Pension Reform Archives - Reason Foundation https://reason.org/topics/pension-reform/ Free Minds and Free Markets Thu, 09 Mar 2023 16:34:56 +0000 en-US hourly 1 https://reason.org/wp-content/uploads/2017/11/cropped-favicon-32x32.png Pension Reform Archives - Reason Foundation https://reason.org/topics/pension-reform/ 32 32 Ways the SECURE Act 2.0 can help people save for retirement https://reason.org/commentary/ways-the-secure-act-2-0-can-help-people-save-for-retirement/ Thu, 09 Mar 2023 16:32:43 +0000 https://reason.org/?post_type=commentary&p=63380 The law provides additional flexibility for tax optimization of retirement distributions and reduces tax code rules that perversely inhibit lifetime annuity solutions.

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The Setting Every Community Up for Retirement Enhancement Act of 2022 (SECURE 2.0) was enacted as part of the Consolidated Appropriations Act of 2023 (HR 2617), the $1.7 trillion omnibus spending bill signed by President Joe Biden in Dec. 2022. Among the long list of changes adopted in the law are some that improve how employer-sponsored defined contribution retirement plans can better deliver financial security in retirement. SECURE 2.0 moves these retirement programs closer to the defined contribution (DC) plan design best practices long promoted by Reason Foundation’s Pension Integrity Project, but it also illuminates the overly complex nature of our tax and labor laws governing these arrangements. 

The major defined contribution retirement plan-related changes in SECURE 2.0 include:

Strengthening auto-enrollment and auto-savings in retirement plans

Effective for plan years beginning after 2024, all 401(k) and 403(b) plans must automatically enroll participants with a 3%-10% contribution rate and provide an auto-save increase of 1% per year until it reaches a maximum of 10-15%. The participant must be given the opportunity to opt out of the default rates under current rules governing so-called “eligible automatic contribution arrangements” (EACA). 

This change is significant as it makes retirement plan participation the default position, which was not an option under current law. This will get more individuals into retirement savings plans—something very much needed in the United States. The Bureau of Labor Statistics reported in 2021 that 68% of private industry workers had access to retirement benefits through their employer, but only 51% chose to participate. In contrast, 92% percent of workers in state and local governments had access to retirement benefits, and 82% participated.  

The impact of this change will not be realized immediately because it only applies to new plans established after Dec. 29, 2022. In addition, government plans, church plans, new businesses, and small businesses with 10 or fewer employees are exempt.  

Refundable saver’s match tax credit

The current tax law provides a “non-refundable” tax credit for eligible individuals who contribute to IRAs or employer retirement accounts. Starting in 2027, The SECURE Act 2.0 changes the tax credit to be “refundable” in the form of a federal 50% matching contribution, up to $2,000 per year. The matching amount phases out depending on the employee’s income (e.g., $41,000-$71,000 for married filing jointly; $20,500-$35,000 for single taxpayers.

Using a federal matching contribution to provide the refundable credit will likely improve lower- and middle-income retirement savings.

Increased catch-up contribution limits for older workers

Individuals aged 50 and older under current law can make “catch-up” contributions up to $7,500 to 401(k), 403(b), and governmental 457(b) plans. The SECURE Act 2.0, effective in 2025, increases the catch-up limit for individuals ages 60-63 to $10,000 (indexed beginning in 2024). For higher-income individuals earning over $145,000 in a tax year, the contribution must be made to a Roth Account on an after-tax basis.

Lowered barriers to the use of lifetime income annuities

Beginning in 2023, the SECURE Act 2.0 further reduces tax code barriers for using annuities in defined contribution plans as recommended in Reason’s DC Personal Retirement Optimization Plan (or PRO) plan design in two ways.

Required Minimum Distribution Rules (RMD) Relaxed for Partial Annuitization: Current law requires an individual to determine RMD separately for annuitized and non-annuitized amounts. The result is a higher RMD amount than if the individual had not annuitized anything. The SECURE Act 2.0 removes this disincentive to annuitize by allowing the individual to aggregate both annuitized and non-annuitized distributions for RMD purposes.

Higher Qualified Longevity Annuity Contract (QLAC) Purchase Limits:  A QLAC product allows an individual to buy an annuity with a start date that begins only if they live longer than a stated age (no later than 85) as a way to help protect against the risk of outliving their retirement assets. Under current law, an individual can purchase a QLAC product but cannot spend more than 25% of the account value up to $135,000 (as currently indexed). The SECURE Act 2.0 eliminates the 25% limitation and increases the dollar limit to $200,000 (indexed). 

Other changes help portability, RMD distribution planning, and flexibility

The SECURE Act 2.0 permits retirement plan service providers to offer account portability services that automatically transfer retirement savings to an individual’s new employer’s plan. This helps preserve retirement savings instead of just cashing out of the prior employer’s plan. 

The act also increases the Required Beginning Date for minimum distributions from 72 to 73, depending on the individual’s “applicable age”:

  • For those who turned age 72 before 2023, the applicable age is 72 (or age 70 ½ if they were born before July 1, 1949).
  • For those who turn 72 after 2022 and reach the age of 73 before 2033, the applicable age is 73. 
  • For employees turning 74 after 2032, the applicable age now is 75.

