police officers, firefighters, and other public-sector workers. And it should not be a surprise that some states are using practices that significantly understate the amount of their promised pensions.

Check out the full write up here.

Check out the infographic below:

The post How Much Do Reported Pension Obligations Increase When Using a Market Valuation of the Promised Benefits appeared first on Reason Foundation.

The op-ed’s author notes that West Virginia closed its DB plan for teachers in 1991 and replaced it with a DC plan. So far, so good. He then cites a series of complaints about the DC plan that was created, and things spin off the rails quickly:

• “Initially there were only seven investment options to choose from.”  — On its face this is not actually bad, as too much choice can be overwhelming to participants. Generally speaking, DC plans should offer 5 to 15 options for participants, with clear descriptions of the differences and a range of option types for different kinds of risk tolerance and retirement goals.
• “Some of the options mirrored each other and didn’t properly allow for investment diversification.” — This certainly sounds like a failure of governance to ensure that the DC plan offered a good mix of options. Other public sector DC plans commonly offer investment options that reflect different risk profiles and options that automatically reallocate and rebalance contributions over a participant’s working life (e.g., target-date funds), so getting the investment mix right need not be rocket science.
• “Additionally, the state offered no education for participants.” — This is abjectly a terrible failure on the part of the DC plan West Virginia set up, but Kentucky can easily avoid this problem with a statutory provision. Providing education and counseling is a best practice that every DC plan should offer. In fact, Arizona’s 2016 public safety pension reform set up an optional (and generous, at an 18% minimum contribution rate) DC plan for new police officers and firefighters, and the law requires the DC plan’s third-party administrator to offer investment education, counseling, and individualized plan advice to participants, via a federally registered investment advisor.
• “By 2005 it became clear the 401(k) system would not provide an adequate retirement for its participants.” — With poor governance and investment options, this is not surprising. This is also a mistake that Michigan made when it first set up its DC plan for state employees in the late-1990s. However, Michigan has since fixed its program and runs one of the better DC plans in the country. West Virginia could have simply done the same. If Kentucky wants to create a DC plan for new teachers, it simply needs to follow best practices, such as a wide mix of investment options that can match different retirement goals, statutorially required education, and contributions between 15% and 20% (combined from the employer and employee) for those not in Social Security.

Collectively, these arguments in the Herald-Leader offer a very, very weak case against defined contribution retirement plans, and if Kentucky wants to avoid West Virginia’s experience, they simply need to design a DC plan using modern best practices, as other states are doing.

Just consider that the particular plan in West Virginia that is being discussed was set up in the 1990s and clearly didn’t follow best practices. Over the past three decades the financial industry has evolved immensely. There has been exponential growth in the kinds of products and services that are provided to DC plan participants. As just one example: when West Virginia launched its DC plan there were no target-date funds that automatically rebalanced portfolios with a desired retirement year in mind. Including target-date funds in a line up of options is now not just a best practice, but probably should be the default option for any plan auto-enrolling its members.

In short, we’ve learned a lot about how to build world class DC plans over the past few decades, and all of that knowledge can be applied in Kentucky. The DC plans recently built for teachers in Michigan and public safety officers in Arizona provide a good guide for Kentucky in ensuring any future DC plan for its teachers provides a meaningful retirement benefit.

Beyond the weak criticism of DC plans in the context of West Virginia’s DC, the author of the Herald-Leader op-ed went on to make a few more claims:

