Pension Reform Newsletter – October 2014

This newsletter highlights articles, research, opinion, and other information related to public pension problems and reform efforts across the nation. To find previous editions, please visit https://reason.org/newsletters/pension-newsletter/.

Articles, Research & Spotlights

• Best Practices in Pension Reform
• Interview: How to End the Public-Sector Pension Crisis
• Pension Reform Handbook: A Starter Guide for Reformers
• California Public Pension Cuts Ties with Hedge Funds
• Stockton’s Bankruptcy: California Public Pensions Put on Notice
• Podcast: Prospects for State Pension Reform
• The Public Sector Ponzi Plan
• Connecticut’s Pension System: “Born Broke”
• Pennsylvania’s State Employees’ Retirement System: Does the Defined Benefit Plan Benefit Public Employees?
• State Pension Funding Review

Quotable Quotes on Pension Reform

Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Best Practices in Pension Reform
By Lance Christensen and Adrian Moore, Reason Foundation

A recent report at Reason Foundation assesses the lessons learned from various efforts to reform public employee pensions in jurisdictions across the United States. It draws on the experience of policymakers, officials and campaigners in Michigan, Alaska, Utah, Rhode Island, San Diego and San Jose to outline a series of best practices that will equip a willing and motivated pension reformer with the tools he or she needs to bring about substantive change.

This document is largely an excerpt from our Pension Reform Handbook: A Starter Guide for Reformers, published in July 2014. It also captures the experience of several jurisdictions that have successfully navigated reform, as spotlighted in our series of case studies, which can be found at Reason.org.

To read the report, go here.

Interview: How to End the Public-Sector Pension Crisis
By Adrian Moore, Reason Foundation

In an 8-minute interview, Adrian Moore, vice president of policy at Reason Foundation, talks with Reason TV’s editor in chief Nick Gillespie about the public pension crisis. Moore starts with the debt numbers: “Optimistic scenario: it’s $1 trillion dollars in unfunded liabilities… Much more realistic scenario: you’re looking at $2 trillion to $4 trillion.”

Moore then explains how important it is for states and cities to pay the annual required contributions. Not setting aside these required contributions each year creates unfunded liabilities, which compound at the assumed discount rate. “Places like New Jersey are not putting that money aside. They’re essentially saying ‘we’ll have to make up for that in the future without the interest earnings.’ So it’s a compounding debt,” says Moore.

In the interview, Moore lists three kinds of problems that get states and municipalities into pension trouble:

• Not making pension contributions that are supposed to be made,
• Assuming an unrealistic rate of return,
• Ratcheting up pension benefits to unsustainable levels.

To read more about the interview, go here.

Pension Reform Handbook: A Starter Guide for Reformers
By Lance Christensen and Adrian Moore, Reason Foundation

Reason Foundation has just released a pension reform handbook as a comprehensive starter guide for state and local reformers. This handbook aims to capture the experience of policymakers in those jurisdictions that have paved the way for substantive reform, and bring together the best practices that have emerged from their reform efforts, as well as the important lessons learned. By presenting these alongside the general principles and approaches that work to reform public policy, this handbook represents a “what you need to know” starter guide for anyone planning to reform his or her jurisdiction’s pension system.

The handbook begins by outlining the causes of pension problems, before taking the reader through seven pension reform case studies. It offers guidance to policymakers seeking to research their jurisdiction’s pension problem, lays out the general principles of reform, and then examines in detail what it takes to build a successful reform effort from the ground up.

To access the handbook, go here.

California Public Pension Cuts Ties with Hedge Funds
By Victor Nava, Reason Foundation

Last week, the California Public Employees’ Retirement System (CalPERS), the largest public pension system in the U.S., announced that it’s going to divest its assets from hedge funds. The move to withdraw about $4 billion of CalPERS $299 billion in total funds is the result of years of poor performance from hedge funds that come at a steep cost and with substantial risk. What led so many U.S. pension funds to invest in hedge funds in the first place? The answer is a long history of unrealistic expectations and mismanagement on behalf of the state government.