The onerous excise tax for RMD violations is also reduced in 2023 from 50% to 25%. The penalty tax is further reduced to 10% if the failure to take the RMD is corrected within a two-year window period.

Conclusion

The SECURE Act 2.0 takes important and meaningful steps toward increasing retirement plan savings participation. It reduces tax policy disincentives and tax code rules that perversely inhibit lifetime annuity solutions, which would improve retirement income security. It also provides additional flexibility for tax optimization for retirement distributions. 

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Testimony on Alaska House Bill 22 https://reason.org/testimony/alaska-house-bill-22/ Wed, 08 Mar 2023 00:03:15 +0000 https://reason.org/?post_type=testimony&p=63295 Reason Foundation’s modeling suggests that HB 22 could cost Alaska upwards of $800 million in the coming decades.

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Testimony on Alaska House Bill 22 (HB 22) submitted to the Alaska House State Affairs Committee.

Good morning, my name is Ryan Frost, and I’m a senior policy analyst with the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way. We have been involved in around 70 pension reforms over the past seven years, all aimed at bringing down long-term risks and costs to the state and taxpayers. Prior to my current role, I spent seven years as the senior research and policy manager for the Law Enforcement Officers and Firefighters (LEOFF 2) Pension System in Washington state. LEOFF 2 has been one of the top-three best-funded public pension plans since its inception in the mid-1970s, and that has primarily been accomplished by keeping it up to date with best practices in plan design and funding policies.

Reason Foundation has worked on some of the nation’s significant pension reforms of recent years, including Arizona’s public safety plan, Michigan’s public-school employees plan, and Texas’ public employees’ plan. Pension plan design is an extremely complex issue. Much like a house, if the plan designer fails to build the pension system’s foundation properly, it can be incredibly costly to fix those later. Alaska is currently dealing with that issue in the Alaska Public Employees’ Retirement System (PERS) and Teachers’ Retirement System (TRS) plans, which have been closed since 2006 yet remain saddled with billions of dollars in unfunded liabilities.

Speaking to Alaska House Bill 22, the state legislature considered a bill identical to this last session, and Reason presented an analysis of the risks to the state in terms of potential unfunded liabilities and short- and long-term costs. Just like last session, our concern is that far too much risk is built into this proposal to reopen a defined benefit pension plan and retroactively undo the risk-reducing measures that Alaska has enjoyed since 2006. The Pension Integrity Project has never seen a defined public benefit plan proposal anywhere in the country with this much risk in the first few years of the proposed plan’s life.

Surprisingly, such a massive plan design change has yet to receive a long-term actuarial study of the potential impacts on the state budget. The only analysis the legislature received last session was a projected six-year cost figure from the PERS actuarial consultant, Buck, and an analysis performed by an outside actuary hired by the bill’s proponents.

We’ve built an actuarial model, using a certified consulting actuary, that allows us to examine and compare costs through many different scenarios, compare benefit levels of the defined contribution plan versus the proposed defined benefit, and perform an accurate risk assessment of the bill, which last year’s bill unfortunately lacked.

To that end, Reason Foundation’s initial modeling suggests that HB 22 could cost Alaska upwards of $800 million in the coming decades. While the proposed ‘new’ defined benefit (DB) plan does have a few modest improvements relative to the legacy pension tier, HB 22 still lacks sufficient controls to justify the proponent’s assertion that there is no risk to state/local budgets, as there is with the current defined contribution (DC) plan today.

The risk from this proposed bill is threefold:

1.          Allowing all previously earned service in the DC plan to be transferred into the proposed DB plan creates massive unfunded liability risk in year one.

Transferring DC balances to a DB pension fund as if they had been there all along sets up a pension obligation bond-like situation where any downturn in stock market performance or lowering of investment return assumptions would quickly create significant unfunded liabilities in the system. There was a lot of discussion at this bill’s first hearing about last year’s proposal almost passing. Let’s say the bill did pass last year, here’s what would’ve happened (and what we warned about last session): All public safety members hired since 2006 would be assumed to transfer all of their assets from the DC plan into a new tier of the PERS DB plan. This effectively means the state would have seen up to 16 years of liabilities added to the plan on day one, all priced at last year’s overly optimistic discount rate of 7.38%. PERS investment returns were negative last year, earning -6%. Missing the long-term assumption on investment returns by more than 13%, this new tier would have had a huge funding hole immediately in year one. The new PERS tier would have added over $33 million dollars in unfunded liabilities before the plan reached one year old.

2.          The current assumed rate of investment returns being used by PERS, which this new proposed plan falls under, is far too high.

Reviewing the landscape of public pension systems nationally, it would be fair to characterize the situation as a race to get down to a 5.5-6% assumed rate of investment returns for other public pension systems across the country. Alaska has followed this trend, lowering its assumed rate from 8% to 7.25% over the last few years.

