In 2000, the North Dakota Public Employees Retirement System (NDPERS) boasted a 115 percent funded ratio and a $135 million surplus of funds to pay for public employee retirement benefits. Since then, NDPERS has accumulated $1.4 billion in unfunded liabilities. This debt is driving up future costs for taxpayers via debt service and the system has plummeted to only 68 percent funded today (see Figure 1).

Figure 1. A History of NDPERS Solvency (2000-2020)

NDPERS’s structural underfunding is primarily driven by the legislature’s historical use of fixed, statutorily set contribution rates that have consistently been set below the amount actuaries calculate is needed to fully fund all earned retirement benefits. This means that for 15 years the state has consistently failed to pay the actuarially required amount to keep the plan solvent (see Figure 2). For the 2020 fiscal year, the deficit between actuarially required contribution rates and the statutory rates was 5.87 percent of payroll or about $67.6 million in missed contributions.

Figure 2. Actuarially Determined Employer Contribution History, 2000-2020 Actual v. Required Contributions

In addition to inadequate contributions, NDPERS investment returns have failed to meet expectations and this shortfall has contributed to the growth of unfunded liabilities. The investment return assumption for the plan was an unreasonably high 8 percent until 2016 when it was reduced to 7 percent. For every year investment returns fail to meet the return assumption, unfunded liabilities grow. The system has fallen short of even a 7 percent return on average and earned an average investment return of 6.1 percent over the last 15 years, and despite a decade-long bull run in the capital markets, NDPERS never fully recovered from the Great Recession (see Figure 3).

Figure 3. NDPERS Investment Returns History, 1997-2020

During North Dakota’s 2021 legislative session, legislators were poised to tackle the state’s pension underfunding and considered several pieces of reform legislation, including a bill to transform the retirement plan design. This bill passed both chambers but failed to get resolved in the conference committee.

That failure to reach a bicameral consensus was unfortunate, but with some simple and straightforward tweaks to the reform legislation, legislators can build on the momentum created in 2021 to enter the 2023 legislative session with a coherent and sustainable plan to improve NDPERS’s solvency and promote stakeholder equity.

Lawmakers’ previous attempts to update the benefit structure for new hires and improve how the state funds the pension system manifested in several different pension bills that attempted to address North Dakota’s pension challenges in different ways. Most focused on the current plan’s funding policy while one—Senate Bill 2046—made provisions for additional funding for the legacy NDPERS defined benefit plan while directing all new hires into the state’s long-established primary defined contribution retirement plan choice.

The Pension Integrity Project at the Reason Foundation provided technical assistance to numerous state lawmakers in North Dakota both in advance of and during the 2021 session, utilizing our in-house actuarial modeling of NDPERS to assess the financial and fiscal impacts of potential reform solutions.

In the preliminary stages of the legislative process, one of the bills, House Bill 1209, was a simple plan to address the chronic underfunding of NDPERS by switching from statutorily established contribution rates to the actuarially recommended contribution rate. As originally introduced, HB 1209 embodied best practices for properly funding NDPERS by stopping structural underpayments that significantly hindered the system’s ability to grow assets to meet the promises made to public workers for decades. For years, contributions based on statutory rates were woefully insufficient according to both our independent analysis and NDPERS’ own actuaries. The Pension Integrity Project provided testimony regarding these issues during the initial House committee hearing on HB 1209, but the bill was subsequently transformed into a study bill.

House Bills 1342 and 1380 would also have increased contributions in different ways. HB 1342 would have increased employer and employee contributions by 2 percent of payroll each (for an aggregate 4 percent increase), while HB 1380 would have transferred 5 percent of the earnings from the state’s sovereign wealth fund to the NDPERS pension fund as one of several dedicated appropriations. These bills would have both improved the funding status of NDPERS but neither were comprehensive reforms that would have prevented future unfunded liabilities from accruing.

Senate Bill 2046 ultimately became the primary legislative vehicle for pension reform proposals. Originally a simple proposal to increase the NDPERS statutory employee and employer rates by 1 percent of payroll, for a combined total of 2 percent, SB 2046 evolved into a more comprehensive reform effort that included:

• Closing the current defined benefit plan to new workers (except those in public safety positions and judges)

• Enrolling all new hires in the currently optional 401(a) Defined Contribution (DC) plan  

• $50 million in biennial legacy fund contributions

• A one-time $100 million cash infusion

• The separation of plan assets/debt by municipal and state employment

The Pension Integrity Project’s preliminary evaluation of SB 2046 found the measure to be lacking in many crucial objectives of good pension reform.

The reform did not properly amortize debt or sufficiently address the state’s problems with annual contributions below the actuarially determined amount. Actuarial modeling showed that over a 30-year period SB 2046 created a serious risk of bankrupting the NDPERS defined benefit system, findings that were further corroborated by analysis from the system.

Although SB 2046 failed in the conference committee during the last week of the 2021 session, there were several positive developments resulting from the process. NDPERS stakeholders were able to successfully explore and debate the state’s pension issues and took the conversation from the periphery to a burgeoning legislative priority. Policymakers, stakeholders, and taxpayers are now more aware of the issues at hand.

However, increasing awareness is not enough. To save taxpayer dollars and return NDPERS to a path towards full solvency, future efforts to reform NDPERS will need to include policies that address all the challenges that face the beleaguered system, especially those associated with long-term funding. Future changes need to address employer, taxpayer, and employee needs.

Examining Potential NDPERS Reform Options

At the heart of good pension reform is a commitment to paying an actuarially based contribution rate. Setting contributions to align with actuarial recommendations would require higher annual contributions in the near term but doing so would dig NDPERS out of a dangerous funding situation (see Figure 4). As seen in Table 1, paying the actuarially determined contribution (ADEC) each year could reduce long-term costs by over $3 billion by reducing expensive interest on pension debt.

Figure 4. How a Crisis Increases NDPERS Costs

Table 1. Scenario Comparison of Employer Costs—ADEC Reform

Implementing ADEC would ensure that the state contributes at a level that fully funds all accrued retirement benefits regardless of market volatility (see Figure 5).  While this commitment would amortize current NDPERS debt on a fixed schedule—ideally less than 30 years—to avoid runaway interest driving up unfunded liabilities and perpetuating intergenerational inequities should also be included in any future reforms.

Figure 5 shows that when paired with an actuarially determined employer contribution (ADEC) funding policy, shorter amortization periods reduce plan debt and lower overall cost, especially during difficult economic conditions (see Table 2). Amortizing any future years’ worth of NDPERS debt on schedules of 20 years or less significantly reduces the risk of runaway debts in the future.

Figure 5. How a Two Recession Crisis Impacts Debt Amortization Schedules

Table 2. Scenario Comparison of Employer Cost—ADEC Reform + Short Amortization

The use of ADEC funding policy and short amortization schedules are both best practices that should be adopted whether the existing defined benefit plan remains open or not, as these policies would essentially address the current $1.4 billion hole North Dakota currently finds itself in. That said, additional proactive reforms would still be necessary to ensure the system avoids future runaway costs, such as lowering the NDPERS assumed rate of return on investments to limit the system’s exposure to market volatility.

Managing Future Risk through Expanded Retirement Choice

State policymakers should also explore policy reforms to offer new retirement options that better match the needs of today’s mobile modern workforce, which is poorly served by retirement designs that rely on long career tenures.

The simplest way for North Dakota to slow the growth of unexpected costs in the future would be to improve the retirement plan choices available to public workers in North Dakota today, which currently consist of the traditional, default defined benefit (DB) pension plan and the NDPERS defined contribution (DC) retirement plan option available only to non-classified workers by written election today.

According to the North Dakota Office of Management and Budget, there were 7,860 benefited state employees in March of 2021. Only 926, or 12 percent of benefited employees were eligible to join the NDPERS defined contribution plan, and even these 12 percent currently default into the NDPERS defined benefit pension, rendering the current “choice” moot, in effect. The results of this restriction and enrollment method heavily favor the defined benefit plan and basically creates an illusion of choice where little exists.

Unlocking the availability of the state’s existing DC plan to all new workers and flipping default enrollment to the DC plan would substantially limit the ability of NDPERS to incur future debt. This move would provide more choice to new workers who are increasingly mobile and less likely to stay under public employment long enough to enjoy the long-term benefits of the defined benefit plan.

Improving the NDPERS Defined Contribution Plan

Currently, the NDPERS DC plan boasts very healthy contributions rates of an aggregate 14.12 percent of salary, which is aligned with industry best practices. However, there is still room for improvement to make the DC plan a more attractive choice for employees.

North Dakota’s DC plan objectives are currently not clearly defined. Although the plan seeks to provide retirement income, it does not set an income replacement goal or cost targets. This makes it hard to tell if the plan is achieving retirement security for members. Also, the DC plan’s standard distribution method is a lump sum, and the plan doesn’t offer a lifetime annuity option. Without a default annuity option, there’s a heightened risk that DC plan members may prematurely exhaust their retirement fund.

In future efforts, the legislature could also consider a choice-focused retirement reform that could keep a defined benefit option for new workers instead of permanently ending it, as SB 2046 attempted. This could be achieved by creating a new risk-managed pension benefit tier for new hires with cost and risk-sharing features incorporated into the fundamental design that naturally winds up as the legacy NDPERS pension tier in effect today winds down through attrition over time.

This new tier should include a 50/50 cost-sharing provision to help reduce the risk for public employers and taxpayers. Cost-sharing means that employees would match every dollar an employer contributes to the fund. A new reduced-risk tier would also need a firm commitment to paying the actuarially required contribution rate to avoid debt, more conservative actuarial assumptions, and a short amortization schedule to ensure any new debt is quickly paid off.

It’s important to responsibly pay off the current legacy NDPERS pension liabilities no matter what happens with new-hire retirement benefits. Amortizing unfunded liabilities associated with any legacy pension plan over total state payroll (legacy pension participants + new and existing defined contribution participants)—as Oklahoma, Arizona, Florida, Utah, and other states have done in similar situations—ensures that legacy unfunded liabilities are paid down in a fiscally prudent manner.

Conclusion

North Dakota’s retirement system has a clear need for reform. We’ve outlined a few options that would ensure fiscal solvency, reduce long-term risk for taxpayers and maintain attractive retirement options for state workers. Despite the lack of legislative changes in 2021, momentum for reform is clearly building. It’s important to build on this interest during the interim to ensure the 2023 legislative session is more successful. Policymakers should keep in mind that of all the possible outcomes, leaving NDPERS’ problems unaddressed will end up being the most expensive and least secure option for North Dakotans, and this challenge will only become more difficult to address as time passes.

The post The Future of North Dakota Pension Reform appeared first on Reason Foundation.

In future retirement reform efforts, Florida policymakers trying to address the challenges facing the Florida Retirement System should recognize that a more collaborative process, which brings together important stakeholders like taxpayer advocates, public employee unions, and retirement experts, is a necessary component to enacting comprehensive reforms.

Using actuarial modeling of the Florida Retirement System (FRS), the Pension Integrity Project identified key policies and practical solutions that could both provide retirement security for state workers and reduce long-term costs for taxpayers.

In 2000, the FRS defined benefit pension plan for state and local government employees had a surplus of $13.5 billion for employee retirement benefits and was 118 percent funded. Today, the pension plan stands at just 82 percent funded, meaning it has only 82 cents of every dollar it owes in retirement benefits.

The Florida Retirement System also has a total of $36 billion in unfunded liabilities, more simply viewed as public pension debt. Perhaps even more concerning, FRS’ debt is growing quickly and over $6 billion of the system’s debt has accumulated in the last two years, as shown in Figure 1 below.

Figure 1 – Florida Retirement System’s Pension Plan Debt Accrual

This pension debt is the result of a variety of factors, including policymakers waiting too long to adjust to changing market conditions and economic trends.

In 2021, the Florida legislature considered Senate Bill 84, a pension reform bill that was a priority of Senate leadership. The reform bill aimed to stop the state government from accumulating future pension debt. The measure, which passed the State Senate, would not have fundamentally altered the conditions driving the rapid growth of FRS’ unfunded pension liabilities and ultimately the legislation failed to receive consideration in the House before the legislature adjourned.

If enacted, SB 84 would have completely closed the FRS Pension Plan to most future hires. This move would have built upon Senate Bill 7022, which was enacted in 2017 and switched the FRS enrollment default from the defined benefit (DB) plan to the primary defined contribution (DC) plan known as the FRS Investment Plan.

The Pension Integrity Project evaluated SB 84 during the 2021 session, identified the bill’s shortcomings, and proposed substantive areas of improvement. Our analysis found that closing the defined benefit option for new workers would produce some long-term risk reduction for taxpayers because the remaining defined contribution plan would have fixed costs and could not accumulate debt, but this positive impact would take decades to realize. That’s because closing the FRS Pension Plan to new employees alone would do nothing to address the system’s existing debt, which would continue to grow even if the FRS Pension Plan was closed. Thus, SB 84 was not a sufficient proposal to meet the state’s debt challenges and additional provisions would be needed to solve the problems that helped create the system’s $36 billion of debt. Senate Bill 84 also met serious opposition from special interest groups, primarily public education associations. Although the concerns levied by these groups were generally misdirected and sometimes ill-informed, including these groups in future reform efforts may help minimize future policy conflict.

With the failed 2021 attempt at retirement reform now in the rear-view mirror, Florida is still in need of a polciy solution to its public pension problems. Below we outline a few of the issues that still face both the FRS defined benefit pension plan and the FRS Investment Plan. Using actuarial modeling we present our long-term evaluation of SB 84’s proposed closure of the existing defined benefit plan for new workers, along with an alternative reform option that would better address the challenges facing stakeholders and the state of Florida. Under the Pension Integrity Project alternative reform option, future workers would still have the option to participate in a defined benefit plan and, with the introduction of improved risk and contribution policies, the alternative would reduce long-term costs and financial risk in ways that SB 84 would not have achieved.

Florida Retirement System’s Funding Challenges

The first pension-funding challenge that Florida policymakers need to face is the system’s unrealistic expectations for market returns. Over the last 13 years, $16.4 billion of Florida’s pension debt has come from failing to meet overly optimistic investment return assumptions.

Every year that FRS fails to meet its investment return assumption, public pension debt grows. Adopting more realistic investment return assumptions should be a top priority for state policymakers because this problem will likely continue to add debt to the system if it is not addressed.

FRS historically assumed an investment return rate as high as 8 percent before lowering the assumption to 7.75 percent in 2004. The system has adjusted the investment return assumption annually since 2014, to reach the current assumed rate of 7 percent for 2021.

Although progress has been made on this front, the system’s expectations are likely still too high for the long term. The FRS modeling that was developed in 2017 by Milliman and Aon Hewitt found that the 50th percentile geometric average annual long-term future returns would be in the 6.6 percent-to-6.8 percent range. Models developed in 2018 by Milliman and Aon Hewitt showed FRS should expect average annual long-term future returns in the 6.4-6.7 percent range, yet the FRS Actuarial Assumption Conference adopted a 7.4 percent return assumption. Presenters at the 2020 FRS Actuarial Conference suggested return assumptions within the range of 6.46 percent (Aon) to 6.56 percent (Milliman).

The Florida Retirement System’s average investment return for the last 20 years was 6.81 percent, well below the current 7 percent assumption (see Figure 2). The market forecasts for the next 10 to 15 years indicate that FRS is more likely to see returns around 6 percent. That means FRS is still likely to experience perpetually growing pension debt unless the system’s investment return assumptions are reduced even further.

Figure 2 – Florida Retirement System’s Investment Return History, 1996-2020

Source: Pension Integrity Project analysis of FRS actuarial valuation reports and CAFRs.