• “The state was now having to pay toward the existing unfunded liability of TRS and pay for the new 401(k) plan as well… [this] was one of many unintended consequence of creating the new retirement system.” — That is not an unintended consequence, that was part of the plan. Creating a DC plan for new hires does not eliminate the debt in the plan for existing DB members. States should live up to their promises and pay out all earned DB plan pensions, and that requires paying off the debt overtime. The benefit of such an approach is that the state avoids racking up even more DB plan debt as more and more people are hired into the new DC plan.
• “West Virginia ultimately did the right thing… we developed a plan to pay down the debt in the TRS pension plan. That commitment to our pension plan has been held up as a model and has turned our worst funded pension plan into one that is over 62 percent funded.” — Not really. What West Virginia actually did was take a $807 million a tobacco settlement and dump it into the pension fund. To be clear, this was a great policy choice. But it could have been done without re-opening the DB plan and it was not a “plan to pay down the debt.” Between 1991 and 2005, the funded ratio for West Virginia’s teacher plan climbed from around 10% all the way to 24.6%. Over two subsequent years tobacco settlement money caused the funded ratio to jump to 51.3%. That this coincided with re-opening the plan is simply a correlation, not causation. This is not evidence that somehow warns off creating a DC plan for new hires. (Nor is having a 62% funded DB system anything to crow about.)

Again, the author has created the false impression that adopting a DC plan somehow had made the DB plan worse (it had not), and that re-opening the DB plan was the catalyst to better funding (it was not). There is a gross misunderstanding of cause and effect. Not to mention absence of some really important facts.

The reality is that there are lots of ways to mismanage a defined contribution plan — having low contribution rates, bad investment options, and no education for participants are top of the list. There are lots of ways to mismanage shifting from a DB plan to a DC plan over time — we have written about them, and foremost among the problems is failing to pay down the DB plan’s debt and keeping unrealistically high assumed rates of return. But these are all problems that can be avoided.

If Kentucky, wants to create a DC plan for future hires the state can do so responsibly and in such a way that it helps preserve the retirement benefits for members currently in the pension plan. Creating DC plans for new hires helps to reduce risk for taxpayers and puts a cap on the growth rate of pension debt — and that can be a huge advantage for a state that wants to start paying its bills and stop kicking the can down the road.

The post Kentucky Can Accomplish World Class Pension Reform by Learning from West Virginia Mistakes appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights

• Analyses of Kentucky Pension Crises Set Stage for Reform Discussions
• Favorable Investment Returns for Pension Funds…This Year
• Do Public-Sector Employees Overwhelmingly “Choose” DB Plans?
• Effects of Alternative Investments on Returns and Volatility
• Los Angeles City, County Facing Massive Pension and OPEB Debt

Quotable Quotes on Pension Reform

Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Analyses of Kentucky Pension Crises Set Stage for Reform Discussions

Late last month, the consulting firm PFM Group released the final of a series of reports analyzing the causes of Kentucky’s current pension crisis and recommending a bold and far-reaching package of proposed solutions that include changes to actuarial assumptions and debt amortization methods, freezing benefit accruals and moving current and future state and local non-hazardous workers to defined contribution retirement plans on a prospective basis, and a host of other funding policy and benefit changes affecting retirees, active workers and future workers alike.

In the wake of the report, Gov. Bevin and legislative leaders have reportedly begun discussions about a comprehensive reform effort expected to culminate in a special legislative session later in the fall. With Kentucky having among the worst underfunding and the highest pension-related burden among the states, Kentucky policymakers’ efforts will be watched closely by pension experts nationally.
» Saving Kentucky’s Pensions (official Bevin administration website)
» PFM Group reports on Kentucky’s pension performance & reform recommendations
» Pension underfunding cited in Kentucky’s July 2017 credit rating downgrade

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Favorable Investment Returns for Pension Funds…This Year

Preliminary fiscal year 2017 investment returns for public sector pension systems are starting to roll in, and the news is mostly good. This is a welcome change of pace for retirement systems across the country, given the anemic investment returns for the past two fiscal years (2015 and 2016). But according to Reason’s Anil Niraula and Daniel Takash, just as one bad year won’t permanently alter a pension plan’s financial future, one year of impressive investment gains doesn’t mean public pension systems across the country are out of the woods.
» FULL ARTICLE

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Do New Public-Sector Employees Overwhelmingly “Choose” DB Plans? Not Exactly