These jurisdictions also commit to higher current pension contributions because lowering the assumed rate makes previously promised liabilities more expensive. This bill, for some reason, sets the assumed rate 125-175 basis points above that near-term market outlook. The Alaska Retirement Management Board (ARM) has already lowered its expected annual rate of return this year, going down from 7.38% to 7.25%. When the PERS investment return assumption is reduced again in the future—which it most certainly will—this new tier will have instantly created unfunded liabilities.

3.          While proponents claim there is built-in cost sharing, it is not true.

Employee contribution rates are essentially fixed in statute, meaning any poor plan experience that brings required contributions above the maximum rate that employees are set to pay would be borne by the state.

HB 22 is being proposed due to concerns with recruitment and retention challenges. Proponents claim they are having trouble recruiting and retaining members due to the lack of a defined benefit pension to offer to their members. However, this claim does not hold up to the data as, according to the National Police Foundation, 86% of police departments across the country face a shortage of members. Proponents stated to the prior committee that all other states offer a defined benefit for public safety employees. If all of those states are also having issues with recruitment and retention, the obvious question would be, if a defined benefit plan isn’t keeping public safety workers everywhere else, why would it be any different here? We even have an academic working paper showing that retention rates saw no change when Alaska swapped from a DB to DC in 2006.

Supporters of this bill often mention that states like Washington are stealing firefighters from Alaska. That may be true at some level, but is the pension the reason they transfer to become cops or firefighters in Washington? Recent salary data in Washington shows the average police and fire salary across the state is over $122,000 per year and firefighters alone average over $130,000 yearly. Most out-of-state police and firefighters I spoke with when I worked for that pension system pointed out that they nearly doubled their salary by moving to Washington.

Then there’s the issue that Washington is also struggling to hire new public safety, specifically law enforcement, officers. The city of Seattle is struggling to convince its current officers to work overtime as security for Seattle Seahawks games because their officers say they are burnt out from all the other overtime they have to work. This is not an Alaska-specific issue, and it is a common issue across the country. In fact, from our experience of studying and working on reforms of other public pension plans around the country, Alaska’s stated 6% turnover rate is on par or lower than what most other public safety plans across the country are seeing. For example, there’s been a major pension reform push in North Dakota, and its defined benefit pension plan for public employees has a 15% turnover rate per year.

The national trend since the Great Recession of 2007-2009 has been for states to adopt greater risk controls in their traditional pension systems and to move toward a variety of plan design options to avoid re-exposing state and local budgets to the risks of worsening unfunded liabilities. Texas, Arizona, Michigan, and Colorado are among the states that have recently adopted new, risk-managed retirement plans that provide adequate retirement benefits but also do not disproportionately burden employers with financial risk. Unfortunately, HB 22 does not resemble those types of prudent reforms.

In closing, retirement plans for public workers must meet the benefit needs of its members and must not apply unnecessary costs to government budgets. While Alaska’s current defined contribution plan is not without opportunities for improvement, it stands as a valuable benefit that works well for the modern workforce. It does not burden the state with significant debt and costs. House Bill 22, as currently written, would not fulfill these same requirements and could very realistically expose the state to immediate risks of runaway costs.

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Chicago wants to open a casino to help pay down its public pension debt https://reason.org/commentary/chicago-wants-to-open-a-casino-to-help-pay-down-its-public-pension-debt/ Tue, 07 Mar 2023 05:01:00 +0000 https://reason.org/?post_type=commentary&p=63164 Chicago recently announced it is in the process of opening a new casino with the intent to use its revenue to pay down significant unfunded liabilities in the city’s public safety pension plan. According to estimates in the recommendation report … Continued

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Chicago recently announced it is in the process of opening a new casino with the intent to use its revenue to pay down significant unfunded liabilities in the city’s public safety pension plan. According to estimates in the recommendation report by Chicago Mayor Lori Lightfoot’s office, the casino will cost around $1.7 billion to build and generate roughly $200 million per year.

But even under the proposal’s optimistic outlook, the casino’s annual revenue is only a fraction of the annual required contributions to the city’s police and fire pension fund. Due to the gargantuan amount of unfunded liabilities the city already owes, this move is unlikely to mitigate future tax hikes, and a significant effort to fulfill the pension promises made to workers still lies ahead.

For context, Chicago’s police and fire pension fund is about $12.5 billion underfunded. Those unfunded liabilities are expected to grow even bigger this year due to the poor investment returns generated in 2022. The estimated $200 million in annual revenue from the casino is only 9% of the $2.3 billion contribution the city must make yearly to avoid further falling behind in debt. Mayor Lightfoot’s most recent budget does allocate $2 million in extra funds to police and fire, some of which will go to paying down pension debt. Yet even with this and the casino revenue, it is still not enough.

While this is the first time a city is taking this particular approach to filling a public pension funding gap, using gambling revenue to plug a pension hole is an extension of a more common practice among underfunded government pension systems—selling lottery tickets. This type of revenue stream is historically unreliable, seeing as lottery revenues dropped heavily during the COVID-19 pandemic, with people staying home and ordering groceries online (most people buy lottery tickets at grocery stores). While the pandemic was an outlier event, lottery revenues have fluctuated a decent amount from year to year.