Florida’s policymakers also need to address the amortization policies of the state’s retirement system. Long debt-payment schedules have contributed to Florida’s inability to pull itself out of its pension debt over the past decade. It is expensive to hold large amounts of unfunded pension liabilities and the longer the state takes to pay off these pension debts, the more it will cost taxpayers in the long run. Florida policymakers need to address this challenge going forward by shortening amortization schedules for any newly accrued debt.

Furthermore, the existing defined contribution option, the FRS Investment Plan, which is offered to new hires, has major problems of its own that are worth tackling as part of any future retirement reform effort. The employer and employee contribution rates for the Investment Plan are low relative to typical private-sector standards, suggesting that many government employees could eventually retire without having sufficient post-retirement income.

Retirement professionals recommend contributing between 10 to 15 percent of an employee’s annual income toward the main retirement account for those participating in Social Security. FRS Investment Plan members, however, contribute just 3 percent of their salaries to their individual retirement accounts, with the state contributing another 3.3 percent. In total, about 6.3 percent of an employee’s pay is going into employees’ retirement accounts, far below even the low end of industry norms. 

Sadly, many workers in the defined contribution plan may be under the false impression that they are saving enough for retirement. If these issues are not addressed, many FRS Investment Plan members may find themselves with income replacement that is substantially below their needs or expectations when they retire.

Evaluating Retirement Reform Options

The Pension Integrity Project has incorporated the above reform elements into actuarial modeling to demonstrate the varied impacts of potential reforms. The analysis below displays the contribution and funding outcomes of three different options:

• Status Quo (baseline)—Represents the current state of FRS, no changes are made.

• Senate Bill 84 (as passed in Senate)—Closes the DB Pension Plan to all new hires except special risk members. Includes no other funding or risk-related policy changes.

• Alternative (a better option for future retirement reform efforts) — This option gives all new hires, regardless of class, the choice between a new, risk-managed, 50/50 cost-sharing FRS Pension Plan and a higher funded FRS Investment Plan. It gradually lowers the FRS assumed investment rate of return to 6 percent and adopts 15-year layered amortization for any new unfunded liabilities as risk-reduction measures for the legacy defined benefit plan.

Reason’s analysis of SB 84 during the legislative session indicated that simply closing the state’s defined benefit plan for new workers would do little to affect contributions into the fund over the next 30 years and therefore would not sustainably improve the state’s ability to fully fund FRS amid a volatile and unpredictable financial future.

By contrast, the alternative reform proposed in this analysis would gradually reduce the Florida Retirement System’s assumed rate of return and would reduce the amortization period used for paying down any new pension debt. These moves would noticeably alter the state’s contributions to the plan over the next three decades. As shown in Figure 3, if we assume a 7 percent constant rate of return over 30 years, the alternative will require higher employer contributions upfront to accelerate the elimination of unfunded liabilities. But in return, rates level out near or below the status quo and SB 84 over the mid-and long-term, a prudent tradeoff to eliminate risk.

Figure 3 – State Contributions for Reform Options if Experience Matches FRS Assumptions

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are adjusted for inflation.

Assuming economic uncertainty in the decades ahead, the next figure models two recessions, in 2021 and 2036, and 6 percent constant returns in the remaining years. Figure 4 shows that the changes proposed in SB 84 would make little difference to year-to-year state contributions. Since these rates would be based on the same assumptions and amortization policies that generated the system’s current $36 billion in pension debt, SB 84 would not have prevented further debt from accruing if FRS’ assumptions prove inaccurate.

Figure 4 – Contributions for Reform Options in Volatile Market Scenario

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100percent actuarially required contributions. Values are adjusted for inflation.

Under the proposed alternative reform the state would agree to higher up-front contributions that would be more reflexive to market returns, as shown in Figures 3 and 4. This change would be the key to establishing a more resilient retirement system that could maintain a path to full funding even under market stress scenarios. Actuarial modeling of the system’s unfunded liabilities (see Figure 5) shows that outside of the idyllic and unrealistic status quo assumptions, FRS is still very vulnerable to the same pressures that caused the system’s $36 billion shortfall in the first place. The reforms proposed in SB 84 would have done nothing to rectify this issue.

Committing to more realistic return assumptions and accelerating amortization payments, however, would insulate the system from future market volatility. Adopting the reform options outlined in our proposed alternative would ensure that Florida is on a path to reducing unfunded liabilities, even while facing a volatile and unpredictable future.

Figure 5 – Florida Retirement System Funding Under Reform Options

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are adjusted for inflation.

Table 1 shows that under the current 7 percent investment return rate assumption, SB 84 would have only marginal reduced the system’s debt and would have failed to generate the same cost savings as the alternative reform design under most market scenarios. Under stress-tested scenarios, SB 84 outperforms the status quo but fails to contain the overall debt, leaving taxpayers still exposed to major risk of continuing unfunded liabilities at the end of the 30-year forecast period.

Florida is facing the very real possibility of dedicating hundreds of billions of additional dollars toward FRS over the next 30 years. Apart from the unrealistic status quo investment return assumption, these extra funds would make practically no progress in reducing the state’s expensive pension debt. While requiring a commitment of higher annual contributions upfront, the alternative proposal would steer FRS away from this no-win situation.

Table 1 – Long Term Results of Different FRS Reform Options

Source: Pension Integrity Project actuarial forecast of FRS. The state is assumed to make 100 percent actuarially required contributions. Values are rounded and adjusted for inflation.

A Summary of Policy Suggestions

Florida policymakers are right to be concerned about the solvency of the state’s pension plan. However, simply closing the Florida Retirement System’s Pension Plan for future hires isn’t a complete solution. For Florida legislators seeking to implement meaningful pension reform next session, it is important that the state address the structural issues plaguing FRS in order to restore solvency and avoid making costly long-term mistakes. This means both tackling the still-growing debt of the defined benefit FRS Pension Plan and building a better-defined contribution FRS Investment Plan for current and future workers.

Next session, pension reform efforts should be centered upon the goals of all stakeholders. State policymakers can do this by considering the following:

• Reducing risk
  • Close the existing FRS pension to new hires and offer a new FRS defined benefit pension option for new workers with the same level of benefits as the current plan, but with features to reduce long-term governmental risks and costs (e.g., 50/50 employer/employee cost sharing and a conservative investment return assumption).
  • Gradually lower the assumed rate of return for the legacy plan to 6 percent.
  • Reduce the amortization period to 20 years or less for legacy debt and to 15 years for new debt.
• Improving the defined contribution plan rates.
  • Gradually increase both employer and employee contributions to the DC plan so contribbutions are above 10 percent of pay.

Conclusion

Florida’s policymakers, public workers, and taxpayers should seek to secure the Florida Retirement System so its ability to keep promises made to workers does not depend on everything going exactly as planned—a recipe that has not panned out over the last decade. The above analysis demonstrates the importance of testing any future potential reforms with an actuarial analysis that includes a variety of potential market outcomes, including those that fall below the plan’s expectations, a practice that is commonly known as stress testing.

There are various ways to achieve the legislative goals of eliminating or vastly reducing current and future public pension liabilities while improving the overall resilience of the Florida Retirement System. However, if Florida doesn’t address the rising debt within its defined benefit plan and continues to use insufficient contributions into the defined contribution plan, taxpayers will likely continue to be saddled with billions more in debt and the long-term retirement security of many public workers will be at risk.

The latest retirement reform effort fell short, both in the actual proposal and the ultimate legislative outcome. The good news is that state legislators do appear to be aware of the problem. Going forward, policymakers should try to foster a more collaborative process that involves as many stakeholders as possible, which will improve the chances of success in the end. To avoid perpetually growing public pension debt and costs, policymakers should also seek out a more comprehensive solution. Lastly, it is crucial to use actuarial analysis and stress testing to properly identify the changes that will effectively address all of the challenges FRS faces.

The post The Florida Retirement System Is Still in Need of Reform appeared first on Reason Foundation.

The three pension systems offered by the city of Hollywood, which provide benefits for firefighters, police officers, and general employees, are each approximately 58 percent funded. This means that for every dollar in retirement promises made to Hollywood’s employees, the city only has 58 cents in assets to pay for them.

By pulling more and more funds from the city’s budget each year, this pension debt could threaten other public priorities like road repairs, public safety, and other key government services. If Hollywood’s economic growth plateaus or another economic recession hits, there will likely not be enough money to both pay retirees and fund essential services. This would likely mean increased taxes, higher contribution rates for employees, or benefit cuts.

Funding for Hollywood’s pension plans has deteriorated sharply since the year 2000, when all three pension plans had more than 80 percent of the assets they needed to pay for future benefits. One reason for this is that the city’s pension plans use overly optimistic investment return assumptions. For example, the city’s fire and general pension plans assume annual investment returns of 7.5 percent, and the police plan assumes an 8 percent return on investments. The average assumed rate of return nationwide is only 7 percent. And a half of a percentage point difference can add hundreds of thousands more in debt each year.

Although Hollywood’s pension plans have had a few years with good investment returns recently, much of this growth has gone to current retirees rather than improving the position of the severely underfunded municipal pensions. As the Sun-Sentinel reported in 2019, Hollywood is one of only five Florida cities to offer pensioners a so-called “13th check” — an extra monthly pension payment when asset returns are strong.

In addition to Hollywood’s pension debt, the city makes no effort to save for retiree health care benefits. Instead of putting aside funds each year and letting the assets grow in the investment market, the city chooses to take the more expensive route and pay retirees out of pocket each year. As a result, the city’s balance sheet shows another $530 million in retiree health care benefit debt.

Relative to other Florida cities, Hollywood’s retiree health care benefits are quite expensive. The city offers retirees similar health benefits to those it provides active employees at an average monthly cost of over $1,200 per retiree. By contrast, nearby Fort Lauderdale only provides retirees insurance premium subsidies of between $100 and $400 per month and stopped offering this benefit to anyone hired after 2015. As a result, Fort Lauderdale’s other post-employment benefit (OPEB) liability is a fraction of Hollywood’s despite its larger population. The city of Weston does not subsidize retiree medical benefits at all, and thus has no OPEB liability.

Thus far, Hollywood’s outsized retirement obligations have not weighed heavily on its bond rating or ability to raise funds on the municipal bond market. But taxpayers’ continued ability to shoulder these large obligations is not guaranteed.

Ninety years ago, Hollywood was among the many South Florida governments that defaulted on municipal bond payments after expected growth failed to materialize. If a natural disaster such as a major hurricane or a sea-level rise stunts Hollywood’s growth, the city could once again struggle to service the billion-dollar debt.

To secure the retirement of its public servants and protect taxpayers, Hollywood’s policymakers need a better plan to fund the city’s pension plans and manage the costs of its health care plan.

A version of this column previously appeared in the South Florida Sun-Sentinel.

The post Hollywood, Florida’s Pension Debt Problem appeared first on Reason Foundation.

If implemented, SB 2046 would close North Dakota’s current defined benefit (DB) plan to most new state hires (with an exception for those in public safety and judges). The bill would allow political subdivisions to remain in the DB plan but become fully liable for the debt their hires generate.

SB 2046 will allocate legacy fund earnings to fund the transition to a full defined contribution (DC) plan and amortize DB plan debt. The bill seeks to achieve this with a one-time cash infusion of $100 million followed by subsequent payments of $40 million payments every two years until the NDPERS DB plan reaches 90 percent funding. If the plan again falls below 90 percent the biannual payments of $40 million will not start again until the plan’s fund ratio hits 70 percent.

The reform also allows for current DB plan members to opt into the DC plan, but the mechanisms to do so (via written election to the board) likely means that this provision would be rarely utilized.

The proposed plan design could reduce risk to the state by limiting the flow of new entrants into a structurally underfunded pension system. By directing new hires into a defined contribution plan the state effectively shifts risk away from taxpayers and eliminates the ability of these new hires to generate new pension debt.

However, to pay off current and future NDPERS debt a switch to a defined contribution plan should be paired with a viable funding strategy, which SB 2046 falls short of doing. While the bill stipulates a plan for additional funding, it is unlikely that these contributions will be enough to bring the system back to full funding under even the most optimistic of market return scenarios.

Working within data constraints and viewing the current NDPERS DB in its entirety as presented in actuarial reports, our preliminary modeling shows SB 2046 would increase unfunded NDPERS liabilities by $500 million dollars, drop the funding ratio to 0 percent and force the plan into a pay-as-you-go model within the 30-year modeling period assuming all other plan assumptions are met. This would imply that SB 2046 would have close to no chance of accomplishing the goal of ending the structural underfunding of NDPERS benefits, and it could make the debt substantially worse.

Likewise, the SB 2046 design for stopping the supplemental payments of $40 million at a 90 percent funded ratio may needlessly allow debt to linger. The trigger to restart payments at 70 percent funding could possibly allow debt to compile for years. Additional supplemental funding from the Legacy Fund should be viewed as a welcomed development, it is no substitute for adopting the actuarially required contribution as policy.

In short, SB 2046 would effectively create an end date for most current and future pension liabilities, but the impact of that change will take decades to make any noticeable impact on the system’s trajectory and risk levels. Given the current ambiguity over the bill provision to separate state and local debt within the fund, it is nearly impossible to know the full cost or date to which the debt will amortize for the state.

To drastically improve the chances of successfully paying down current debts and ensure full solvency of the DB plan while properly transitioning new hires to a defined contribution we recommend the following:

• Commit to pay the actuarially required contribution rate. This would guarantee that the state contributes at a level that fully funds all accrued retirement benefits regardless of market volatility.
• Amortize current NDPERS debt on a fixed schedule, ideally less than 30 years, to avoid runaway interest driving up unfunded liabilities and perpetuating intergenerational inequities;
• Amortize any future NDPERS DB debt in a given year on a closed schedule of 20 years or less schedule to ensure the legislature won’t need to address the issue again in the future; and
• Amortize unfunded liabilities for the legacy DB plan over total state payroll (legacy pension participants + new and existing defined contribution participants)—as Oklahoma, Arizona, Florida, Utah, and other states have done in similar situations—in order to ensure that legacy unfunded liabilities are paid down in a fiscally prudent manner.
• Lower the NDPERS assumed rate of return on investments gradually to 6.0 percent over a 10-year period to limit the system’s exposure to market volatility.

SB 2046 represents a good faith attempt to address the problem of runaway NDPERS pension debt. The Pension Integrity Project believes the efforts made by legislators, NDPERS members, and stakeholders are commendable.  Be that as it may, if enacted as currently proposed, SB 2046 will likely require immediate follow-up legislation in future sessions to ensure the goals of improving NDPERS solvency and managing taxpayer risk fully materialize.

Full Scorecard for Senate Bill 2046

The post North Dakota Should Prioritize Paying Down Pension Debt appeared first on Reason Foundation.

Chairman Kasper, committee members, thank you for the opportunity to offer a brief technical assessment of Senate Bill 2046 (as amended) and the implications of the state adopting a new approach to offering future public employees a secured retirement option through the North Dakota Public Employees Retirement System (NDPERS).

My name is Raheem Williams, and I am a policy analyst with the Pension Integrity Project at Reason Foundation, a national 501(c)(3) nonpartisan think tank offering pro-bono technical assistance and policy research to lawmakers and other stakeholders to help design and implement policies aimed at improving public pension plan resiliency, promoting retirement security for public employees, and lowering long-term financial risks to taxpayers. I am also a former NDSU research specialist and am currently collaborating with them on an independent assessment of NDPERS’s long-term solvency.

Over the last 20 years, the NDPERS defined benefit (DB) plan has gone from 115 percent funded with a surplus of $135 million to holding over $1.4 billion in unfunded pension obligations. We commend those legislators and stakeholders raising awareness of the need to finally tackle the structural underfunding of the NDPERS defined benefit plan.