A new research paper from the National Institute on Retirement Security and Milliman examined public sector plans that offer participants either a defined benefit (DB) pension or defined contribution (DC) plan and concludes that around 88% of new hires prefer DB plans to DC plans. Reason’s Daniel Takash challenges this interpretation, finding that many of the participants considered did not choose either a DB or DC plan—instead they simply stayed with the default option presented to them, a finding consistent with behavioral economics.
» FULL ARTICLE

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Effects of Alternative Investments on Returns and Volatility

A recent study by the Center for Retirement Research at Boston College explores pension fund investment in alternatives and related impacts on returns and volatility. The study finds that different alternative categories may have different effects on risk and returns. Further, investing in alternatives does not necessarily yield higher returns, and the additional risk involved is not clear either. However, Reason’s Truong Bui finds that this does not mean that the current investments made by public plans are not highly risky.
» FULL ARTICLE

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Los Angeles City, County Facing Massive Pension and OPEB Debt

A recently completed actuarial report shows that Los Angeles County has over $25 billion in unfunded retiree healthcare liabilities, which dwarfs the County’s already sizeable $7.4 billion in unfunded pension liabilities. Meanwhile, the City of Los Angeles is operating three pension funds for its employees that have $10.3 billion in combined pension debt. In a recent set of blog posts, Reason’s Marc Joffe writes that both jurisdictions need to take steps to address these major threats to their long term fiscal sustainability.
» BLOG: City of Los Angeles Pension Gap Surpasses $10 Billion
» BLOG: L.A. County’s $25 Billion OPEB Debt

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Quotable Quotes on Pension Reform

“Modernizing the [Michigan] school employee retirement system means these benefits will be there for retired school employees in the long term, while at the same time protecting taxpayers from escalating liabilities. […] We worked hard to make sure everyone was at the table in discussions about how to best revise the system and I’m thankful for all of the input and collaboration that led to a great outcome for current and future retirees as well as all Michigan taxpayers.”

—Michigan Gov. Rick Snyder on signing into law Senate Bill 401, quoted in “Gov. Rick Snyder signs legislation that protects retirement benefits of school employees, reduces financial risks for taxpayers” (press release), July 13, 2017.

“No more pretending that everything is just fine. […] Everyone needs to understand the severity of the [pension] situation. To do otherwise will lead to solutions that fall short of solving the problem.”

—Kentucky state budget direction John Chilton in an email to city and county officials, cited in John Cheves, “‘No more pretending.’ Kentucky issues dire warning on pensions to local governments,” Lexington Herald Leader, September 7, 2017.

“This crisis is no longer on the horizon, it is at our doorstep. […] The future of Missouri’s finances are at stake, and this is a conversation that we need to have.”

—Missouri State Treasurer Eric Schmitt commenting on the state’s pension plan being only 60% funded, cited in, Summer Ballantine, “Missouri employees’ pension plan underfunded by $5 billion,” Columbia Daily Tribune, September 13, 2017.

“We’re not paying anywhere close to what we should be paying, and if we did it would absolutely decimate schools. […] It’s shocking. The numbers just keep going up, and it’s going to take a lot more out of what we’re able to do for kids in the classroom.”

—Oregon School Boards Association Executive Director Jim Green commenting on Oregon’s rising pension contribution rates, quoted in Ted Sickinger, “PERS: Oregon pension deficit climbs to $25.3B, meaning higher costs going forward,” The Oregonian, September 27, 2017.

“In total more than $250 billion will be diverted from California classrooms to finance unfunded retirement promises. That’s five times more than Bernie Madoff stole. Even the 2008 federal bank bailout doesn’t compare because in that case taxpayers got all their money back plus profits. The money already stolen in the Great California Classroom Robbery —it’s truly a theft, as explained below — will never be recovered and provides a devastating illustration of how “debt devours the future,” as Thomas Piketty puts it in Capital in the 21st Century. The victims are schoolchildren, young teachers and taxpayers.” [emphasis author’s]

—David Crane, “The Great California Classroom Robbery,” Medium.com (blog), July 8, 2017.