The use of novel sources of revenue is not new for Chicago, and unfortunately, other methods policymakers have attempted have been less free-market oriented. In 2003, Chicago introduced red-light cameras as a way to curb traffic accidents, but this later became a crucial revenue source for the city, so much so that, at one point, Chicago lowered yellow-light intervals to catch more people and generate more through fines. Chicago has also tried many unique taxes to gin up revenue, such as a Netflix tax, a soda tax, and, perhaps most controversially, a commuter tax. The commuter tax was intended to tax city government workers who worked in the city but lived in the outlying suburbs, implying they were “freeloading.”

While there are ethical differences between generating revenue from something like a red-light camera vs. a casino, these tax and revenue plans all highlight that Chicago is using desperate tactics in hopes of generating revenue to pay for decades of budgetary mismanagement.

The truth is that the casino revenue will barely make a dent in Chicago’s pension funding shortfalls. The city needs to make substantive pension reforms rather than look for these stopgap measures. Even should the casino succeed, Chicago still needs to raise its contributions, whether through a larger portion of the city’s budget or some shared sacrifice between city employees receiving the pensions and taxpayers. When it comes to retirement benefits, policymakers need to consider alternative plan designs for new employees that do not risk piling unexpected costs on the city’s taxpayers.

Pension reforms will likely be an uphill battle for Chicago, considering legal restrictions set at the state level. The Illinois Supreme Court has struck down public pension reform efforts, such as cost-of-living adjustments and salary caps for benefit payments, as unconstitutional. Despite formidable legal obstacles, these are the types of public pension reforms that Chicago needs to address the source of its hemorrhaging pension debt.

Pursuing inadequate solutions with highly politicized taxes or through a brand-new casino is a futile way to dodge the city’s public pension debt and fiscal challenges head-on.

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Survey finds pensions are not a high priority for young government workers https://reason.org/commentary/survey-finds-pensions-are-not-a-high-priority-for-young-government-workers/ Wed, 01 Mar 2023 16:46:24 +0000 https://reason.org/?post_type=commentary&p=62987 Given a list of eight benefits to public sector employment, personal satisfaction from the job and salary were ranked highest, and life insurance and retirement benefits ranked lowest.

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The Great Resignation, the noticeable shift in employees leaving their jobs at faster rates during and after the COVID-19 pandemic, has had a significant impact on the public sector workforce.

In March 2022, over a third of the state and local government workers said they were considering quitting, according to a survey by MissionSquare Research Institute and Greenwald Research. This suggests that the worrisome trend of record resignations in the public sector could continue. In response to growing challenges in attracting and keeping valuable workers, lawmakers and government employers are eager to find solutions. Many policymakers are considering whether retirement benefits can be used to improve recruiting and retention. 

But addressing issues with retirement benefit design can be complicated because it is unclear how much value employees attribute to each benefit when they decide on accepting a job offer. Although government employers may assume that retirement benefits can help them attract a quality labor force, research is inconclusive. This topic deserves more attention in the face of ongoing recruitment challenges. One way to investigate further is to ask labor force entrants about their preferences directly. At least one survey suggests that younger public workers might not perceive retirement benefits as a highly motivating factor, contradicting conventional wisdom.

Because retirement benefits make up a large share of the compensation package, a change in the value of retirement benefits can influence employment decisions. The traditional belief is that—other factors being equal—a change in retirement benefits may lead to a change in employment attractiveness and, over time, changes in retention. When researchers study retirement benefits empirically, using data from pension plans, we assume workers’ actions change based on the shift in incentive (retirement benefit). But deriving such a conclusion requires an assumption that employees value retirement as much as other parts of their compensation package, including salary, health insurance, stability, etc. Is that assumption true? 

One way to get a better understanding is to implement a qualitative study tool that would reveal how employees value retirement benefits when compared to other deciding factors. Specifically: Ask prospective employees whether they find specific benefits meaningful enough to motivate their employment decisions. 

An April-May 2022 survey by MissionSquare Research Institute did that by asking 102 fellowship candidates from the national service program Lead For America to gauge their motivation toward public service, impressions of the application process, and other career aspirations. (Figure 1)

Figure 1. Ranking of workplace considerations 

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Source: MissionSquare Research Institute

Given a list of eight benefits to public sector employment, personal satisfaction from the job and salary were ranked highest, and life insurance and retirement benefits ranked lowest. According to the respondents, health insurance benefits are still very important for young workers, ranking third in the survey’s list of priorities. Moreover, even nontraditional benefits such as tuition assistance, student loan repayment, employee assistance programs, and childcare assistance ranked higher than retirement benefits in the survey. 

This finding reveals important insight into how these Gen Z employees think about retirement benefits. If retirement benefits are not valued as much as other benefits, perhaps public sector employers are overinvesting in pensions at the expense of other components, like professional development programs and childcare. 