As currently written SB 2046 would primarily close the current system to most new entrants except for those in public safety, the courts, municipal employees and other categories and dedicate a portion of future Legacy Fund earnings to additional NDPERS unfunded liability payments. The proposed plan design would reduce risk to the state by limiting the flow of new entrants into a structurally underfunded pension system that bears significant financial risk to current and future taxpayers. However, any switch to a defined contribution plan should be paired with a viable funding strategy to pay off current and future NDPERS plan debt, which is where we see gaps in the current proposal.

If fully implemented as currently written, our preliminary actuarial modeling shows SB 2046 would have little chance of accomplishing the goal of ending the structural underfunding of NDPERS benefits. While additional supplemental funding from the Legacy Fund would certainly be warranted, what is needed first is a viable ongoing pension funding policy, which starts with adopting the actuarially required contribution as a policy instead of continuing to structurally underfund the plan with legislatively determined contributions. We also believe that the current concept would be more effective if paired with other changes to funding, amortization, and assumption-setting policies to effectively contain the risks of growing pension debt.

To that end we offer the following technical adjustments to SB 2046 that would improve the chances that any policy changes would achieve the goal of eliminating the NDPERS unfunded liability on a sustainable basis:

• Committing to pay the actuarially required contribution rate annually would guarantee that the state will contribute at a level that fully funds all accrued retirement benefits regardless of market volatility;
• Lowering the NDPERS assumed rate of return on investments gradually to 6.0 percent over a 10-year period would limit the system’s exposure to market volatility;
• Amortizing current NDPERS debt on a fixed schedule, ideally less than 30 years, would avoid runaway interest driving up unfunded liabilities and perpetuating intergenerational inequities;
• Amortizing any prospective future NDPERS debt in a given year on a closed schedule of 20 years or less, ensuring the legislature won’t need to address the issue again in the future; and
• Amortizing unfunded liabilities for the legacy DB plan over total state payroll (legacy pension participants + new and existing defined contribution participants)—as Oklahoma, Arizona, Florida, Utah and other states have done in similar situations—in order to ensure that legacy unfunded liabilities are paid down in a fiscally prudent manner.

Again, we commend legislators, NDPERS members, and stakeholders for recognizing the current financial challenges with NDPERS and being willing to engage these important issues. We will continue to offer our technical perspective on any policy proposals stemming from today’s discussion and thank you for the opportunity to share our perspective. We look forward to providing our modeling and technical expertise to help facilitate a productive exchange of ideas.

The post Testimony: Legislation in North Dakota Would Not Fully Address Pension Debt, Funding Risks appeared first on Reason Foundation.

The post Florida’s $36 Billion Problem appeared first on Reason Foundation.

The Florida Retirement System manages retirement benefits for almost 648,000 active members and over 584,000 retirees in the state and is comprised of a traditional pension plan and a defined contribution retirement plan option called the FRS Investment Plan.

Two decades ago the retirement system held a surplus of over $13 billion in assets and stood at 118 percent funded. Today, FRS finds itself $36 billion in debt with only 82 percent of the assets on hand needed to pay out benefits over the long-term, which represents a net change in position of almost $50 billion in just 20 years.

Investment returns falling short of the system’s expectations have been the largest contributor to the Florida Retirement System’s growing debt, adding $16.4 billion in unfunded liabilities since 2008.

The chart below shows the increase in the Florida Retirement System’s debt since the year 2000:

Despite pension reform efforts in 2011 and 2017, structural deficiencies within FRS continue to risk the retirement security of employees and retirees. The 2011 legislative effort reduced retirement benefits for employees and while such a change did lower some costs, it did not fundamentally address why pension debt continues to grow. Similarly, defaulting new FRS members into the Investment Plan in 2018 was a move that better aligned with workforce mobility trends and reduced future financial risks, but it did not address why the system’s pension debt has persisted for a decade.

Furthermore, the FRS Investment Plan is no closer to providing retirement security for Florida’s public retirees than the debt-riddled FRS Pension Plan, as it relies on contribution rates that fall far below industry standards for adequate retirement benefits. Industry experts estimate that 10 to 15 percent of annual income should be required as a contribution to a defined contribution retirement to provide adequate retirement income for public workers. FRS’s aggregate 6.3 percent contribution falls well short of this standard.

Bringing stakeholders together around a central, non-partisan understanding of the challenges the Florida Retirement System faces —complete with independent third-party actuarial analysis and expert technical assistance— is crucial to ensuring the state’s financial solvency in the long-term. The Pension Integrity Project at Reason Foundation stands ready to help guide Florida policymakers and stakeholders in addressing the shifting fiscal landscape.

Current Retirement Option Sets

FRS Pension Plan

• Type: Final Average Salary Defined Benefit Pension Plan
• Final Average Salary: Average of the 8 highest years
• Multiplier: 3%
• Vesting: 8 years
• Normal Retirement Eligibility: Any age @ 33 YOS or vested by age 65
• Regular Member Contribution:
  • 3.09% for Normal Cost
  • 4.30% for Unfunded Liability Payment (beginning FY2019-20)
• Employee Contribution: 3%

FRS Investment Plan

Default option as of January 1, 2018

• Type: Defined Contribution Retirement Plan
• Employee Contribution: 3%
• Employer Contribution:
  • 3.3% to member IP account
  • 3.56% to legacy FRS Pension Plan unfunded liabilities
• Vesting: 1 year
• Investment Options:
  • Investment Funds
  • Target Date Funds
• Default Investment Strategy: Target Date Funds

Reviewing Prior Reforms

Major Reforms to FRS

2000 – House Bill 2393

• Provided a defined, participant-directed contribution (DC) plan option to FRS members.
• One-year vesting for the portability of employer contributions.
• Based retirement benefits on market returns rather than a fixed benefit guarantee.
• Existing members given the option to switch future FRS participation into the DC plan without losing their already earned pension benefits.

2011 – Senate Bill 2100

• Created a new benefit tier for “special-risk” new hires.
• Renamed the FRS defined benefit plan the Florida Retirement System “Pension Plan.”
• Renamed the FRS defined contribution plan from the Public Employee Optional Retirement Program to the Florida Retirement System “Investment Plan.”
• Eliminated post-retirement increases on pension benefits earned after July 2011.
• Decreased both employer and employee contribution rates effective July 2012.
• Led to unfunded accrued liabilities decreasing from $16.7 billion to $15.6 billion.

2017 – Senate Bill 7022

• Defaults new employees hired after January 2018 into the FRS Investment Plan (DC plan) if no election taken after eight months of employment.

Previous Reforms Have Not Set the FRS on a Path to Sustainability

• The historic 10-year bull market has not helped FRS recover.
• The 2008 financial crisis weakened FRS’s funded status, but since then markets have recovered while pension funding has not.
• Reducing benefits in 2011 reduced some costs at the expense of inflation protection for retirees, but it did not fundamentally address why pension debt continues to grow.
• Defaulting new FRS members into the Investment Plan in 2018 was better aligned with workforce mobility trends and reduced future financial risk, but it did not address why pension debt has persisted for a decade.
• For three straight years (2016, 2017 & 2018) FRS’s consulting actuary has warned that the assumed rate of return is not reasonable.
• Additional reforms are necessary to ensure long-term solvency.

FRS Remains Unsustainable Despite Recent Reforms

Challenge #1:

FRS Defined Benefit Pension Plan Still Not on a Path to Solvency

• Overly optimistic assumed rate of return creates unnecessary risk.
• Unmet actuarial assumptions and slow-paced changes to those assumptions increases unfunded liabilities over time.
• Insufficient employer contributions inhibits plan assets from compounding growth over decades.
• Discount rate misaligned with risk, underpricing pension cost and undervaluing FRS unfunded liabilities.

Challenge #2:

FRS Defined Contribution Retirement Plan Not Built for Retirement Security.

• An inadequate contribution rate is shortchanging worker retirement security.

Challenge 1: FRS is Still Not on a Path to Long-Term Solvency

Driving Factors Behind FRS Pension Debt

• Changes to Actuarial Methods & Assumptions to better reflect current market and demographic trends have exposed over $16.6 billion in previously unrecognized unfunded liability.
• Deviations from Investment Return Assumptions have been the largest unintended contributor to the unfunded liability, adding $16.4 billion since 2008.
• Insufficient Contributions contributed $1.8 billion to FRS unfunded liability since 2008.
• Undervaluing Debt through discounting methods has led to the tacit undercalculation of required contributions.

Overly Optimistic Assumed Rate of Return

Unrealistic Expectations: Despite the recent change to 7.0%, the Assumed Investment Return for FRS continues to expose taxpayers to significant investment underperformance risk.

Underpricing Contributions: The use of an unrealistic Assumed Return has likely resulted in underpriced Normal Cost and an undercalculated Actuarially Determined Contribution.

FRS Actuaries on Current Return Assumption

• All models developed in 2017 by Milliman and Aon Hewitt had 50th percentile geometric average annual long-term future returns in the 6.6%-6.8% range.
• Models developed in 2018 by Milliman and Aon Hewitt show the average annual long-term future returns in the 6.4-6.7% range, yet FRS Actuarial Assumption Conference adopted a 7.4% return assumption.
• Presenters at the 2020 FRS Actuarial Conference suggested return assumptions within the range of 6.46% (Aon) to 6.56% (Milliman), with a lower inflation assumption of 2.1% to 2.2% relative to the previous conference assumption of 2.6%.
• The 2020 FRS Actuarial Assumption Conference adopted a 7.0% return assumption.

Investment Return History 1996-2020

Investment Returns vs. Assumptions

• FRS historically assumed an investment return rate as high as 8.00% before lowering the assumption to 7.75% in 2004. The plan has adjusted the assumption annually since in 2014, to reach the current 7.0% for 2021.
• FRS expanded investments in high-risk holdings in a search for greater investment returns over the past decade.
• The FRS Pension Plan investment portfolio’s trends have not matched longterm assumptions:

Note: Past performance is not the best measure of future performance, but it does help provide some context to the problem created by having an excessively high assumed rate of return.

FRS Funded Ratio Did Not Recover Despite a Historic Decade for the Stock Market

New Normal: The Market Has Changed

The “new normal” for institutional investing suggests that achieving even a 6% average rate of return in the future is optimistic.

1. Over the past two decades there has been a steady change in the nature of institutional investment returns. 30-year Treasury yields have fallen from near 8% in the 1990s to consistently less than 3%. New phenomenon: negative interest rates, designates a collapse in global bond yields. The U.S. just experienced the longest economic recovery in history, yet average growth rates in GDP and inflation are below expectations.
2. McKinsey & Co. forecast the returns on equities will be 20% to 50% lower over the next two decades compared to the previous three decades. Using their forecasts, the best-case scenario for a 70/30 portfolio of equities and bonds is likely to earn around 5% return.
3. The FRS Pension Plan 5-year average return is around 6.48%, well below the assumed 7% return assumption.

Expanding Risk in Search for Yield

Probability Analysis: Measuring the Likelihood of FRS Achieving Various Rates of Return

Probability Analysis: Measuring the Likelihood of FRS Achieving Various Rates of Return

FRS Assumptions & Experience

• A probability analysis of FRS historical returns over the past 20 years (2000-2020) indicates only a modest chance (28%) of hitting the plan’s 7.0% assumed return.
• FRS’s own investment return assumptions imply a 43% chance of achieving their investment return target over the next 20 years.

Short-Term Market Forecast

• Returns over the short to medium term can have significant negative effects on funding outcomes for mature pension plans with large negative cash flows like FRS.
• Analysis of capital market assumptions publicly reported by the leading financial firms (BlackRock, BNY Mellon, JPMorgan, and Research Affiliates) suggests that over a 10-15 year period, FRS returns are likely to fall short of their assumption.

Long-Term Market Forecast

• Longer-term projections typically assume FRS investment returns will revert back to historical averages.
  • The “reversion to mean” assumption should be viewed with caution given historical changes in interest rates and a variety of other market conditions that increase uncertainty over longer projection periods, relative to shorter ones.
• Forecasts showing long-term returns near 7.0% likely also show a significant chance that the actual long-term average return will fall far shorter than expected.
  • For example, according to the BlackRock’s 20-year forecast, while the probability of achieving an average return of 7.0% or higher is about 56%, the probability of earning a rate of return below 5.5% is about 26%.

Risk Assessment

How resilient is FRS to volatile market factors?

Important Funding Concepts

Statutory rates are more susceptible to the political risk inherent to the legislative process and often result in systemic underfunding, especially when legislatively established rates fall short of what plan actuaries calculate as necessary to ensure funding progress.

Employer Contribution Rates

• Statutory Contributions: Annual payments usually based on rates set in state statute, meaning contributions remain static until changed by legislation.
• Actuarially Determined Employer Contribution (ADEC): Unlike statutory contributions, ADEC is the annual required amount FRS’s consulting actuary has determined is needed to be contributed each year to avoid growth in pension debt and keep ERS solvent.

All-in Employer Cost

• The true cost of a pension is not only in the annual contributions, but also in whatever unfunded liabilities remain. The ”All-in Employer Cost” combines the total amount paid in employer contributions and adds what unfunded liabilities remain at the end of the forecasting window.

Baseline Rates

• The baseline describes FRS current assumptions using the plan’s existing contribution and funding policy and shows the status quo before the 2020 market shock.

Quick Note: With actuarial experiences of public pension plans varying from one year to the next, and potential rounding and methodological differences between actuaries, projected values shown onwards are not meant for budget planning purposes. For trend and policy discussions only.

Stress Testing FRS Using Crisis Simulations

Our risk assessment analysis shows that under likely market fluctuations, FRS funding could decline significantly more.

If you assume FRS will achieve an average six percent rate of investment return over the next 30 years plus experience one financial crisis in this time, analysis shows that the pension plans unfunded liability would spike to $80 billion before the year 2050.

This likely economic scenario would cost the state almost $120 billion more in pension contributions than what they currently plan to spend on the plan.

Seeing as FRS only averaged a 5.62 percent market valued investment return rate between 2000 – 2019, and that we have seen two major economic crisis in the last 20 years, it is reasonable to assume the next 30 years will look somewhat similar.

An additional $120 billion in pension costs would put significant strain on the state budget.

Stress on the Economy:

• Market watchers expect dwindling consumption and incomes to severely impact near-term tax collections – applying more pressure on state and local budgets.
• Revenue declines are likely to undermine employers’ ability to make full pension contributions, especially for those relying on more volatile tax sources (e.g., sales taxes) and those with low rainyday fund balances.
• Many experts expect continued market volatility, and the Federal Reserve is expected to keep interest rates near 0% for years and only increase rates in response to longer-term inflation trends.

Methodology:

• Adapting the Dodd-Frank stress testing methodology for banks and Moody’s Investors Service recession preparedness analysis, the following scenarios assume one year of -24.6% returns in 2020, followed by three years of 11% average returns.
• Recognizing expert consensus regarding a diminishing capital market outlook, the scenarios assume a long-term investment return of 6% once markets rebound.
• Given the increased exposure to volatile global markets and rising frequency of Black Swan economic events, we include a scenario incorporating a second Black Swan crisis event in 2035.

Outdated and Aggressive Actuarial Assumptions and Methods

• Deviations between actuarial experience and assumptions, and delays updating those assumptions, has led to an underestimation of the total FRS Pension Plan liability.
• Adjusting actuarial assumptions to reflect the changing demographics and new normal in investment markets exposes hidden pension cost by uncovering existing but unreported unfunded liabilities.
• If aggressive assumptions continue to misprice pension benefits, FRS experience will continue to deviate from the plan’s expectations and allow for the continued growth of unfunded liabilities.
• Generally, each assumption used by plan actuaries to calculate the cost of benefits over time come with the inherent risk of being wrong any given year resulting in unfunded liabilities.
• When an assumption is off, and assets actuaries were expecting from a given source are not contributed to make up the difference, the plan passively accrues unfunded.
• When an assumption is deliberately adjusted in a way that increases the probability of the expected outcome, cost hidden in the assumption are exposed, resulting in unfunded liabilities increasing in exchange for a more stable assumption and contribution rate.