CalPERS’ foray into the world of hedge funds has not only been plagued with scandals, it has been a disappointing investment. In 2013, CalPERS paid $135 million in fees to hedge funds and generated a rate of return of 7.1 percent. Over the last 10 years, the annualized rate of return on its hedge fund investments has been a mere 4.8 percent. CalPERS turned to hedge funds back in 2002 as the result of the growing cost of public employee retirement benefits and the high assumed rates of return that pension funds are expected to generate on an annual basis. In some states and municipalities, these expected rates of return can be as high as 8 or 9 percent. In California, CalPERS currently assumes an expected rate of return of 7.5 percent, down from an 8.25 percent expected rate of return in 2003. CalPERS’ actual rates of return on total investments since 2003 have failed to meet expectations, averaging 6.68 percent.

To read more about the issue, go here.

Stockton’s Bankruptcy: California Public Pensions Put on Notice
By Steven Greenhut, via Reason.com

Public-employee pensions are not protected when a city goes belly-up, according to a ruling Wednesday by the judge overseeing Stockton’s much-watched federal bankruptcy case. Judge Christopher Klein’s few words have re-energized the state’s disheartened pension-reform movement – and left the nation’s most-powerful pension fund reeling.

One can’t go a day in Sacramento without hearing about a “historic” piece of legislation or a “groundbreaking” decision, but the Stockton case – held in a downtown Sacramento courthouse – could change everything on the pension front. Klein said in the verbal ruling that pensions are just another contract: “Impairing contractual obligations – that’s what bankruptcy is all about.”

Until now, there has been no way for California cities to get out from underneath the overly generous pension promises they have made to public employees over the past 15 years, the result in part of a pension-increasing bonanza spurred by 1999 legislation championed by the California Public Employees’ Retirement System.

To read more about the issue, go here.

Podcast: Prospects for State Pension Reform
By Lance Christensen, Reason Foundation

Lance Christensen, director of Reason Foundation’s Pension Reform Project, sat down with Caleb Brown, director of multimedia at the Cato Institute, to discuss the dire situation of state and local pension funds across the country. After reviewing the root of the pension problem and case for reform, Christensen and Brown discuss the right questions interested parties, taxpayers and lawmakers can ask fund managers and actuaries to set the stage for pension reform. They also talk about best practices in pension reform and address common misconceptions and objections to reforming failing systems. More can be found on the basics of pension reform in the following piece, The Public Employee Pension Crisis Explained.

To listen to the podcast, go here.

The Public Sector Ponzi Plan
By Maureen Bader, Wyoming Liberty Group, and Lance Christensen, Reason Foundation

Pension misunderstanding and misinformation are alive and well in Wyoming. Talking about pension reform raises both hopes and hackles. While many worry about the legacy of pension debt, the resulting tax hikes and service reductions imperiling future generations, others drag out the litany of common, but incorrect, objections to reform.

In a recent article, Maureen Bader from the Wyoming Liberty Group and Lance Christensen from Reason Foundation tackle some popular objections to pension reform in Wyoming. These objections range from low investment returns in defined contribution plans to “pension liability as 30-year mortgage”.

To read the article, go here.

Connecticut’s Pension System: “Born Broke”
By Truong Bui, Reason Foundation

A recent analysis by the Yankee Institute for Public Policy shows a bleak picture of Connecticut’s public pension system. By the state’s own estimations, pension liabilities for active and retired state employees, teachers, and judges totaled $48.2 billion in 2012. The total assets, however, were only $23.7 billion, leaving an unfunded liability of $24.5 billion. The funded ratio was as a result 49 percent, one of the lowest in the nation.

The official numbers however do not show the whole picture. Connecticut’s pension system is in a much worse shape if a more realistic discount rate is used. A near risk-free discount rate brings the funded ratio down from 49 percent to a dismal 25 percent, which is the second lowest in the US, after Illinois.

If Connecticut’s pension funding is bad enough, its Other Post-Employment Benefits (OPEB) system, which includes healthcare and life insurance obligations, is in a direr state. The OPEB funded ratio in 2013 was 0.6 percent. The state has virtually zero assets ($144 million) to cover $22.7 billion in OPEB obligations. Future generations in Connecticut will bear this huge financial burden if the state does not take early action.

To read more about the analysis, go here.