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Contact the Pension Reform Help Desk

The Pension Integrity Project’s Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

» return to top

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 leonard.gilroy@reason.org.

Leonard Gilroy
Senior Managing Director, Pension Integrity Project
Reason Foundation

Anthony Randazzo
Managing Director, Pension Integrity Project
Reason Foundation

The post Pension Reform Newsletter – September 2017 appeared first on Reason Foundation.

According to Moody’s:

The [reform] is credit positive for the state and participating local governments in the Michigan Public Schools Employee Retirement System (MPSERS) because these governments will no longer carry the entire burden of investment performance risk for new employee pensions.

The Moody’s assessment is consistent with a similar finding last year after overwhelming voter approval of Arizona’s Proposition 124, a key element of that state’s 2016 public safety pension reform effort:

Approval of [Proposition 124] is credit positive for Arizona and its local governments because it will replace PBIs, which were unfunded benefit increases, with more predictable cost-of-living adjustments (COLAs) that will be funded as part of ongoing plan costs.

The Pension Integrity Project at Reason Foundation is proud to have been part of developing both of these pension reform efforts that have been viewed positively from a state credit rating perspective. Read more about Michigan’s MPSERS reform here and Arizona’s public safety pension reforms here and here.

The post Michigan Teacher Pension Reform is “Credit Positive,” Per Moody’s appeared first on Reason Foundation.

As I wrote last month with my colleagues Len Gilroy and Daniel Takash, “the reform is grounded in a focus on reducing risk, while stabilizing cost, and preserving choice:

• New hires will be auto-enrolled in a defined contribution retirement plan (DC Plan) that has a default 10% total contribution rate. DC Plans inherently have no risk of unfunded liabilities, and the maximum employer share for the plan (7%) is less than what employers should be paying for the current plan.
• However, if new teachers would prefer a defined benefit pension plan (DB Plan), they will have the choice to voluntarily switch to a new “hybrid” plan that, unlike the current “hybrid” plan offered to teachers, uses very conservative assumptions and short amortization schedules and splits all costs 50-50 between the employee and employer.
• Uniquely, the hybrid plan will have a safeguard mechanism that would trigger closure if the funded ratio falls below 85% for two consecutive years.
• And to top it off, the reform design improves certain actuarial assumptions and infuses the plan with $250 million in additional contributions to chip away at the pension debt.”

To be sure, elements of the Michigan teacher pension reform can be found in other retirement system changes in other states. But no state in the country thus far has embraced the full scope of these reform components for a teacher pension system in a way that will virtually eliminate the possibility of unfunded liabilities for new hires, while also allowing future teachers a choice of retirement benefit styles (DB or DC).

Some other plans in the country have adopted similar components as the Michigan teacher pension reform:

• Florida moved to default employees into a DC Plan earlier this year.
• Pennsylvania overhauled its retirement benefits earlier this month by giving new hires a choice between two hybrids or a DC Plan.
• Arizona has embraced 50-50 cost sharing for its public safety, state employee, and teacher defined benefit plans.
• South Carolina changed its funded policy to increase employer contribution rates by 100 basis points a year until 2023.
• And Kentucky’s state and local pension system moved to adopt a very conservative 5.25% assumed rate of return last month.

The structure of this blended approach should serve as a model for teacher pension reform in other states facing similar challenges as MPSERS does today.

Read our whole story on the Michigan teacher pension reform effort here.

Read our comments in the Detroit News on how the reforms will be good for teachers here.

Read our testimony on the merits of the Michigan teacher pension reform effort here.

The post Snyder Signs Michigan Teacher Pension Reform Into Law appeared first on Reason Foundation.

Though, to read the press release from the Governor’s office you’d think he was the nation’s biggest pension hero, instead of the perennial pension underfunder that is suggested by the facts. The statement is so remarkable that we felt the need to mark it up with some commentary on what is actually going on in New Jersey:

• Pension Integrity Project Comments on “Gov. Christie’s 8th and Final Budget Statement”

The post Marking Up Gov. Christie’s Pension Math appeared first on Reason Foundation.