Insufficient Contributions

Imprudent Funding Policy is Creating Structural Underfunding for FRS

1. From 2011-2013, FRS employer contributions failed to meet the actuarially determined contribution (ADC), increasing the Unfunded Actuarial Liability by $2.45 billion.
2. In 7 of the past 17 years, employer contributions have been less than the interest accrued on the pension debt (e.g., negative amortization), which allowed for the unfunded liability to grow in absolute terms.
3. The 30-year period FRS uses to pay off unfunded liabilities is greater than the Society of Actuaries’ recommended funding period of 15 to 20 years, resulting in higher overall costs for the plan. Due to the long 30-year closed amortization schedule used to pay off the annual unfunded liability employer pension contributions have not always kept up with the interest accrued on the pension debt.

Actual v. Required Contributions

Negative Amortization: Understanding the Current Funding Policy

• From 2011-2013, FRS employer contributions failed to meet the actuarially determined contribution (ADC), increasing the Unfunded Actuarial Liability by $2.45 billion.
• Starting in the 1998 actuarial valuation, the Legislature required all UAL bases in existence to be considered fully amortized, since the plan was in a surplus position.
• As part of the funding policy selected by the Florida Legislature, the actuarially calculated contribution rate is based on a “layered” approach that includes closed 30-year charge and credit bases for the amortization of any accrued UAL.
• The Unfunded Actuarial Liability (UAL) is amortized as a level percentage of projected payroll on which UAL rates are charged in an effort to maintain level contribution rates as a percentage of payroll during the specified amortization period if future experience follows assumptions.

Negative Amortization Growth (2009-2020)

Discount Rate & Undervaluing Debt

The “discount rate” for a public pension plan should reflect the risk inherent in the pension plan’s liabilities:

• Most public sector pension plans — including FRS — use the assumed rate of return and discount rate interchangeably, even though each serve a different purpose.
• The Assumed Rate of Return (ARR) adopted by FRS estimates what the plan will return on average in the long run and is used to calculate contributions needed each year to fund the plans.
• The Discount Rate (DR), on the other hand, is used to determine the net present value of all the already promised pension benefits and supposed to reflect the risk of the plan sponsor not being able to pay the promised pensions.

Setting a discount rate too high will lead to undervaluing the amount of pension benefits actually promised.

• If a pension plan is choosing to target a high rate of return with its portfolio of assets, and that high assumed return is then used to calculate/discount the value of existing promised benefits, the result will likely be that the actuarially recognized amount of accrued liabilities is undervalued.
• Milliman, argues the discount rate for calculating the total pension liability should be equal to the return assumption.

It is reasonable to conclude that there is almost no risk that Florida would pay out less than 100% of promised retirement income benefits to members and retirees.

• State law requires protection of pension benefit payouts. Florida State Statutes § 121.011- 121.40; 121.4501-121.5912 & Florida Administrative Code 60S-4

The discount rate used to account for this minimal risk should be appropriately low.

• The higher the discount rate used by a pension plan, the higher the implied assumption of risk for the pension obligations.

Sensitivity Analysis: Pension Debt Comparison Under Alternative Discount Rates

Change in the Risk-Free Rate Compared to FRS Discount Rate (2001-2020)

Challenge 2: FRS Defined Contribution Plan is Not Built for Security

FRS Defined Contribution Plan Overview

The FRS defined contribution retirement plan—the FRS Investment Plan—is the state’s current default (as of 2018).

• Members are vested after one year of service in the FRS Investment Plan.

Employees may choose to receive their account balance at the end of employment as a lump sum or take periodic withdrawals either on-demand or by a pre-determined payout schedule.

The FRS Investment Plan has shown consistent growth since its introduction in 2002.

•  FRS Defined Contribution Plan members currently account for nearly 23% of total FRS membership and 26% of total FRS payroll.

The Legislature can increase or decrease the amount employers and employees contribute to plan members’ accounts.

FRS Investment Plan Funding

Current FRS Investment Plan contribution breakdown:

Best practice says employers should continue making payments towards their legacy pension debt as if all new hires were still entering the Pension Plan.

Inadequate Contribution Rates are Jeopardizing Retirement Security

• The aggregate 6.3% FRS Investment Plan contribution rate falls far below industry standards for retirement benefit adequacy.
• Industry leaders, retirement experts and independent studies consistently estimate 10% to 15% of annual income to be required to provide adequate retirement income.
• For regular plan members alone contribution rates need to rise at least 400 basis points to provide retirement security.
• Higher contribution rates may be required for older workers to achieve adequate savings for retirement due to chronic underfunding.

FRS Investment Plan – Gold Standard Score

A Framework for Policy Reform

• Keeping Promises: Ensure the ability to pay 100% of the benefits earned and accrued by active workers and retirees
• Retirement Security: Provide retirement security for all current and future employees
• Predictability: Stabilize contribution rates for the long-term
• Risk Reduction: Reduce pension system exposure to financial risk and market volatility
• Affordability: Reduce long-term costs for employers/taxpayers and employees
• Attractive Benefits: Ensure the ability to recruit 21st Century employees
• Good Governance: Adopt best practices for board organization, investment management, and financial reporting

Defined Contribution Reform Best Practices

1. Adopt Better Risk Assessment and Actuarial Assumptions

• Lower the assumed rate of return to align with independent actuarial recommendations.
• These changes should aim at minimizing risk and contribution rate volatility for employers and employees.

2. Establish A Plan To Pay Off The Unfunded Liability As Quickly As Possible

• The Society of Actuaries Blue Ribbon Panel recommends amortization schedules be no longer than 15 to 20 years.
• Reducing the amortization schedule would save the state billions in interest payments.

3. Review Current Plan Options To Improve Retirement Security

• Consider offering additional retirement options that create a pathway to lifetime income for employees that do not stay in public service.

4. Adopt Better Funding Policy

• Financial experts strongly recommend contributions 10 to 15 percent of pre-tax earnings into a retirement account.
• Older workers with a closer retirement horizon and inadequate savings may need to contribute even more.

5. Encourage Use of Target Date Funds

• Well-designed DC plans should also offer the correct age-appropriate investment mix. This is generally accomplished by using target date funds that adjust investment risk to the employee’s retirement horizon to protect the value of the account from market fluctuations as the worker nears retirement.

6. Encourage Use of Annuities for Improved Retirement Security

• The mix of proprietary investment funds and reasonably priced target-date funds give participants adequate “one-choice” options. However, without guaranteed investments included in the target-date portfolio constructions and deferred annuities the FRS Investment Plan will continue to limit a members’ financial flexibility.
• Despite a lifetime annuity option being available to members, generally the distribution choices offered by the FRS Investment Plan limit its attractiveness as a true, core retirement option.

Full Florida Retirement System Pension Solvency Analysis 

The post Florida Retirement System (FRS) Solvency Analysis appeared first on Reason Foundation.

Chairman Koppelman, committee members, thank you for inviting me to offer a brief technical assessment on House Bill 1209 and the implications of the state adopting an actuarially determined employer contribution funding policy—commonly referred to as the ADEC rate—to address the state’s worsening public pension underfunding and put the North Dakota Public Employees Retirement System (NDPERS) on a sustainable fiscal trajectory.

My name is Raheem Williams and I serve as a policy analyst with the Pension Integrity Project at Reason Foundation, a national 501(c)(3) libertarian-leaning think tank that offers pro-bono technical assistance and policy research to public officials and other stakeholders to help design and implement policy solutions aimed at improving public pension plan resiliency, promoting retirement security for public employees, and lowering long-term financial risks to taxpayers. I am also a former NDSU research specialist and am currently collaborating with them on an independent assessment of NDPERS’s long-term solvency.

Public pension systems like NDPERS rely on contributions from public employees and their public employers—as well as compounding investment returns—over long periods of time to save the necessary amount of funding needed to pay the retirement benefits promised to generations of public employees.

Over the last 20 years, NDPERS has gone from 115 percent funded and a surplus of $135 million to holding over $1.4 billion in earned, yet unfunded, pension obligations that are implicitly protected by both the state and federal constitutions.

Over $585 million of that $1.4 billion in NDPERS pension debt—nearly a third—can be attributed to the way the state systematically underfunds its largest public pension system, according to annual public reports published by NDPERS. In their most recent report, NDPERS actuaries determined that the state needed to contribute 12.94 percent of payroll to put the plan on the path to full funding. However, the statutory contribution rate established in state law is only 7.16 percent of payroll, shorting NDPERS the 5.78 percent needed to get back on track to full funding.

The consistent practice of setting NDPERS contribution rates too low in state law instead of paying the amount actuaries calculate is needed each year to stay on track to meet promises has consistently shorted the system of expected revenue, every single year for the last 18 years (2003-2020). In short, the state is structurally underfunding the plan, which only drives up costs for taxpayers since, like any debt, pension debt that is not paid down will only grow. If not addressed, the system will never reach full funding, nor will the current funding method ever pay down the current $1.4 billion in pension debt. This only drives up the cost to taxpayers of providing constitutionally protected pension benefits higher and higher.

The reason the current NDPERS funding policy is broken is simple. By statutorily setting contribution rates below the ADEC rate policymakers ensure expected revenue will never make it into the fund to be invested, and thus will never earn a return. To put this in context, the fund was shorted $1.6 million in 2003—that’s $1.6 million that did not earn a return in subsequent years. This effectively compounds each year as not only the plan’s growth is stifled but interest on the debt is accumulated. According to NDPERS’ 2020 Comprehensive Annual Financial Report, the annual contribution deficiency has grown to $55 million.

Ignoring pension obligations is a costly decision that puts taxpayers at risk, threatens retirement security for retirees, and runs counter to prudent stewardship of public finances. Courts nationwide have interpreted pension benefits as contractual obligations that have to be paid, one way or the other. Generally speaking, in the context of underfunded pensions, debt is debt—you either pay more now or pay even more later.

And credit rating agencies routinely evaluate pension solvency as they make credit rating determinations, generally taking a dim view of pension underfunding and demonstrating a willingness to issue improved forecasts or even credit rating upgrades in states like Michigan and Colorado that have recently enacted similar pension funding policy reforms designed to pay down pension debt faster.

Furthermore, the Society of Actuaries Blue Ribbon Panel on Public Pensions Funding advises that a plan should not settle for any level of funding below 100 percent and should always guide their funds to reach full funding within 20 years or less and under a median level of possible long-term returns.

The increases needed now to meet the ADEC rate will pale in comparison to maintaining the structural underfunding of today and the ever-compounding accumulation of pension debt. ADEC funding alone will not guarantee the plan reaches full funding, nor will it address the systemic risk inherent in making assumptions about future investment returns and demographic changes. However, shifting to the use of an actuarially determined contribution rate for NDPERS would be a prudent funding policy step to ensure that today’s missed contributions do not become the financial burden of tomorrow’s North Dakotans.

The post Testimony: North Dakota Should Fix the State’s Inadequate Public Pension Funding Policy appeared first on Reason Foundation.

The North Dakota Public Employees Retirement System (NDPERS) has seen a significant increase in public pension debt in the last two decades. In the year 2000, the public pension plan, which serves North Dakota’s state employees, was 115 percent funded and had a $135 million surplus of funds for retirement benefits. Today, the pension plan is only 68 percent funded and has $1.4 billion in debt.

The latest analysis by the Pension Integrity Project at Reason Foundation, updated this month (January 2021), shows that for decades policymakers have created structural underfunding problems for the pension plan. Between 2003 and 2020, employer contributions into NDPERS were consistently less than the actuarially determined employer contribution (ADEC) rate, leading to an increase in unfunded liabilities.

In fact, since 2003, the state has not paid over $585 million in actuarially determined employer contributions to NDPERS because the contribution rate is set in the North Dakota state statute.

Additionally, deviations from the plan’s investment return assumptions have contributed to its unfunded liability growth. This growth in unfunded liabilities has driven pension benefit costs higher while crowding out other taxpayer priorities and programs in North Dakota.

The chart below, from the full solvency analysis, shows the increase in the North Dakota Public Employees Retirement System’s debt since 2000:

Today, NDPERS has only 68 percent of the assets needed to fully fund the pension system in the long-term.

This underfunding not only puts taxpayers on the hook for growing debt but also jeopardizes the retirement security of North Dakota’s state employees. Left unaddressed, the pension plan’s structural problems will continue to pull resources from other state priorities.

The solvency analysis also offers stress-testing designed to highlight potentially latent financial risks the pension system is facing. Reason Foundation also provides a number of policy suggestions that, if implemented, would address the declining solvency of the public pension plan. A new, updated analysis will be added to this page regularly to track the system’s performance and solvency.

Bringing stakeholders together around a central, non-partisan understanding of the challenges the North Dakota Public Employees Retirement System is facing—complete with independent third-party actuarial analysis and expert technical assistance—the Pension Integrity Project at Reason Foundation stands ready to help guide North Dakota policymakers and stakeholders in addressing the shifting fiscal landscape.

North Dakota Public Employees Retirement System (NDPERS) Pension Solvency Analysis

The post North Dakota Public Employees Retirement System Pension Solvency Analysis appeared first on Reason Foundation.

Executive Summary

The primary objectives of any employer-sponsored retirement plan should be to enable employees to maintain their standard of living in retirement after a career in the workforce, to meet employer needs for recruiting and retaining a talented workforce, and to do both in a financially prudent and sustainable manner.

Several types of retirement plan designs have proven successful over long periods of time in achieving these objectives. In the public sector traditional defined benefit pensions have become increasingly strained financially, leading to more difficulty meeting the needs of a modern workforce that increasingly sees public service as a temporary stop along a varied career path blended with other private sector work, as opposed to a destination for full-career employment.

This has prompted policymakers at all levels of government in the U.S. to consider introducing alternative types of pensions and other portable retirement plan designs—including defined contribution (DC) retirement plans—as a viable alternative to better serve the needs of shorter-tenured workers and reduce financial risks for employers.

A retirement plan that effectively meets both employer and employee needs can encompass any number of plan types, as well as combinations. When structured properly, DC retirement plans—plans with individually controlled investment accounts with contributions made by both employers and employees—can offer governments an approach to retirement plan design that garners retirement security for employees while actively working. Defined contribution plans accomplish this by modernizing the retirement option set and managing employers’ financial risks that are inherent in traditional pension plans that have accumulated to over $1.28 trillion in unfunded public pension liabilities nationwide in 2019.

However, like any tool, a retirement plan can be designed well or poorly, and the design will ultimately determine any retirement plan’s ability to achieve its objectives.

The best practice design elements discussed in this paper are critical to building well-structured defined contribution retirement plans and should be considered in any plan design effort.

DC plans have certain key advantages over other retirement plan designs. Among these, especially for public sector employers, is that no unfunded liabilities can be created with a DC design. Employer obligations are fully met when contributions are made. This stands in stark contrast to the traditional defined benefit pension systems that have created unsustainable unfunded liabilities borne by governments, and ultimately taxpayers, in a number of jurisdictions. DC plans are also well suited to meeting the career mobility needs of public employees in the modern workforce. In today’s norm of working for several employers during a career, a retirement plan that recognizes this mobility addresses a key societal need for retirement savings adequacy.

In defined contribution plans, the contribution itself does not guarantee any fixed level of future benefit, which can be seen, understandably, as a shortcoming of DC. However, this paper discusses how policymakers can effectively mitigate this risk by incorporating products like annuities and even using emerging DC design innovations that focus on “lifetime income” via new investment strategies and technologies that ensure annuity-like income throughout retirement.