Public sector employers should prioritize understanding the work components that matter to their employees. MissionSquare’s small survey of young workers reveals that retirement benefits might not be a high priority for the incoming labor force. So perhaps that is not the right way to attract and retain valued workers. Judging by the responses of this young group of public workers, policymakers should further survey a broader sample of government workers because they may find similar results suggesting they should prioritize recruitment and retainment policies that improve personal satisfaction and general compensation.

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Modeling methodology and approach to analysis of public retirement systems https://reason.org/backgrounder/modeling-methodology-approach-to-analysis-of-public-retirement-systems/ Sat, 18 Feb 2023 04:01:50 +0000 https://reason.org/?post_type=backgrounder&p=62632 The Pension Integrity Project uses custom actuarial and employee benefit models tailored to reflect each unique public pension system.

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Reason Foundation’s Pension Integrity Project provides technical assistance to government policymakers to assess the solvency of public employee retirement systems and analyze the potential impacts of potential reforms.

This assistance is grounded in years of experience developing effective, bipartisan policy solutions that address the complex needs of government employers, employees, retirees, and taxpayers. The Pension Integrity Project work demystifies complicated retirement policies with advanced actuarial modeling, built by a team of experts and backed by industry-leading actuarial consultants.

To advise on the immediate and long-term effects of policy decisions, the Pension Integrity Project uses custom-built actuarial and employee benefit models that are tailored to reflect each unique retirement system. While Reason Foundation does not have access to individual participant-level data—accounting of the behavior of each individual participating member—given its proprietary nature, that level of data is not necessary to develop highly accurate models that allow for forecasting the factors most relevant to policymaking: general projections of liabilities, assets, and employer/employee contributions.

Highly accurate actuarial models require only the assumptions used by the pension system, which are publicly available and reported in the annual actuarial valuation and other common reports. The Pension Integrity Project uses the public pension system’s current assumptions to develop advanced and dynamic actuarial modeling to provide valuable context on the near and long-term fiscal and financial impacts of various policy options.

The Pension Integrity Project’s team of policy experts frequently carries out checks and calibrations—holding findings up to official actuarial reporting—to ensure the accuracy of the models used. Reason also subjects forecasts and outputs to rigorous review by policy experts and licensed consulting actuaries.

Reason Foundation’s experts are particularly proficient at delivering intricate and plan-specific analyses in a way that is easy to understand and applicable to policymakers. Reason also develops interactive tools that put the wide possibilities of modeling directly in the hands of policymakers.

The Pension Integrity Project develops several different types of modeling to address the various policies that affect the overall success of a public retirement plan:

  • Funding models project the liabilities of a plan as well as the short and long-term costs associated with policies.
  • Employee benefit models calculate the utility of a retirement plan over time, illustrating how well a plan delivers on benefits offered to public workers at different ages and years of service.
  • Return probability analyses evaluate the likeliness of specific plans achieving different market results.

Reason Foundation Pension Integrity Project’s actuarial modeling and analysis have contributed valuable, decision-relevant information to the policymaking process in several states that have successfully implemented bipartisan public pension reforms, including Texas, Michigan, Arizona, Colorado, New Mexico, and Florida.

The Pension Integrity Project’s Modeling Methodology and Approach to Analysis of Public Retirement

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Pension Reform News: Montana’s proposed reforms, poor 2022 investment results, and more https://reason.org/pension-newsletter/montanas-proposed-reforms-poor-2022-investment-results-for-state-plans-and-more/ Fri, 17 Feb 2023 16:15:00 +0000 https://reason.org/?post_type=pension-newsletter&p=62473 Plus: Undoing Alaska's pension reforms could cost $800 million, PRO Plan offers modern approach to public retirement.

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This month’s newsletter from the Pension Integrity Project at Reason Foundation highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions here.

In This Issue:

Articles, Research & Spotlights 

  • Montana’s plan to improve pension funding and governance
  • Efforts to undo Alaska’s pension reforms could cost close to $1 billion
  • North Dakota’s potential pension reform
  • State pension plans’ poor investment results in 2022
  • Reason’s PRO Plan offers a modern approach to public retirement

News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk


Articles, Research & Spotlights

Two Bills in Montana Could Improve Pension Plan Design and Funding

Montana’s Public Employee Retirement System has $2.2 billion in unfunded liabilities, and if left unaddressed, funding issues are likely to continue. A new reform proposed in the state’s legislature would address some of Montana’s ongoing pension challenges, first by committing employers to make adequate annual contributions and second by setting the existing defined contribution retirement plan as the default benefit for new employees. In recent comments to the House Committee on State Administration, Reason Foundation’s Steven Gassenberger explained how House Bill 226 would reduce long-term costs by locking the state into eliminating its pension debt and reshaping its retirement offerings to fit the modern workforce better. Gassenberger also testified on House Bill 228, which would improve governance by setting stronger boundaries on what pension plan administrators can consider when making investment decisions.