Costs of paying off the state’s rising teacher pension debt are scheduled to skyrocket and consume any future resources that could otherwise be used to increase teacher pay or get money into the classrooms. Absent reform, this debt growth would have been unconstrained and posed a threat to the retirement of teachers across the state.

Retirement security and good compensation for teachers are important issues to us. Professionally, we work on a national project that aims to ensure pension plan solvency and retirement security for public sector workers. Personally, we both have close family who are active or retired teachers in Michigan.

We firmly believe that states need to keep 100 percent of their pension promises, and Michigan’s new reform legislation does that. First, all new teachers will have a real choice of retirement plans upon hiring and can pick the option that works best for them and their families. The default is a “defined contribution” retirement plan similar to the 401(k)s offered in the private sector, but with a big difference – teachers do not have to pick their own investments or make strategic allocation of assets if they do not want to.

Teachers could simply set their preferred retirement date – say 35 years in the future – and let professionally designed “target date funds” reallocate their assets over time in a way that creates minimal risk and maximizes return. And they can choose to purchase annuities if they’d like their benefits distributed just like a traditional pension check.

The other option is a “Pension Plus” plan with the same defined benefit pension currently offered to teachers, but with its own big difference – the state will be more honestly accounting for the cost of providing this new benefit than they are now. Ensuring that pension benefits are accurately priced by actuaries to avoid pension debt is what makes Michigan’s new retirement legislation so strong. Plus, where teachers currently pay two-thirds of the costs of the pension plan, under the new design they will pay 50 percent of costs.

Second, 20 percent of teachers hired since 2012 have chosen an optional-but weak-401(k)-style benefit over a pension, where if they put in 6 percent, their employer matches an additional (and skimpy) 3 percent. The reform upgrades this benefit to match the new defined contribution plan, where new teachers will only have to put in 3 percent of their salary and to get 7 percent from their employer.

Last, for retirees or teachers who have already earned pensions, the adopted legislation creates a viable path to solvency for their beleaguered pension fund $29 billion in debt. Absent changes, Michigan was on track to see pension debt payments effectively double by the 2030s, requiring billions in annual debt payments for teacher pensions coming out of the state’s School Aid fund (instead of going into the classroom or enabling teacher pay increases).

Unfortunately, the state has currently saved less than 60percent of the money it needs to pay promised pension benefits. This dismal fiscal position is mostly because actuarial assumptions used to determine annual contributions for the pension fund have been consistently inaccurate. For example, the state has consistently underperformed its expected rate of return on invested assets for the past 20 years. As a result, Michigan had over $2 billion in required pension debt payments last year – more than 25 percent of the amount paid in salary to teachers.

Fortunately, the Legislature and governor are embracing more realistic assumptions about the cost of funding pensions and planning to chip in more money every year down the road to get pension debt paid off. While there is still more room to adopt better assumptions, this year’s state budget allocates an additional down payment towards the debt of over $200 million.

Teachers themselves should welcome the new reforms. Not a single dollar of pension benefits was cut. Teachers currently in a weak retirement plan are getting a sweetened benefit in the process. Future teachers will have a real choice between generous defined contribution plan or a pension (with a similar benefit as today’s teachers). And the Legislature is depositing hundreds of millions more into the pension fund. All together, the reform package will ensure retirement security for every teacher in Michigan.

This column originally appeared in The Detroit News.

The post Pension Reform Will Help Michigan Teachers appeared first on Reason Foundation.

• Michigan Adopts Nation’s Most Innovative Teacher Pension Reform
• Pennsylvania Enacts Major Pension Reform
• Texas Enacts Dallas, Houston Pension Reform Legislation
• Florida to Default New Hires to Defined Contribution Retirement Plan
• News Notes
• Quotable Quotes

The full newsletter is available here, and previous editions of the newsletter are available here.

The post Pension Reform Newsletter #37 (June 2017 edition) appeared first on Reason Foundation.