Critical steps toward creating an effective retirement plan design include:

• Clearly articulating plan objectives for lifetime income and other key considerations,
• Clearly stating and explaining the plan’s purpose to all interested parties,
• Communicating important features and educating participants,
• Using auto-enrollment,
• Providing adequate contributions,
• Choosing appropriate portfolio design, and
• Providing benefit portability and flexibility of benefits distribution.

Designing and administering a core defined contribution retirement plan that meets these best practices will result in a plan that meets the employee retirement needs of today’s evolving and dynamic public sector workforce. A well-designed DC plan will also enable crucial recruiting and employee retention needs of the public sector.

Utilizing defined contribution plan best practices can ensure retirement security for public employees without the risk of accumulating the types of unfunded liabilities associated with many public sector defined benefit plans nationwide.

Introduction

Any employer sponsored retirement plan should aim to enable employees to maintain their standard of living in retirement after a career in the workforce, to meet employer needs for recruiting and retaining a talented workforce, and to do both in a financially prudent and sustainable manner. Several types of retirement plan designs have successfully achieved these objectives over long periods of time. But in the public sector, traditional defined benefit pensions have become increasingly strained financially, leading to more difficulty meeting the needs of a modern workforce that increasingly sees public service as a temporary stop along a varied career path blended with other private sector work, as opposed to a destination for full-career employment.

As a result, U.S. policymakers at all levels of government are considering introducing alternative types of pensions and other portable retirement plan designs—including defined contribution (DC) retirement plans—as a viable alternative to better serve the needs of shorter-tenured workers and reduce financial risks for employers. Although DB pension plans have been predominantly used in the public sector for many years, DC plans have proven their worth as core retirement plans. By including new and emerging financial services technologies available today, plan sponsors can design and implement DC plans that are more effective and efficient than ever in meeting plan objectives. To understand the role both DB and DC plans play within public sector retirement systems, we need to identify key features of both.

Defined contribution (DC) retirement plans have successfully served as the core retirement vehicle for certain public employees, including most academics in public higher education, for many decades. The availability of various DC plan features has evolved over time with the changing needs of the workforce and workplace needs of employers. Advances in financial technology have made innovative plan features available today that simply didn’t exist a generation ago. Utilizing the best practices outlined in this brief, a plan sponsor can create a plan that meets employee and employer needs without creating additional unfunded liabilities for state and local governments.

For traditional public DB pension programs, states like Wisconsin, South Dakota, and North Carolina have exceptionally well-funded plans, which demonstrates that a plan can work quite well if properly designed and managed, despite detractors’ claims that pensions are inherently unsustainable.¹ By contrast, states like Kentucky, Illinois, and Connecticut need to see substantial and immediate improvements to keep their state-run public employee DB plans solvent. Nationwide, most public pension plans can be categorized as underfunded, meaning they don’t have sufficient funds invested today to cover all the long-term retirement promises made to their employees. A 2019 study by Milliman found the nation’s top 100 largest public pensions systems have on average only 73.4% of the assets needed to pay out future benefits.² This suggests a strong need for states and local governments to adopt widespread reforms in order to improve the long-term financial sustainability of their pension systems.

Public sector defined contribution (DC) retirement plans differ in quality of plan design, but all provide retirement benefits for employees by making regular contributions into a retirement account invested in a defined portfolio. At the end of employment, the accumulated savings and investment returns fund the employee’s retirement. This eliminates the public investment underperformance exposure risk that DB pensions have, because under DC plans employer contributions into the plan remain constant despite good or bad returns on investments. Put differently, a DC plan cannot contribute to or create a debt liability, making it an attractive retirement option for public employers.

In this paper we lay out best practices, beginning with plan objectives that, when adhered to, will create a DC retirement plan that meets key stakeholder needs. We specifically address core plan design elements such as contribution rates, auto-escalation, transition cost, risk, and retirement security. We provide comparisons in functionality of both DC and DB plans to illuminate the pros and cons of reform elements. Finally, our analysis concludes with real-world examples of successful reforms.

Although each public retirement system is different, with varying levels of solvency, all plan managers should consider the reforms discussed in this brief to bolster future pension solvency.

Defined Benefit Plan vs Defined Contribution Plan

What Is a Defined Benefit Plan?

• A defined benefit (DB) pension plan is an employer-sponsored core or supplemental retirement savings plan that specifies the monthly retirement money retirees will receive, which is typically based on the employee’s salary, years of work, and age.
• Employers typically control the investment strategy in the account.
• If sufficient assets are not available in the pension trust to pay out all promised
  benefits over time, the DB pension system will accrue unfunded liabilities that in most cases are borne entirely by employers, thus exposing taxpayers to significant financial risk.
• DB pensions are designed to be pre-funded such that when an employee retires, the employer has reserved enough money to pay for all promised retirement benefits. Thus, there is no need to have new entrants into a DB pension plan to keep it working properly. DB pensions are very different from Social Security, which relies on contributions from active employees to finance current retiree benefits.

What Is a Defined Contribution Plan?

• A defined contribution (DC) retirement plan is an employer-sponsored core or supplemental retirement savings plan that specifies the amount of money designated by the employee, the employer, or both to be contributed.
• Employers direct these contributions into an investment account to accumulate a return in capital market investments commensurate with the funds needed for retirement. Employees typically control the investment strategy (e.g. risk tolerances, portfolio composition, etc.) in the account within the provisions allowed in the plan document.
• Once the employer’s contribution is made, their obligation is fulfilled; thus there is no possibility of unfunded liabilities within a DC retirement plan.
• Some DC plans provide a minimum contribution rate that could increase up to a maximum rate depending on matching contributions from employees.
• Retirement planners typically recommend targeting enough retirement assets between an employer-sponsored DC retirement plan and Social Security to replace between 70% and 90% of pre-retirement income, depending on the employee’s lifestyle preferences.

Understanding Defined Contribution Retirement Plans

DC plans can offer many distribution options for assets ranging from cash withdrawals to guaranteed lifetime annuity payments, similar to a pension. This means that the plan can be tailored to different types of retirement income consumption patterns.

Tax-favored savings in DC plans are covered under Internal Revenue Code (IRC) sections 401(k), 403(b), 457(b) and 401(a) (among other IRC sections) depending on the particular employment sector. The IRS restricts maximum pre-tax contributions and distributions from the plan assets. Failure to comply with the restrictions results in significant financial penalties.

One important factor from the standpoint of plan managers is that DC plans cannot create unfunded liabilities like DB plans can. An employer’s obligation is fully satisfied when a contribution to the plan is made.

Core DC and supplemental DC plans, which are discussed in the following sections, together with Social Security form a composite benefit that, when structured properly, supports lifetime financial security for the employee upon retirement.

Core DC Retirement Plans

The most widely known DC plan, defined under IRC Section 401(k), originally developed as a supplemental retirement savings plan. These 401(k) plans have come to define the corporate world’s primary or core retirement plans since the widespread demise of DB pensions in this market.

Like other IRC sections, 401(k) allows employees to defer a portion of their wages to an individually controlled account under the plan. Also, a 401(k) plan can utilize non-wage compensation such as profit-sharing and stock bonus.³ In a core DC retirement plan the employer makes a contribution, defined as a percentage of employee salary, into the individually controlled account. Often the employer mandates an employee contribution to receive the employer “match.”

For the purpose of this report, we focus on the public sector equivalents of corporate 401(k) plans. Sections 401(a), 403(b) and 457(b), in combination with several other IRC sections, define the public sector DC plans much like 401(k) does for the corporate sector.

Supplemental DC Plans

With the exception of public and private higher education, where DC plans have been the primary retirement plans for over a century, DC plans originally were designed to supplement an employee’s DB pension. For the public sector, the IRS uses code 457(b) to define supplemental DC plans. Depending on employment sector, 457(b) allows an employee to tax-defer income up to an amount defined formulaically under the Code into an individually controlled account. Distributions are limited and defined in order to maintain the tax-preferred status.

Today, many supplemental DC plans are used in conjunction with core DC plans to help meet the employee’s financial objectives in retirement. In the public sector, employers commonly offer traditional DB pension plans combined with supplemental DC plan benefits as a way of providing enhanced retirement security options without adding to the financial risks that often accompany public pension benefits in the United States.⁴

While DC plan retirement benefits are not defined, much of the longevity risk and other risks inherent in traditional DC plans can be mitigated through proper plan design, which the next section discusses.

The Gold Standard for Public Sector DC Core Retirement Plan Design

Designing a DC plan requires an understanding of human behavior. Studies show that employees are more likely to engage in passive decision-making with respect to retirement.⁵

This means that most employees depend on the default settings built within the plan to guide them to their retirement objectives. Plan design should account for this by mandating industry best practices and defining them within the plan document.

Define Plan Objectives

If any retirement plan is to be effective in meeting plan objectives, those objectives must first be defined. It is a best practice for a plan sponsor to define those objectives in writing as part of a comprehensive “benefits policy statement” or at least within a “retirement plan policy statement.” For a core DC retirement plan, this statement should discuss the plan’s objective to provide lifetime retirement income security in combination with other plans (personal savings and Social Security) following a career of employment.

The statement should clearly describe that a “career of employment” does not necessarily carry the expectation that the entire career would be with the current employer. In January of 2020, according to the U.S. Bureau of Labor Statistics, median tenure for state government workers was just 5.6 years.⁶ While somewhat longer than private sector workers, this clearly shows that the vast majority of state government employees do not spend a career with one employer. Recognition of the reality of the modern workforce is essential to the success of a plan. Income security in retirement can be defined as a range, for example, 70% to 90% income replacement in retirement from all sources.

Communicate & Educate

Plan sponsors need to ensure plan members are educated on the available choices and have all the relevant information to make competent retirement choices. Not doing so could lead to the plan’s objectives not being met for a broad cross-section of participants. Education on plan objectives, investment options, and all plan features can be provided by the employer, the financial services provider hired by the plan sponsor, or by third-party financial education providers. The important factor is that the education must be unbiased and directly tied to plan objectives.

Additionally, best practice makes specific investment guidance and advice available to individual plan participants. To prevent a potential conflict of interest and ensure that the employee’s best interest takes precedent over firms seeking to sell financial instruments, an independent third party (not a party providing investments available in the plan) must formulate the advice for a plan participant. As compared to “guidance,” “advice” includes specific, fund-level investment recommendations. With advances in technology available in the financial services area, such advice can be provided for plan participants at very low cost. Plan sponsors can contract with independent advisors, making advice available to all plan participants without direct cost to them.

Auto-Enroll All Participants

In order for a core DC retirement plan to meet its defined objectives effectively, the employee must participate in it. This seemingly obvious observation is critical. The first step of any competent core DC plan design is to mandate participation. This can be accomplished through auto-enrollment features that enroll new employees immediately upon being hired. Research shows that the likelihood that an employee participates in a retirement plan and the timing of this decision are strongly correlated to auto-enrollment features. Absent auto-enrollment, employees may opt out of retirement planning altogether or wait too long to start saving, which lowers the probability of achieving satisfactory income replacement in retirement.⁷

Make Adequate Contributions

Any retirement plan’s most basic goal should provide enough income during retirement to maintain the retiree’s pre-retirement standard of living. As a rule of thumb, a well-designed retirement plan (or combination of employer-sponsored retirement plans, Social Security, and/or private savings) should replace approximately 80% of a worker’s final salary.⁸ This assumes retirees will have a lower cost of living with major financial commitments such as mortgages and childrearing complete. Public sector DC plans should be designed to meet this standard, with a more accurate replacement ratio ranging between 70% and 90% of average final income, with the actual percentage being inversely correlated to income. In other words, the higher the income, the lower the replacement ratio is necessary to maintain an employee’s standard of living.

An important component of plan design defines a contribution rate that, in combination with other plan features, will mitigate underfunding risk. Financial experts strongly recommend total contributions of 10% to 15% of pre-tax earnings into a retirement account throughout the employee’s career for those participating in Social Security; a higher 18%-25% is generally recommended for those with no other DB pension or Social Security to rely on.⁹ This is a combined employer/employee rate that could be divided any number of ways between the two parties.

Often, the employer contribution will be “matched” or dependent on the employee contribution. Older workers with a closer retirement horizon and inadequate savings may need to contribute even more than otherwise to achieve income adequacy in retirement.

One technology-based feature that plan sponsors can use to ensure the recommended contribution rates are reached is auto-escalation within plan design. Auto-escalation slowly increases employee contributions into DC plans over a period of several years. Auto- escalation can be tied to rising wages of an employee, so that it increases proportionally to the wage increase.

Use Retirement-Specific Portfolio Design

Achieving a plan’s ultimate objectives requires including investment options that directly target a long-term retirement time horizon. Among these, well-designed DC plans should offer “one-touch” investment options for employees who are not sophisticated investors and do not want to avail themselves of in-plan investment advice. Today’s plans often use target date funds that adjust asset allocation to the employee’s retirement horizon to mitigate investment loss risk as retirement approaches. Target date funds (TDFs) allow a worker to take on more risk while young for higher returns. The worker’s investment mix slowly shifts to a more conservative asset allocation as the worker nears retirement, locking in gains.¹⁰

While a significant step forward, TDFs do have limitations. Basically, they treat everyone with the same birthdate as having the same asset allocation needs throughout their careers. While this is broadly accurate, individuals with common birthdates may realistically have vastly different investment and retirement planning needs.

With continuing technological advancements in the financial services industry, new methods of determining asset allocations on the individual level are becoming available. Whereas a generation ago these approaches were largely manual and thereby cost prohibitive, they are now based on highly sophisticated computer-based stochastic modeling that makes them cost effective for all employees and plan sponsors. This newly available approach to asset allocation is based on Liability Driven Investing (LDI) techniques. DB plans have long used LDI on the plan level, and now DC plans can use it on the individual participant level. In contrast to TDFs, which treat each individual of the same age the same, LDI looks at each participant’s specific financial picture and creates and manages the asset allocation for that individual over time. Furthermore, LDI modeling can heed the plan’s ultimate income replacement goal and manage assets over a career to best match that goal for each participant.

Make Benefits Portable

DC plans are uniquely able to meet the career mobility realities of the modern workforce, where median job tenure for state government employees’ is 5.6 years according to Bureau of Labor Statistics.¹¹ However, plans need to be properly designed to meet this critical objective.

Plan sponsors should reduce or eliminate vesting periods (the time spent participating in the plan before the assets are fully “owned” by the participant). Since the amount of accumulated assets an individual owns determines the retirement income from a DC plan, short or immediate vesting is directly tied to retirement benefit adequacy and can help employees accumulate the assets necessary to meet plan income objectives.

Since plan participants will almost certainly work for several employers during a career, shorter vesting periods or immediate vesting at each career stop is critical to achieving adequate retirement income. Traditional defined benefit plans have long vesting periods that often take years. If an employee leaves before being fully vested, their benefits are either substantially reduced or eliminated. This punishes modern workers who change jobs often.

Offer Distribution Options

Many believe that DC retirement plans can only distribute plan assets to individuals as a lump sum, but this is inaccurate. A plan sponsor can very specifically define the asset distribution methods available in the plan document. Employers can distribute some or all of an individual’s accumulated assets as lifetime income (or “annuitizing” assets) using fixed and/or variable annuities, guaranteed minimum withdrawal benefits, or any number of other available products.

Distribution options minimize retirement income inadequacy and should align with plan objectives. In other words, if the plan’s defined and articulated objectives seek to maintain a standard of living in retirement, the plan should make lifetime income options available to participants. Advanced TDF offerings and LDI designs can increasingly factor future income needs into their product designs.

DC plans can also offer lump-sum withdrawals and rollovers, which may be appropriate for some plan participants depending on their specific financial circumstances. Traditional DB plans typically do not offer this range of distribution options. A lifetime income is the only distribution available at retirement under most of these plans.