Alaska Pension Bills Could Undo Previous Reform and Cost $800 Million

Following an effort to reopen a pension plan for public workers during last year’s legislative session, Alaska policymakers are again deliberating on several bills that could undo the state’s decision to close its defined benefit pension plans in 2006. Two identical proposals—House Bill 22 and Senate Bill 35—would allow public safety workers to retroactively switch from the existing defined contribution plan to a newly opened defined benefit plan. A Pension Integrity Project evaluation of these bills and an actuarial analysis of potential long-term costs find that this change would add more expensive debt to the plan’s already $5 billion in existing unfunded liabilities and could cost the state an additional $800 million over the next 30 years. Since public safety employees only make up around 10% of the system’s members, this proposal would be a costly move that would benefit a relatively small group.

Updates to North Dakota’s Pension Reform Effort

North Dakota lawmakers continue to discuss House Bill 1040, which would commit participating employers to make required annual payments in full and make the state’s defined contribution plan the only option for new hires. This backgrounder from the Pension Integrity Project responds to a recent statement from the North Dakota Public Employees Retirement System (NDPERS) that claims the adoption of proposed House Bill 1040 would require a drastic reduction to the plan’s discount rate. The system’s claim is inconsistent with other state plans that have undergone similar reforms, and there is no legal or financial requirement to change discounting like this when a pension plan is closed.

Updated 2022 Fiscal Year Investment Results for State Pension Plans

Investment returns are a crucial part of a pension plan’s funding of promised retirement benefits. While the ultimate success and cost of a public pension do not hinge on a single year of market results, each year that a pension plan falls below investment expectations adds to the growing—over $1 trillion nationally by the latest estimates—unfunded liabilities of state-run pension plans. An update to our October 2022 analysis compiles the investment returns reported by state pensions from the 2022 fiscal year. As expected, the research shows 2022 was a notably poor year of investment returns. All state-run pensions saw results that fell short of expectations, leading to significant growth in unfunded liabilities. Reason Foundation finds the median investment return achieved by the listed pension plans was -5.2% in 2022, well below the national average expected rate of return of 7.0%. Following an exceptional 2021, the latest investment results demonstrate that public pensions still have a steep hill to climb to get back to full funding.

PRO Plan: A Better Public Sector Retirement Plan for the Modern Workforce

Beyond the crippling growth of expensive unfunded liabilities, public defined benefit (DB) plans have failed to adjust to the evolving needs of today’s increasingly mobile workforce. Defined contribution (DC) plans aren’t without their shortcomings either, a common concern being that retirees can outlive their retirement savings. Both types of plans suffer from a lack of flexibility and personalization. The Pension Integrity Project’s Personalized Retirement Optimization Plan (PRO Plan) addresses these issues by structuring a guaranteed lifetime income on the foundation of an enhanced DC plan. In this commentary, the developers of the PRO Plan, Richard Hiller and Rod Crane, summarize the advantages of this approach to retirement for public employees.

News in Brief

Paper Proposes a Novel Discounting Method for Public Pensions

Discounting is how pensions calculate the future value of liabilities they have promised, and the rate used for this calculation has a massive impact on their funding. A new paper by Florida International University researchers identifies the problems with current discounting norms, namely their tendency to understate required contributions. They also acknowledge that discounting at a zero-risk rate—a method promoted by some to reflect the guaranteed nature of government pensions—likely overstates funding shortfalls and is too disconnected from financial reality. To strike a more appropriate balance between these two approaches, the researchers propose a new discounting method that applies a lower limit based on the lowest expected return among risky assets. A historical back-testing using this new discounting method going back to 2001 saw most plans (94%) exceeding these investment return expectations, resulting in funding improvements. The full paper is available here.

Quotable Quotes on Pension Reform 

“Divestment of these holdings would do nothing to stop climate change. The companies in question can easily replace CalPERS with new investors.”

—Marcie Frost, CEO of the California Public Employees’ Retirement System, on proposed legislation to force divestment from fossil fuel companies, in “Keep Politics Out of CalPERS, Reject Senate Bill 252,” Whittier Daily News, Feb. 8, 2023.

“Each year I’ve been in office, we have reduced the assumed rate of return…If we had the more rosy assumptions, we’d probably be 86, 87% funded…So the fact that we’ve had all this turmoil, had some market turmoil, and we’re basically where we were and probably much better if you had that, I think that’s a good sign. I think we’re going to be able to build from here…At the end of the day, we really want honest accounting. And we can fudge the numbers a little bit, but you know, so we’ve been reducing that assumed rate of return. I think that’s the conservative approach. I think that’s something that makes the most sense.”

—Florida Gov. Ron DeSantis, in “Gov. DeSantis Pushes for More Pension Spending in New Budget,” Florida Politics, Feb. 1, 2023.

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analysts Jordan Campbell and Steve Vu show the distribution of investment returns for state pension plans in 2022. You can access the graph and find more information here.

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Contact the Pension Reform Help Desk

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

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

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Public pension fund trustees have a perfect path to avoid the politics of ESG investing https://reason.org/commentary/public-pension-fund-trustees-have-a-perfect-path-to-avoid-the-politics-of-esg-investing/ Thu, 16 Feb 2023 15:25:24 +0000 https://reason.org/?post_type=commentary&p=62465 ESG is a political construct and has no direct correlation to how a pension system should invest its assets. 