Pennsylvania’s State Employees’ Retirement System: Does the Defined Benefit Plan Benefit Public Employees?
By Truong Bui, Reason Foundation

Pennsylvania’s State Employees’ Retirement System (SERS), one of the two largest pension plans in the commonwealth, is not very healthy. Based on its own assumptions, which are favorable, the plan is only 59 percent funded, leaving an unfunded liability of $18 billion. A more proper valuation of the debt using a risk-free discount rate points to a funded status of 35 percent. These facts suggest the vital need for pension reform, which would move the system away from the traditional defined benefit (DB) design to a more sustainable model that can be fully funded. Many people do not welcome such a change due to concerns about retirement security. Policy makers should ask whether SERS’s current DB system provides enough retirement security for the public workforce. They might find their answer in the recent study by the Urban Institute.

The study finds that the plan provides modest pension benefits to short and medium-term employees while heavily rewarding long-term workers. This “backloaded” benefit structure essentially has younger and shorter-tenured employees, many of whom serve for decades in state employment, subsidize the pensions of longer-tenured counterparts. Given the fact that most Pennsylvania state employees complete less than 25 years of service, the benefit distribution does not work to the benefit of the majority of the workers. In fact, 76 percent of state-financed pension benefits go to only 25 percent of employees. According to the Urban Institute report card, the plan receives a “C” for rewarding younger workers, an “F” for short-term employees’ retirement income, and a “D” for promoting a dynamic workforce. The plan ranks as the third-worst plan in the United States for covering newly hired general state employees.

To read more about the study, go here.

State Pension Funding Review
By Truong Bui, Reason Foundation

A recently released report by Loop Capital Markets reveals some interesting facts about the state of public pensions in the United States. Using a database covering 247 plans from 50 states, and 84 local plans from 25 large U.S. cities, the report finds that the aggregate funded ratio for state plans dropped slightly from 73.5 percent in 2012 to 73.1 percent in 2013. For major cities, the funded ratio decreased from 65.6 percent in 2012 to 65.3 percent in 2013.

According to the report, state performance tends to be “sticky,” meaning that four of the five best funded pension plans were in the top quartile in 2005, while four of five worst funded plans were in the bottom quartile in 2005.

Funded ratios increased for 19 states in 2013. States with the largest improvements in funded levels were Montana, Oregon, South Dakota, Ohio, Indiana, New Mexico, Utah, and Arkansas. Most of these states appear to be fiscally conservative, have small populations, and have lower union concentration. On the other hand, 26 states saw their funded ratios decline in 2013. The worst performers were New Jersey, Massachusetts, New York, Virginia, Michigan, Kansas, South Carolina, and North Dakota. Funding deterioration, however, seemed to occur under progressive and conservative administrations alike. Most the states that saw the largest drops in funded ratios were weak performers to begin with.

To read more about the report, go here.

Quotable Quotes on Pension Reform

“The fiscal bottom line is that York City does not generate enough revenue to meet its financial obligations, and under the current system it cannot. The biggest driver of those costs is unsustainable retiree benefits. If nothing changes, the annual deficit is projected to grow to $9 million by 2017. The city has been approaching the fiscal cliff for years and without fundamental structural changes, it will fall off. The city’s expenses for retiree health care benefits and claims have steadily grown from $1 million in 2003 to $2.7 million in 2013, while employee contributions to their health care have remained flat. Pension payments have also risen in that time period from $1 million per year to a projected $7.9 million annually in 2015.”
– William R. Hartman, Paul L. Rudy III, and Loren H. Kroh, The York County Community Foundation

“States are playing catch-up — you see more discipline and more public acknowledgment that plans have got to make the required payment every year,”
– Eileen Norcross, senior research fellow at George Mason University’s Mercatus Center

“We need to have an open and honest conversation and address the harsh realities about what could happen and what it would mean to Illinois residents, especially those most vulnerable. It’s not an easy conversation to have, but it certainly is the right thing to do given what’s at stake. Now is the time to have this conversation.”
– Ty Fahner, President, Civic Committee of The Commercial Club of Chicago

“This is yet another alarm that should be going off. Nothing short of both reduced benefits and increased taxes by Chicagoans is going to stabilize these funds. Anything else ignores the dire financial condition. This is an argument to do it as soon as possible. Police and fire have eroded to such a state, the city has very little time to save these funds.”
– Laurence Msall, President, Civic Federation

Contact the Pension Reform Help Desk

Reason Foundation set up a Pension Reform Help Desk to provide information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

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Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website or on Twitter @ReasonReform. As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to lance.christensen@reason.org.

Lance Christensen
Director, Reason Pension Reform Project
Editor