Another distribution-related DC plan best practice prohibits participants from borrowing against their account balances. The legal structure of DC plans may allow participant loans but a plan sponsor need not make them available. While loans may have a place in supplemental DC plans, they most certainly do not in core retirement DC plans. A best-practice retirement plan focuses on providing lifetime income security in retirement as a primary objective. Borrowing from the assets in a core DC retirement plan is inconsistent with that objective.

Ensure Disability Coverage

Employees who suffer a long-term disability during their tenure need insurance coverage to replace the income suddenly lost as a result. Public DB pension plans normally provide a disability income benefit for employees, and DC plans should offer the same disability protection. Government employers can generally purchase a separate disability insurance benefit from a quality insurer—or even self-insure—for somewhere between 50 to 150 basis points (0.5% to 1.5% of salary).

Are Defined Contribution Plans Right for Your State Employee Benefits?

In the varied approaches to pension reform, debate often revolves around whether policymakers should improve an existing DB program or switch the program completely to a DC retirement plan. Reality isn’t so black and white: a much more robust set of policy options, choices, and hybrid concepts can be customized outside a simplistic “DB versus DC” framing. Optimal retirement plan designs vary with system objectives that may require different approaches, with pros and cons to every plan type. The overarching goal, however, is to design a sustainable plan that meets the needs of both public employers and employees.

Some perceive defined contribution (DC) retirement plans as less effective than defined benefit (DB) pension plans at providing retirement security in both the public and private sectors. When an unmanaged supplemental DC plan is employed as a core plan, this argument has merit. For example, West Virginia closed its traditional teachers’ pension plan, the Teacher Retirement System, in 1991 and replaced it with a DC plan. Only a few years later, in 2005, the state reversed course, closing the DC plan and switching all members back to a DB plan.¹² While this failure was blamed on an alleged inherent inadequacy of DC plans, in reality the culprit was poor plan design for that particular DC plan.¹³ If the DC design had followed the best practices described in this report, the plan would likely have met its objectives effectively.

In general, DC plans shift investment risk to employees, given that account values fluctuate with financial markets. Compared to DB plans, which require taxpayers to bear the financial risks of fluctuating markets by paying out a fixed, scheduled benefit, DC plans tend to be perceived as risky or inadequate by employees. Employees may wonder if DC plans can offer adequate retirement security in the face of uncertain market returns. One need look no further than public higher education, however, to realize just how effective DC plans have been in meeting employee retirement needs over a long period of time.

When DC plans are judged “inadequate,” one has to assess the defined objectives and plan design to pinpoint what actually led to the DC plan’s inadequate performance. While DB plans may look stronger to career employees than DC plans, this discounts the needs of shorter term employees, which comprise a growing share of the modern public sector workforce. When assessing adequacy and value to employees, DB to DC plan switch must account for the percentage of new hires who will leave public service before vesting in their DB pensions, thereby sacrificing the employer contributions made toward their benefit, and the likely detrimental impact this has on their retirement.

Recruitment and Retention

Employee benefits are a key aspect of total compensation and a key role in recruiting prospective employees and retaining current employees. The 2016 Metlife U.S. Employee Benefit Trends Study found that 83% of employers believe that retaining employees is their top goal. Similarly, 51% said that using benefits to retain employees will become even more important in the next five years. Empirical literature that suggest that compensation and benefits play a major role in recruitment and retention of quality employees further supports this idea.¹⁴

The aforementioned narrative gives rise to the debate over which structure improves public sector employers’ ability to recruit and retain talent. Again here, many DB advocates view DC plans as an inferior product that may harm the recruitment and retention of talented workers.¹⁵ But does the evidence bear this out?

Although the research in this area has mixed findings, there is evidence that DC retirement plans could benefit employee retention. Broadbent et al. (2006) examined the transition from DB to DC plans, finding that the gradual shift away from DB toward DC favors labor market mobility, which alleviates the accrual risk associated with DB plans. The authors argue that DC plans can provide employees with more control and flexibility in managing their retirement savings and investments. Likewise, researchers Goad, Jones, and Manchester (2013) found evidence of positive selection into DC plans over DB plans for employees with higher mobility tendencies.

Furthermore, academics Goldhaber, Grout, and Holden (2016) studied pension structure and employee turnover in public pension systems, finding no association between shifts away from DB plans and higher turnover. DC retirement plans were introduced in higher education over a century ago specifically to address the recruitment and retention of mobile faculty in a nationwide employment pool, and today almost all professions are mobile. State government employees’ (including public school teachers, public safety, and other state government workers) median employment tenure in 2020 was just 5.6 years, which belies the notion that people seek public sector work for permanent, lifetime employment anymore these days, as was assumed in the past.¹⁶

State retirement system data support these numbers. For example, Colorado PERA School Division data show that only 37% of hires remain in the system after five years of service. Today’s typical public sector DB plans simply do not meet the portability needs of the modern mobile workforce.

Transitioning from DB to DC

Properly designed public sector DC plans should not siphon off funds from the traditional DB plans when new employees choose between traditional DB and DC. As DB plans fund promised benefits, implementing a DC plan does not eliminate the need to continue full, actuarially determined contributions to any legacy DB plan still in operation. Continuing funding discipline for legacy DB pensions has been a challenging policy issue in states like West Virginia and Michigan over the years. This is important because it’s easy for policymakers and stakeholders to mistakenly believe that shifting workers toward DC plans either inherently poaches funding away from, or removes the need to continue to fully fund, legacy DB plans, which is not the case.

Properly designed, prefunded, public DB pension plans do not and should not require future employee contributions to cover benefits promised to current employees—this would be, by definition, a Ponzi scheme, not a prefunded, actuarially sound pension. At the same time, even if a traditional DB pension plan has no new future entrants joining the plan, governments are still fiduciarily obligated to continue making payments to amortize legacy unfunded liabilities. The best approach for employers—used in states like Arizona, Oklahoma, and Florida—is to, from an unfunded liability amortization policy perspective, act as if all new DC retirement plan entrants had instead entered the legacy DB plan, and thus continue making the usual percent-of-payroll-based pension contributions over a total payroll that includes the full employee headcount, no matter whether or not employees are in the DB or DC plans.

Furthermore, adding a DC option does not prevent the state legislature from making additional payments and changing current members’ contribution schedule to pay down any existing pension debt over time. Notably, the vast majority of public pension plans do not operate on a pay-as-you-go basis. This makes it possible to decouple employment growth (or the number of new workers paying into the system) from pension liabilities. Using level-dollar amortization can accomplish the task successfully, removing membership or payroll growth expectations from the pension contribution and debt calculations.

Traditional DB pension plans took root and became the most common plan type in the public sector decades ago. Accordingly, with the notable exception of public higher education, the number of primary DC retirement plans used by U.S. state and local governments is relatively limited. However, policymakers can use some historical examples as a guide for good and bad practices when developing a DC plan design.

Some jurisdictions have successfully achieved this transition, with DC plans that have stood the test of time. In 1987, Washington D.C. closed its defined benefit plan to new employees and replaced it with a hybrid retirement plan—the Federal Employees Retirement System— that pairs a modest DB pension benefit (with a 1% or 1.1% annual accrual rate) with a world-class DC plan (the popular Thrift Savings Plan) and Social Security membership.

Michigan became the first state to close its state employee DB pension plan to new entrants and enroll all new hires in a DC plan back in 1996. Though this plan began with weak contribution rates and governance, it has improved remarkably over the last two decades—improving contribution rate adequacy, adding auto-default and auto-escalation policies, and offering annuities, for example—evolving over time into a high-quality DC plan. Likewise, Alaska closed its defined benefit plans in 2006 for new employees in favor of a DC plan with healthy contribution rates.¹⁷ And in public higher education, DC plans have predominantly provided successful retirement benefits in nearly every state, some for more than 100 years.

Case Studies in the Best Practice Public Sector DC Retirement Plan Design

Arizona Public Safety Personnel Defined Contribution Retirement Plan (Tier 3 DC Option)

Arizona significantly reformed its Public Safety Personnel Retirement System (PSPRS) in 2016, which created a new and more affordable tier of benefits for public safety personnel. Due to this reform, new public safety employees hired since July 1, 2017 (referred to as Tier 3 employees) are offered a choice between a risk-managed defined benefit pension plan (or a hybrid variant for those personnel under employers not participating in Social Security) and a pure DC plan—the Public Safety Personnel Defined Contribution Retirement Plan (PSPDCRP)—as their primary retirement benefit. Employees have 90 days to elect the PSPDCRP; otherwise they are defaulted into the risk-managed pension option. Personnel are also eligible to participate in a deferred compensation (e.g., supplemental) DC plan too, regardless of the primary plan chosen.

Those Tier 3 new hires choosing the PSPDCRP in an irrevocable election within the first 90 days of employment receive tax-deferred retirement savings in a professionally managed and self-directed 401(a) plan, including these features:

• Employees contribute a minimum of 9% of salary and can contribute up to limits established by the IRS, and vesting of employee contributions is immediate.
• Employers contribute 9% to employee DC accounts, and those contributions vest at a rate of 10% per year over 10 years.
• Participants are defaulted into an appropriate target date fund and can choose between five and 25 total investment fund options, including options that reflect different risk profiles and various automatically rebalancing target date funds. Participants can mix and match, splitting their DC investments across several of the predetermined investment portfolio options.
• PSPRS is required to hire a third party administrator, with periodic rebidding, to manage the PSPDCRP using evaluation criteria that cover the company’s financial stability, its ability to provide the participants’ benefits, fees and cost structures, experience in administering primary DC retirement plans in the public sector, and experience in providing member education.
• The third party administrator for PSPDCRP—currently Nationwide—is required by law to provide education, counseling, and objective participant-specific plan advice to participants through a federally registered investment advisor that acts as a fiduciary to participants and is thus required to act in the participant’s best interest.
• Upon retirement, participants can roll over their DC plans to an IRA plan or, alternatively, PSPRS is required to offer participants a menu of lifetime annuity options, either fixed or variable or a combination of both.
• Members and employers also make a relatively small contribution each pay period to the PSPRS DC disability program; those contributions are sent to PSPRS and are not included in their DC plan assets.

The 18% minimum annual contribution to the PSPDCRP exceeds the 10%-15% recommendation commonly made by financial advisors and retirement planners for those workers covered by Social Security. This means participants are substantially more likely to accomplish (maybe even exceed) the desired income replacement levels during retirement, making Arizona’s standalone DC retirement plan one of the nation’s best.

That said, Arizona reform efforts faced a unique issue—a large portion of current public safety personnel work for employers that participate in Social Security while many others do not. This created a discrepancy in which some employees will both participate in Social Security and receive a PSPRS pension, while other employees receive only the PSPRS pension. To remedy this, the 2016 reforms introduced a PSPRS DB hybrid plan for employees not covered by Social Security. The hybrid plan offers those employees the risk- managed Tier 3 pension benefit along with a small 401(a) component of a 3% of pay employer contribution with an equal employee match for a total 6% supplemental DC contribution. This hybrid plan was also made retroactively available to all workers hired between 1/1/2012 and 6/30/2017 (“Tier 2” employees), and these workers received “catch- up” contributions as if they had been in the new PSPDCRP since the beginning of Tier 2.

A subsequent reform in 2017 opened up the PSPDCRP to state and local corrections officers, who are defaulted into a 7% employee contribution rate, but can drop that to no lower than 5% (or contribute more). However, the contribution rate they choose when they join the plan cannot be changed. These workers receive a far more generous vesting schedule. Members in this plan always own their contributions and investment earnings and will gain “vested” ownership of them at a rate of 25% after year one, 50% after year two, and 100% after three years.

Arizona’s PSPDCRP structure provides a road map for legislators and stakeholders seeking to reform their antiquated systems to reduce financial risk while ensuring multiple pathways to retirement security. Arizona created a credible DC retirement plan option to stand up next to a traditional pension and built out a generous contribution schedule that exceeds best practices. The system has adequate defaults that ensure workers are taken care of even if they do not take an active interest in their retirement planning. The system also offers varying investment options for workers seeking a more proactive role in their own retirement planning. Arizona PSPRS isn’t perfect; police and fire personnel members face a 10-year vesting period for the employer portion of the contributions, but the average job tenure in the U.S. is less than six years. Nevertheless, there is still a lot to learn from Arizona’s pension reform efforts.

Michigan’s Evolving DC Reforms

In 1996, former Michigan Governor John Engler and State Treasurer Douglas Roberts successfully pushed to create the nation’s first modern, large-scale, state-level DC plan for state employees covered by the Michigan State Employee Retirement System, under the notion that the traditional pension system was a poor fit for a changing workforce with shorter tenures. As Roberts told Reason Foundation in a 2014 interview:

Even in the late 1990s, it was clear that society was changing. Our technology and our workforce were changing. People were no longer working for a single employer over their lifetime, but taking advantage of our strong sense of upward mobility. An individual might change jobs five, six, or seven times over a career. It’s very difficult to vest in a pension system when you’re changing jobs so frequently, assuming that your workplace requires 10 years of work to qualify for pension benefits.¹⁸

Under Michigan House Bill 6229—later to become Public Act 487 of 1996 after being signed into law in December 2016—all state employees hired on or after March 31, 1997 were automatically enrolled in a defined contribution retirement plan called “MSERS Tier 2.”¹⁹ The MSERS Tier 2 DC plan began as a fairly meager benefit; the only mandatory contribution was a 4% required employer contribution. If employees chose they could contribute an additional 3% of pay that would be matched by the employer, but many did not since this was not a default option.

Hence, this contribution policy led to fairly small DC account balances for the first waves of employees hired under the new plan. Over time the legislature and Office of Retirement Services, which administers the state’s largest pension plans, rectified the situation, steadily improving the contribution policy in both state law and administrative rules to focus on promoting retirement security. The plan has evolved to feature the following characteristics today:

• The state contributes 4% of each employee’s salary into their DC account, with immediate vesting of employee contributions. Employer contributions to the account vest over four years.
• Employees are now auto-enrolled at a 3% of salary contribution to their DC accounts, triggering an equal matching payment by the state of 3%, leading to a default 10% contribution rate for all new hires in Michigan state employment.
• Employees can contribute more beyond the required 3% without a match, and in fact the Office of Retirement Services maintains an auto-escalation policy that increases employee contributions by 1% per year as a means of “nudging” higher retirement savings.
• The current Tier 2 DC plan offers 11 target date fund options and another 18 asset class-based funds for individuals to choose from, depending on their investment appetite and retirement goals, including a totally self-managed plan.
• The current third-party administrator for the Tier 2 DC plan—Voya Financial—offers financial advisory services to plan participants, as well as fee-based professional financial portfolio management.

In 2010, the legislature extended DC retirement plans into public education, creating a hybrid DB/DC plan for new teachers and school personnel called the Pension Plus Plan to be administered by the Michigan Public Schools Employees’ Retirement System (MPSERS). Public Act 75 of 2010 enrolled new hires by MPSERS employers after July 1, 2010 into a new DB pension plan with the same benefit formula as before, but the benefit left out cost- of-living adjustment, extended some members’ final average salary numbers from three to five years, and capped the assumed rate of return on that DB tier at 7% (relative to the 8% in use at the time for the legacy DB tier). This pension was paired with a small DC element—a 2% of salary contribution to a DC fund with up to 1% of salary matched by the state—to create a fairly weak and unbalanced DB-heavy hybrid.

In 2012, Public Act 300 introduced the concept of DC choice to teachers and school district employees. MPSERS-participating employees could keep the same pension benefit but increase employee contributions, keep the same contribution rate but accrue prospective benefits using a lower benefit formula, or drop the pension portion of the hybrid to retain only the DC portion (with a low default contribution rate). New hires were defaulted into the new, reduced-benefit Pension Plus hybrid plan, but for the first time they were also offered a full DC retirement plan option if chosen in the first 75 days of employment. Rather than mirror the DC offered to state employees, the optional MPSERS DC required a 6% employee contribution with a 50% match up to 3% of salary. Notably, at a 9% aggregate contribution rate, the full DC retirement plan offered to new hires came fairly close to the 10% rate offered in the MSERS Tier 2 DC plan for state employees, but both were far higher than the 3% default rate offered to existing teachers opting to switch plans under the 2012 law.