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It seems almost everyone involved in government, politics, and public pensions wants to talk about environmental, social, and governance (ESG) investing for public pension systems. Depending on who is commenting, they will tell you ESG is either completely necessary for the strong long-term performance of investments or ESG will preclude any possibility of strong performance in the future. The reality, of course, is that ESG is a political construct and has no direct correlation to how a pension system should invest its assets. 

Environmental, social, and governance issues are commonly packaged together in investment discussions through the ESG acronym, but a closer examination of these components raises questions about the value of grouping these things together.

It is evident that the concept of ESG investing owes its existence to politics by simply looking at its components. Why else would environmental, social, and governance criteria be lumped together other than for political positioning? Why not past, present, and future?  Or animal, vegetable, or mineral? 

Some idealists with a political agenda made the determination that these separate elements, ESG, were, in total, critical for long-term investing success, as well as other broader goals. They were also successful in positioning these three elements as a singular, necessary approach to investing success. ESG opponents then emerged, and the debate commenced. Through years of engagement, even opponents contributed to the idea that these three elements should be treated as one. Their position then became one where absolutely no credence could be given to any ESG investing criteria.

A prudent person, on the other hand, can see elements in standalone environmental, social, and governance issues that should be considered when public pension systems are making investment decisions. That same prudent person would also see that not every one of these issues should be applied to each and every investment decision. In fact, it is just as foolish to eliminate all such criteria from investing as it is foolish to include all such criteria. 

Fortunately, public pension fund trustees must follow prudent fiduciary standards, which set boundaries on how investment decisions are to be made. Given this, public pension fund trustees are afforded a perfect path to avoid the purely political argument that ESG investing has become. Fiduciary standards require that pension fund trustees make investment decisions based on providing the best possible financial outcomes consistent with the pension plan’s objectives for the plan’s participants and for the plan itself. 

All-in or all-out ESG investing is not sound, prudent fiduciary policy.  Therefore, public pension fund trustees should make investment decisions based on practical and sound financial criteria, not based on political ESG classifications that prioritize other factors above returns and volatility. The likely outcome of prudent decision-making is that some decisions will be made that align with the ESG approach, and others will not. All of these decisions, however, must be made for the good of the pension plan’s members and not to satisfy political agendas. 

The practical approach to responsible public pension system governance is there, fiduciaries just need to follow it.

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Pension changes in House Bill 22 and Senate Bill 35 threaten Alaska’s budgets https://reason.org/backgrounder/pension-changes-in-house-bill-22-and-senate-bill-35-threaten-alaskas-budgets/ Thu, 09 Feb 2023 18:40:05 +0000 https://reason.org/?post_type=backgrounder&p=62051 Alaska House Bill 22 and Senate Bill 35 would re-open a defunct pension plan for public safety workers and allow police and firefighters hired after 2005 to use their defined contribution (DC) benefits to buy their way in. Despite claims … Continued

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Alaska House Bill 22 and Senate Bill 35 would re-open a defunct pension plan for public safety workers and allow police and firefighters hired after 2005 to use their defined contribution (DC) benefits to buy their way in. Despite claims that the change would be cost-neutral, this move could realistically add close to $1 billion in additional costs to future state budgets and reintroduce the state to significant pension risk—the same risk that generated over $5 billion in pension debt and spurred the 2005 reform that closed the defined-benefit pension plan to new hires.

HB 22/SB 35 costs are dependent on a flawed discount rate: The claim that the proposed changes will not require any additional funding relies on the pension’s current investment return assumption. Alaska PERS would need to achieve overly-optimistic 7.25% annual returns on investments for decades to avoid additional costs to the state.

  • Overly-optimistic investment return assumptions were a major contributor to Alaska’s $5.1 billion debt still owed on the legacy pension plan.
  • The average assumed return used by public pension systems around the country is now just below 7%, so Alaska PERS’s current assumption is rosier than peers.
  • Capital market forecasts suggest returns closer to 6% for the next 10-15 years.

HB 22 and SB 35 could cost the state an additional $800 million: Actuarial analysis of Alaska PERS that anticipates realistic market stress and multiple recessions over the next 30 years shows HB 22/SB 35 likely expose the state to significant potential costs.

 Status QuoHB 22 / SB 35
Total Employer Contribution: Alaska PERS (2023-52)$20.4 billion$20.8 billion
Unfunded Liability:
Alaska PERS
(2052)
$2.0 billion$2.4 billion
All-in Cost to Employers$22.4 billion$23.2 billion
Source: Pension Integrity Project 30-year actuarial forecast of Alaska PERS. The scenario applies recession returns in 2023-26 and 2038-41 and 6% returns in all other years. Values are adjusted for inflation.

Bottom Line: HB 22 and SB 35 could cost Alaska upwards of $800 million in the coming decades. Since public safety employees make up only about 10% of PERS members, this could be a very costly move that only benefits a relatively small group.

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Scrutinizing NDPERS’ cost claims on House Bill 1040 https://reason.org/backgrounder/scrutinizing-ndpers-cost-claims-on-house-bill-1040/ Wed, 08 Feb 2023 03:34:16 +0000 https://reason.org/?post_type=backgrounder&p=61997 NDPERS misleadingly claims that closing the defined benefit pension plan to new entrants under HB 1040 would inherently result in cash flow issues decades from now.