In 2017, the legislature continued its reform efforts. Public Act 92 of 2017 led to a different retirement option—either a revamped DC retirement plan or a redesigned “Pension Plus 2” hybrid plan—for all Michigan public school employees who began working on or after February 1, 2018. One important change in the 2017 reform package is that it changed the default plan to the DC retirement plan.

The upgrades to the core DC plan come from essentially replicating the MSERS DC plan design—with a 4% minimum employer contribution, triggering another 3% employer contribution and 3% employer match—extending the provisions backward in time to those hired since the first DC option launched in 2012. Another upgrade involved improving retirement security through auto-escalating contributions. Auto-escalation automatically increases employee contributions by 1% each year up to a maximum of four years. This feature can be disabled, and contributions can be voluntarily reduced by the employee. But if left to operate, in a short span of time—the same time required for employer contributions to fully vest in the DC plan—the aggregate DC default contribution rate rises from 10% to 14% of salary. This auto-escalation feature represents an upgrade from the 3% default some existing teachers selected in the wake of the 2012 legislation passage to strengthen retirement readiness.

Furthermore, Public Act 92 required the Michigan Treasury Department, which manages the DC Plan, to add at least one fixed rate annuity and at least one variable rate annuity to its investment option mix to provide more benefit withdrawal options at retirement and improve the system’s ability to provide lifetime income.

On the hybrid side, the choice improved as well, particularly from concerning long-term financial resiliency. While the Pension Plus 2 Plan still combines the same post-2012 pension benefit with a small (3% aggregate contribution) DC plan in a weak hybrid structure, it nonetheless exemplifies a newer generation DB pension design built to be risk- managed, using 50/50 employer and employee cost-sharing and short amortization schedules, minimizing the potential for contribution rate volatility. And, like the Pension Plus Plan before it, Pension Plus 2 capped the investment assumed rate of return for that tier of the pension system, this time at an even lower 6%. The reform push has been praised by Standard & Poor’s, which cited pension reform as key in its subsequent decision to increase the state’s credit rating from -AA to AA with a stable outlook after the 2017 reform passed.

The reform push has been praised by Standard & Poor’s, which cited pension reform as key in its subsequent decision to increase the state’s credit rating from -AA to AA with a stable outlook after the 2017 reform passed.

All pension reform efforts should primarily seek to keep all promises made to existing employees and retirees and to support retirement security for current and future members. These principles were on display in Michigan. The state’s pension reforms placed a major focus on limiting the state’s current and future financial exposure. Some Michigan stakeholders insisted employees have the option for a traditional defined benefit, while other stakeholders focused on providing a sound DC plan that would provide portable, quality benefits for the more mobile teachers of today and tomorrow. Although these could be mistaken as competing interests, Michigan proves that is not the case—different plan designs offer different trade-offs and ultimately expand personal choice and responsibility.

Colorado’s PERAChoice DC Option

Colorado Public Employees’ Retirement Association (PERA) provides retirement and other benefits to employees at more than 500 government agencies and public entities in the state. Colorado has a long history of offering choice options to its public workers, a tradition the state excels in and continues to build upon.

Colorado PERA’s core DC plan—PERAChoice—was established in 2006 and is structured as a 401(a) for state employees hired from that year on seeking an alternative to PERA’s current defined benefit plan. The legislature expanded eligibility for the PERAChoice DC plan to community college employees in 2008, then to state university and local government employees in 2019.²⁰

Currently, members contribute 10% of salary for state division employees, 8.5% for local government participant, and 12% for public safety officers. Employers contribute an additional 10.9% for state division employees, 13.6% for state safety officers, and 10.5% for local government division. This adds up to 20.9%, 23.6%, and 20.9% in total contributions for state employers.²¹ These contribution rates exceed the 10%-15% commonly recommended by financial advisors because many members do not participate in Social Security.

For PERAChoice’s core DC, employee contributions automatically vest at 100%, and employer contributions vest at 50%, rising an additional 10 percentage points every year for five years until they reach 100%, at which point if an employee decides to leave he will be entitled to 100% of the employer contributions.

A third party vendor manages the PERAChoice DC core plan and the various supplemental DC plans it offers. Each plan has identical investment options. The plan design allows participants to set their own investment allocation. Members can choose among a list of varying investment funds or a self-directed brokerage account, allowing users a wide breadth of investment options. The vendor provides education and advice to new members and defaults all core DC participants in the appropriate aged-based target date fund.

Furthermore, Colorado’s PERA DC does not negatively affect the DB plan. Colorado requires employers to remit an Amortization Equalization Disbursement and Supplemental Amortization Equalization Disbursement to amortize the DB plan’s legacy debt across total payroll for all PERA members. Actuaries calculate these additional contributions to direct payment to legacy pension debt even as more employees opt for DC benefits.

Reform efforts in Michigan, Arizona, and Colorado are apt evidence that policymakers need not view DB and DC plans as an either/or proposition. These systems can be very complementary. A jurisdiction can find an appropriate balance between the two options that reduces costs and risks to taxpayers while still providing attractive and reliable retirement options for public servants.

Conclusion

Many public retirement systems desperately need modernization that recognizes and accommodates an evolving modern workforce’s professional and geographic mobility. Retirement systems built around an expectation of full, multi-decade service at one employer will increasingly fail to ensure retirement security for a workforce largely comprising non-full-career employees. This mismatch creates a need for serious conversations about modernizing benefit offerings, including expanding choice and offering more-portable plan designs, including DC retirement plans.

This brief delineates the best practices that ensure functionality and successful DC retirement plans execution, notably the following features, which are inseparable to a well- designed, well-functioning DC plan:

• Plan Objectives: The plan’s purpose must be clearly stated and understood by all stakeholders.
• Communication and Education: Communicating plan features and educating participants on their options is critical to fulfilling objectives.
• Auto-Enrollment: Making sure all eligible employees participate in the plan is essential.
• Contribution Adequacy: Both employer and employee plan contributions must be sufficient to meet future income needs in retirement.
• Retirement-Specific Portfolio Design: Investments available within the plan should be specifically selected to meet plan objectives, and “one-touch” default options (such as target date funds) must be provided.
• Benefit Portability: Plan design features must meet the modern public sector workforce’s needs.
• Distribution: Asset distribution in retirement should target plan objectives by offering flexible lifetime income options to meet the varying needs of employees.

A properly designed DC retirement plan can meet employee needs for retirement security and mitigate inherent financial risks to taxpayers. Following the best practices outlined here, a jurisdiction can be confident that its public retirement plan will meet the modern workforce’s needs while also addressing state and local governments’ critical financial solvency needs.

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This brief is part of the Pension Integrity Project at Reason Foundation’s Gold Standard In Public Retirement System Design series reviewing the best practices of state-level public pension systems and providing a design framework for states that are struggling under a burden of post-employment benefit debt. The series includes recommendations to help states move into a more sustainable model for employees and taxpayers.

The post Defined Contribution Plans: Best Practices in Design and Utilization appeared first on Reason Foundation.

Public pension fund managers are not tasked with conducting U.S foreign policy. As the stewards of our nation’s public retirement systems, plan managers have an ethical obligation as fiduciaries to make prudent, risk-appropriate investment decisions. This undoubtedly requires analysis of all types of risk, including those that are geopolitical. However, they should avoid using the influence granted to them by their funders—public workers and taxpayers—to exacerbate geopolitical risk. Plan managers should defer the politics of foreign policy to the U.S. Congress and White House

Divestiture politics predate the current moment, and past movements have successfully altered the behaviors of pension funds. Nevertheless, shaping pension investment policy based on political activism is likely to become increasingly problematic. Activists that target pension fund investment policies represent a host of ideologies. Fund managers risk making themselves referees on some of society’s most contentious issues as they seek to placate a growing list of contradicting interests.

Not only do divesture policies based on political interests extend beyond the role of public pension fund managers, but they are also very unlikely to accomplish the intended outcome. There is little evidence that divestment movements influence the desired target to encourage policy changes. In the 1980s, students across the U.S. protested the apartheid system in South Africa, demanding their universities divest from companies operating in the country. Despite about 150 educational institutions heeding the plea, researchers found that divestment had no effect on the market value or behavior of South African companies. Given the massive size and economic influence of China, divestment movements targeting China would likely have a similar effect or lack thereof.

The long-term viability of a pension system is contingent on the ability of fund managers to strike a balance between achieving sufficient investment returns to have the necessary funding to provide promised benefits and managing risk through diversified investments. The loss of diversification associated with refusing to invest in the world’s second-largest economy will increase the risk facing these funds, and it will likely hamper the efforts to recoup investment losses from the COVID-19 market shock. Divestment policies can be a significant disservice to the public workers that are depending on their benefits to be there when they retire.

The motivation of plan administrators should be exclusively centered on maximizing investment returns and managing the security of the fund through risk-reduction policies – otherwise they will be undermining their fiduciary responsibility to their members. There should be no exceptions for industries some find objectionable (e.g., firearms, tobacco, pipelines, petroleum, etc.), nor are there exceptions for nations.

Although blanketed divestitures policies should warrant hesitation, plans to improve general transparency for foreign securities trading in the United States are a step in the right direction. All foreign financial instruments sold to Americans should be held to the same regulatory standards as their American peers.

With over $1.2 trillion in national public pension debt, the continued challenges governments face during the COVID-19 pandemic, and inadequate retirement security plaguing state and local governments, the nations’ public pension managers need to be focused on advancing prudent pension policy. Pension managers should protect the interests of plan dependents and reject political meddling.

A version of this column previously appeared in Townhall Finance. 

The post Pension Funds Should Reject Politically Motivated Divestiture appeared first on Reason Foundation.

Public pension systems are funded by contributions from workers and employers. These contributions are then pooled and invested to earn a return. The assets accumulated within the fund are used to pay out retirement benefits over time. Pension managers and actuaries have to prudently manage these funds to ensure pension systems remain solvent. Market downturns complicate this. When investment returns fail to meet the return assumptions, the pension debt grows.

In the five years following the Great Recession, market returns for TFFR and NDPERS averaged -1.2 percent and -0.29 percent, respectively, well below the 8.0 percent return assumptions used for the plans at the time.

The Great Recession manifested into serious losses. In July of 2007, NDPERS had a funded ratio of 93 percent, meaning it had about $93.40 in assets for every $100 promised in benefits (liabilities). The financial crisis blew holes in the state pension funds that are still visible today. As of July 2019, the NDPERS’ funded ratio was only 72 percent, with $1.2 billion in pension debt. During the same period, TFFR’s funded ratio decreased from 79 percent to 66 percent, compiling over $1.35 billion in unfunded pension liabilities.

If the current market downturn produces a -5 percent annual investment return, similar to what was experienced in 2008, the Reason Foundation conservatively projects that 2020 unfunded liabilities will rise an additional $400 million for NDPERS and an additional $300 million for TFFR.

In addition to missed investment return assumptions, the state has consistently failed to make the required contributions needed to achieve and maintain a 100 percent funded ratio.

According to financial reports, from 2003 to 2019, the state of North Dakota has missed over $539 million in actuarially determined employer contributions for NDPERS. Similarly, from 2004 to 2019, the state has missed over $117 million in actuarially determined employer contribution for TFFR. For nearly 20 years, North Dakota has failed to adequately fund its major state pension system.

The current coronavirus-sparked market downturn will undoubtedly exacerbate the problems public retirement systems face. Despite a decade-long bull run, pensions in North Dakota never fully recovered from the 2008 recession. It’s clear from the last 12 years that managers can’t invest their way out of this hole without significant changes in policy. To have any hope of recovering from the current crisis, elected leadership needs to address the problems that hindered the state’s pension recovery in the aftermath of the 2008 recession. The legislature, specifically the Employee Benefits Programs Committee, should consider implementing serious pension reforms.

The post For Two Decades, North Dakota Has Failed to Properly Fund Its Public Pensions appeared first on Reason Foundation.

While it is true that Florida is in a better position to weather the current economic and market volitivity than the state-run pension plans with even more unfunded liabilities that Sen. Scott chose to compare Florida’s system to, like Illinois, New Jersey, and California, the state’s policymakers should not mistakenly view the Florida Retirement System’s (FRS) current financial status as strong or acceptable.

Florida’s pension system is $30 billion short of the money needed to provide the retirement benefits that have been promised to the state’s public employees. Using actuarially-adjusted values in the most recent FRS valuations, which were made prior to the current coronavirus pandemic and this year’s stock market losses, the state retirement system’s funded ratio was 84.2 percent, well below the 100 percent funded ratio target recommended by the American Academy of Actuaries’ Pension Practice Council and the Government Finance Officers Association. In other words, at that time, FRS only had 84 cents for every dollar it needs to pay for the retirement promises the state has made to its public workers and retirees.

Unfortunately, the pension system’s funding situation is likely to deteriorate further due to the current economic conditions.  During the financial crisis of 2008, for example, the Florida Retirement System’s investment return was -19.71 percent. As a result of that bad year for investment returns, FRS’ funded ratio plummeted from 106.7 percent to 88.5 percent, pushing the system from having a surplus to reporting $23.6 billion in debt. The impact of the current COVID-19 pandemic and economic downturn could produce similar or even worse investment return results for FRS.

If FRS’ investment returns come in at -5 percent for this fiscal year—a number many experts think is an optimistic scenario given the stock market, the Pension Integrity Project at Reason Foundation finds FRS’ unfunded liabilities could grow to $47.7 billion. If the state’s investment returns come in at -15 percent this fiscal year, FRS’ unfunded pension liabilities could balloon to $63.7 billion.

So, rather than comparing FRS to some of the worst-off public pension plans across the county, as Scott did, Florida lawmakers should address the serious issues that were causing FRS to have multi-billion-dollar pension shortfalls well before the coronavirus pandemic and are likely to be significantly exacerbated by the economic downturn.

Similarly, the state should revisit its previous pension reforms. In 2000, the Florida legislature prudently decided to offer an additional retirement plan to new hires called the FRS Investment Plan, a portable, defined-contribution retirement plan similar to 401(k) retirement plans most private-sector workers are familiar with.

Unfortunately, the state’s Investment Plan has its own financial problems. Public employees contribute 3 percent of their annual salary into their retirement accounts and the employer, the state, contributes an additional 3.3 percent, for a combined contribution of 6.3 percent of an employee’s salary. This is well below the estimated 10 to 15 percent contribution rate needed to generate sufficient retirement income to supplement Social Security for most people. Although defined contribution plans generally do not add to state pension debt, dangerously inadequate contributions could leave thousands of Floridians financially vulnerable in their retirement years.

Considering these realities, Florida is in desperate need of structural public pension reforms. FRS never fully recovered from the 2008 financial crisis—despite the decade of stock market growth that followed. And now, amidst the coronavirus pandemic and decreased economic activity, FRS is arguably more financially vulnerable today than at any time in the last 25 years. Rather than congratulating themselves, the state’s leaders should pursue the reforms needed to ensure pension promises made to public workers are kept.

The post Instead of Boasting, Florida Should Be Bracing for Bad Pension News and More Debt appeared first on Reason Foundation.

The Massachusetts’ Public Employee Retirement Administration Commission (PERAC) oversees both the State Retirement System, which serves general state employees, and the Teachers Retirement System which provides retirement benefits to K-12 teachers. Together, these systems manage the retirement promises for over 300,000 active and retired members. Combined, they have a funded ratio of 56.3 percent, well below the 100 percent funded ratio target recommended by the American Academy of Actuaries’ Pension Practice Council and the Government Finance Officers Association. PERAC has amassed nearly $44 billion in pension debt.

In 2019, PERAC made roughly 75 percent of the actuarially-required employer contribution to the system, meaning the state’s payments did not meet the suggested levels set by their own actuaries. However, under Gov. Baker’s proposed plan, employer contributions would rise by more than 30 percent over the next three-years. This amounts to a jump from $2.84 billion in 2020 to $3.11 billion in 2021.

If implemented, Gov. Baker’s plan would wisely correct a dangerous trend of chronic underfunding and help ensure the state’s ability to provide promised benefits.

Massachusetts’ system, like most public pension plans, uses a combination of member and employer contributions and investment returns to finance workers’ retirement benefits. Pension plan managers depend heavily on investment returns to help grow the system’s fund to adequate levels. If the actual rate of investment returns fall short of what the plan managers assumed, a funding shortfall is created. This shortfall increases exponentially over time and erodes the plan’s ability to meet the promises made to retirees.

Fortunately, PERAC’s plan managers have noted the trend towards lower investment returns. PERAC has consistently adopted more conservative investment return assumptions. Over the last decade, plan managers lowered the rate of expected investment returns from 8.25 percent in 2012 to 7.25 percent in 2019. These adjustments have helped align the system’s assumptions with the reality that fund managers will likely not be able to depend on market returns at the levels they did in previous years.

Given today’s diminishing stock market forecasts, PERAC may need to reduce these expectations even further, as their current investment return assumptions still may not be conservative enough. Over the past 19 years (2000-2018), for example, PERAC’s average rate of annual return was approximately 6.2 percent. This falls short of the plan’s current assumed rate of return of 7.25 percent.

Overall the pension plan’s current rate is unaligned with the emerging “new normal” of a lower-yield investment environment that is the consensus among major investment managers. Additionally, the J.P. Morgan Asset Management Company expects an aggressive 60 percent equity/40 percent bond portfolio to earn somewhere between 5.4 percent and 6.0 percent in the next 10 to 15 years. This view is further supported by similar analyses by industry peers such as McKinsey, Vanguard and Charles Schwab.

Thus Gov. Baker is right to push for public pension contribution increases in his budget. Elected officials in Massachusetts, however, need to also understand that this move should be just the start of pension reforms.

The governor’s proposal would simply require the state to pay 100 percent of what it already should have been paying into the pension plans. Baker’s proposal does not address structural issues within the pension system’s design that has contributed to billions of dollars in underfunding. Absent additional reforms to solve these issues, there’s a real risk that higher contributions would not solve the underlying solvency challenges. Higher contributions should be coupled with targeted reforms that comprehensively address sources of the government’s pension struggles.

With the near-term investment forecast looking increasingly bleak (even before recent events related to the coronavirus pandemic), Massachusetts should be contributing much more than is needed to only pay the current bill if there’s going to be any hope of eliminating unfunded liabilities in the long run. If it doesn’t, pension debt will likely continue to grow.

Legislators should certainly embrace the governor’s current policy agenda as a starting point for pension reform and commit to working with Gov. Baker on additional steps needed to ensure Massachusetts’ taxpayers and pensioners are protected for decades to come.

The post Massachusetts’ Legislature Should Help Gov. Baker Make Good on Pension Promises appeared first on Reason Foundation.

The post North Carolina Teachers’ and State Employees’ Retirement System: A Pension Solvency Analysis appeared first on Reason Foundation.

In 2018, the ACC implemented an assumed rate of return of 7.4 percent, well above the 7 percent Milliman recommended expecting from FRS’ investment returns. The decision by FRS to reject the suggestion of its own actuarial advisors is extremely unusual in the world of pension management. And differences like these prompted Milliman actuaries to issue several rare and unusual warnings within the system’s annual actuarial reports over the last several years. Millman wanted to go on the record stating that the optimistic investment return assumptions being made by FRS were not professionally defensible.

Adopting an assumed rate of return that is too high can result in a significant overvaluation of the funds that the retirement system will have available to provide the pension benefits already promised to Florida’s public workers. Similarly, using that same figure as the plan’s discount rate—a common practice—can lead to undervaluation of the system’s liabilities. Put simply, the decision to adopt overly-optimistic assumptions makes the Florida Retirement System’s funding status look better than it actually is. Even worse, this puts the fund in a position of unnecessary risk.

In an overdue but positive move, the 2019 ACC recently agreed to lower the FRS assumed rate of return by 20 basis points—from 7.4 percent to 7.2 percent. This brings FRS closer to alignment with the plans’ consulting actuary, but the assumption remains still 20 basis points above the Milliman 2018 recommendations of 7 percent.

The lowered assumption for expected investment returns resulted in the recognition of $4.8 billion in additional actuarial unfunded liability causing FRS’ pension debt to rise from $29.8 billion to about $36.7 billion. But the move improves the pension system’s resilience to poor market performance (plans with a lower return assumption have a higher probability of matching or exceeding their assumed long-term investment returns).  

Although the change made by the ACC is welcomed and warranted, a recent Reason Foundation analysis suggests that a 7.2 percent assumed rate of return is still well above reasonable performance expectations. Employing a comparative analysis (see figure 1) based on the capital market forecasts of several major financial advisors (JP Morgan, BNY Mellon, BlackRock and Research Affiliates), and applying their expected returns to the asset allocation of FRS, the prospects for achieving a long-term 7.2 percent return seem unlikely at best. Reason’s analysis suggests that pension investment returns over the next two decades are likely to hover closer to the 6 percent range, generally speaking.

The analysis suggests FRS is likely to fall well below the plan’s historic assumed return over the next decade, which means the current policy exposes the system to the considerable risk of underperforming investments. The system’s actuaries forecast FRS has just a 40 percent probability of meeting its new 7.2 percent ARR, meaning the system is far more likely than not to miss the mark. 

Long-term projections appear more optimistic than short-term projections generally due to a speculative assumption that, absent any certainty at all about market returns 20-30 years from now, FRS investment gains will revert to their historical mean—an increasingly unlikely prediction given the “new normal” investment environment. Even in those more optimistic long-term forecasts, the new 7.2 percent assumed rate of return has barely more than a 50/50 chance of proving accurate beyond 20 years. It should go without saying that investment return forecasts for the years 2039 and beyond are highly speculative, and there is no crystal ball to suggest a reversion to the mean that far away in time.

The disconnect between what is assumed and what actual experience has been, and likely will continue to be, is a significant problem for FRS. When pension funds fail to meet investment assumptions, unfunded liabilities rise. Underperformance inevitably leads to an underfunded system. In fact, missing the mark on its assumed rate of investment returns has added $17 billion to FRS’ unfunded liability over the past decade.

The Florida Retirement System is taking a small step in the right direction by lowering the rate, but the assumed rate of return for its investments continues to be overly optimistic and is likely to continue to add to the state’s growing pension debt.

Update: The original title of this post was, unfortunately, ‘Florida’s Pension Debt to Rise As It Lowers Assumed Rate of Return to More Realistic Levels,’ which is technically an oversimplification in that it makes it sound like the lower assumption creates more pension debt. Like an iceberg, pension debt is whatever it is—the grand sum of all individual pension liabilities paid out which is only ever known with certainly once a member is no longer receiving benefits. Hence, actuaries make estimates that act as the water line—reported pension debt as determined by the old assumed rate of return is above the line but there’s really more below.

The post More Pension Debt Revealed As Florida Lowers Assumed Rate of Return to More Realistic Levels appeared first on Reason Foundation.

Pension benefits have been promised to nearly 1.2 million active and retired teachers and government workers.

In 2008, the Florida Retirement System had a $6.6 billion surplus and boasted a funded ratio of 105 percent, well above the recommended 100 percent-funded mark.

Today, the Florida Retirement System is $29.8 billion in debt and has just 84 percent of the funding it needs to pay for retirement benefits.

One reason the pension system has dipped so far into the red are overly optimistic investment return assumptions. Currently, the plan assumes it will earn a 7.4 percent rate of return on its investments, a rate that was firmly rejected by the independent actuaries the state hired.

Economic models developed by Milliman Inc. and Aon Hewitt found all financial forecasting “models developed in 2018 indicated a likelihood of 35 percent or less of actual long-term future average returns meeting or exceeding 7.40 percent.”

This is bad news for workers and taxpayers. Despite the stock market’s strong performance, investment returns for the Florida Retirement System have failed to meet expectations in four of the last 10 years.

The pension system is funded by the contributions made by employees and employers, plus its investment income, so whenever investment returns do not meet the plan’s predictions, unfunded liabilities and debt rise.

Ultimately, to make up for the shortfall, contributions from public workers have to increase, the government via taxpayers can increase its contributions to the system or the state can try to divert funding that was intended for other programs, including schools, roads, and public safety.

In the long run, rising pension debt can often crowd out important public programs.

The debt and unfunded liabilities are just one of Florida’s retirement problems though. So in 2000, the Florida Legislature prudently decided to offer an additional retirement plan to new hires called the FRS Investment Plan, a portable, defined-contribution retirement plan similar 401(k) retirement plans.

Unfortunately, Florida’s Investment Plan has been woefully underfunded according to industry standards. Employees contribute 3 percent of their salary and the state, as the employer, contributes 3.3 percent for a combined contribution of 6.3 percent of the employee’s salary, which falls far below the 10 percent to 15 percent annual contribution rate that financial planning professionals say is needed to generate sufficient retirement income.

Dangerously inadequate contributions could lead retirees, who may have a false sense of financial security, into insolvency during their most vulnerable retirement years.

Florida is setting itself up for a retirement crisis of its own making.

This column originally appeared in the Florida Times-Union.

The post The Florida Retirement System Is Being Mismanaged In a Variety of Ways appeared first on Reason Foundation.

This is despite several previous reforms enacted to lower financial risk and cost to Florida’s public employers that helped the situation some, but not enough. Today the FRS system as a whole continues to pile up pension debt, and worse, the current benefit design is undermining the retirement security of the current generation of Florida’s public employees.

The growing pension debt stems from the FRS Pension Plan which has yet to find its path to long term solvency due to, among other things, an unnecessarily high amount of systemic risk built into the plan. Yet the FRS Investment Plan—although free of pension debt and a great option for short to medium term employees—is no closer to providing retirement security for Florida’s public retirees than the debt-riddled FRS Pension Plan, as it relies on contribution rates that fall far below industry standards for retirement benefit adequacy.

This analysis by the Pension Integrity Project at Reason Foundation finds that the retirement benefits ultimately received by members of both plans within FRS will come at an ever-increasing cost to taxpayers and other public services if needed technical adjustments to both plans go neglected. FRS pension debt has risen steadily despite the longest bull market in American history, and without additional reforms, FRS will continue to face financial headwinds and public employees will continue to see diminished retirement security.

Full Analysis— Florida Retirement System (FRS): Despite Reforms, Remaining Challenges Are Undermining FRS Member Retirement Security

The post Continuing Reform: Challenges Persist With the Florida Retirement System (FRS) appeared first on Reason Foundation.

Gov. Kelly has defended her approach to pension funding by claiming it’s part of an effort to limit government expenditures. In this respect, her policies and actions are counterproductive. The danger in allowing pension debt to fester is that pension problems tend to compound with time, they don’t simply go away.

The legislature is correct to prioritize funding the pension system today. The problems of growing pension debt consuming funding and crowding out other public priorities are only exacerbated by allowing the debt to linger. Although Kansas switched to a cash balance retirement plan for new hires in 2013, the legacy pension plan still requires immediate attention.

According to its latest report, the legacy Kansas Public Employees Retirement System (KPERS) has a funded ratio—how much of the pension system’s liabilities are already covered by assets— of 68 percent. This is well below the 100 percent target recommended by the American Academy of Actuaries’ Pension Practice Council and the Government Finance Officers Association. A decade-long bull run in financial markets has helped the plan but hasn’t sufficiently bolstered its funding ratio to acceptable industry standards.

KPERS has been hurt by years of missed investment return assumptions. The system has an assumed rate of return on investments of 7.75 percent. This is above the national average of 7.4 percent for similar public plans, which means KPERS’ current investment return assumptions are likely to be overly optimistic in regards to national norms and the emerging “new normal” consensus among major investment managers. This has immense ramifications on the financial future of the plan and the costs of running it.

Similarly, KPERS’ discount rate of 7.75 percent may also be problematic. Unlike the assumed rate of return, the discount rate helps determine the present value of promised pension liabilities (see more on the difference here). A 2018 Milliman Public Pension Study of the 100 largest U.S. public pension plans found average discount rates fell from 7.5 percent in 2017 to 7.25 percent in 2018. Furthermore, KPERS’ current discount rate is also misaligned with the implied risk premium of the national average discount rate, as determined by federal and/or municipal bond yields.

The inflated assumed rate of return and unusually high discount rate are likely causing KPERS to substantially overestimate the value of its assets and underestimate its current pension debt.

It’s clear Gov. Kell has a genuine concern for the taxpayers and public workers and it is wise for her to look for ways to limit government spending. But letting public pension debt grow increases long-term spending.  Addressing the decades of underfunding to the state pension system and its unreasonable assumptions requires an aggressive approach today to save taxpayers and workers tomorrow. There’s still a lot of work to be done for Gov. Kelly and the state legislature.

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Every time Birmingham makes an annual payment into its pension system below 100 percent of what actuaries determine is needed to fully fund the plan, it adds to its increasingly burdensome pension liabilities. This worsening trend in annual contributions has become a significant factor in the city’s growing $378 million pension debt.

Credit rating agencies are starting to take note.  Last month, Fitch Ratings downgraded Birmingham’s issuer default rating and general obligation bond ratings to A+ from AA-. The rating agency cited the city’s growing pension debt as the principal contributor to a “less robust fundamental financial profile for the city and will lead to materially weaker spending flexibility.” Fitch views weak pension funding as a form of deficit financing.

Birmingham’s recent credit downgrade may be the first of many as other credit rating agencies notice what’s happening. Based on the current situation, there’s a high probability that more credit rating agencies will follow suit. Moody’s used similar reasoning to downgrade Dallas’ credit rating on general obligation bonds. If officials fail to act, Birmingham’s fiscal issues will only compound. If more credit downgrades take place the city would likely begin to suffer from increased borrowing costs.

Municipalities have budget constraints and are very sensitive to long-term changes to the tax base. Likewise, as pension liabilities grow, more resources must be diverted away from core city functions in order to pay the pension debt. City services could have to be reduced as taxpayers’ money is shifted to pick up the increasing cost of pension system neglect.  If it continues to worsen, Birmingham’s growing pension debt could put pressure on the city to reduce future funding for critical services such as education and public safety.

In the worst-case scenario, if Birmingham officials continue to ignore the Retirement & Relief Pension Plan, unfunded liabilities could ultimately drive the city into bankruptcy.  The city of Prichard, Alabama declared bankruptcy twice (in 1999 and 2009) due to an inability to pay pensioners. Similar stories have played out from Rhode Island to California. Although municipal bankruptcy is rare, local governments nationwide are already paying a dire cost in reduced services for chronically underfunding their public pension systems.

Birmingham’s credit downgrade shouldn’t be taken lightly. The city needs to reform its pension system to ensure taxpayers and retired public servants are not hurt by underfunding and mismanagement. History has shown that minor credit downgrades are often precursors to much worse situations for local governments. Birmingham Mayor Randall Woodfin has correctly identified the city’s pension debt as a pressing issue. Now, it is time to act with meaningful and lasting reform. Warning signs abound, and every day that passes absent of change compounds Birmingham’s current pension problem.

The post Birmingham’s Pension Woes Continue to Compound appeared first on Reason Foundation.