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Today, the North Dakota Public Employees Retirement System (NDPERS):

  • Holds $1.8 billion in unfunded liabilities;
  • Is structurally underfunded by legislatively set contribution rates;
  • And is expected to become insolvent around the turn of the century even if all its actuarial assumptions are met (faster if they do not).

This backgrounder examines claims the North Dakota Public Employees Retirement System is making about North Dakota House Bill 1040.

Scrutinizing NDPERS’ cost claims on House Bill 1040

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A better public sector retirement plan for the modern workforce  https://reason.org/commentary/a-better-public-sector-retirement-plan-for-the-modern-workforce/ Thu, 26 Jan 2023 00:13:38 +0000 https://reason.org/?post_type=commentary&p=61553 The PRO Plan can meet both employer and individual employee needs for a more effective retirement plan.

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Defined benefit (DB) and defined contribution (DC) plans have well-documented shortcomings in meeting the needs of employees and employers in the modern age. Yet, these plans continue to be standard, especially among public pensions. With an evolving workforce, it is time to build the next generation of retirement plans. 

Beyond the growing pressures of crippling unfunded liabilities, DB plans suffer from a fatal flaw – they are unable to meet the portability needs of today’s highly mobile workforce. Only about one-third of plan participants will ever receive a meaningful benefit from a public DB plan.  

Another significant shortcoming of DB retirement plans is a failure to address specific individual needs. In a traditional DB plan, every person with the same salary and length of service is eligible for the exact same annual benefit. But treating everyone the same ignores the reality that individuals are almost never average. Individuals have different needs based on many factors, such as health or other sources of income.   

A typical DC arrangement suffers many of the same shortcomings. Managing investment risk is often solely on the shoulders of participants. Default investments often use target date funds, so every person with the same birthdate has the same investment mix regardless of circumstances.   

Neither DB nor DC plans are able to meet the needs of broad swaths of individuals. Historically, cost restrictions have made it difficult to design a plan that recognizes individual needs while covering a wide range of participants. Fortunately, that is no longer the case. 

To address these traditional design shortcomings, and in partnership with the Pension Integrity Project at Reason Foundation, we applied decades of retirement plan-related experience to develop a new design approach: The Personalized Retirement Optimization Plan (PRO Plan). This new plan design uses a mix of tested and proven options, making it easy for policymakers to implement. Offering a wide range of individual flexibility in contributions and annuities, the Pro Plan can better fit the unique retirement needs of each individual, making the plan advantageous not only for employees but for employers looking to better serve and retain their workers. 

The PRO Plan starts with the endgame in mind: a lifetime of inflation-protected replacement income. With immediate or very short vesting periods, the plan allows all participants (not just a few) to earn meaningful benefits. It also allows individuals to tailor and structure funding of the target benefit and benefit distribution strategy by first using independent financial advisors and/or advice tools to determine the appropriate investment strategy.  

All other assets available to the individual are considered, including other retirement plans, spousal assets, inheritance, and others. While participant input is critical for success, it is not overly burdensome and only needs periodic updating. This input enables the creation of an appropriately risk-managed and liability-driven portfolio that is adjusted as appropriate throughout the working career. Utilizing a combination of plan-provided annuities and other distribution methods, a default income plan is created that is specifically tailored to the individual.   

Our analysis comparing this new design to existing options finds that the PRO Plan addresses many of the common shortcomings and enables each participant to address their specific retirement needs. Using existing market-based products and modern financial technology, the PRO Plan enables government employers to provide lifetime-guaranteed benefits to their employees, and in a way that is cost-effective. Our research indicates that our new plan design could meet the needs of retirees at 28 to 38 percent lower cost than it would be for an individual covering lifetime benefits on their own. 

Applying some of the best features found in DB and DC plans, along with modern financial technology, the PRO Plan can meet both employer and individual employee needs for a more effective retirement plan. Rather than attempting to fix current plans, the PRO Plan is a design that should be considered throughout the public sector as a plan that policymakers can fully implement today. 

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Pension Reform News: Modernizing public sector retirement plans, North Dakota reforms, and more https://reason.org/pension-newsletter/modernizing-public-sector-retirement-plans-north-dakota-reforms-and-more/ Tue, 24 Jan 2023 17:42:15 +0000 https://reason.org/?post_type=pension-newsletter&p=61265 Plus: States expanding into alternative investments and ESG proxy voting.

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This month’s newsletter from the Pension Integrity Project at Reason Foundation highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions here.

In This Issue:

Articles, Research & Spotlights 

  • Designing an optimized retirement plan for today’s public workers
  • North Dakota considers pension reforms
  • How ESG policies impact institutional investors
  • State pension systems expand high-risk, high-reward investments

News in Brief
Quotable Quotes

Data Highlight
Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Designing an Optimized Retirement Plan for Today’s State and Local Government Employees

The discourse about public retirement policy often revolves around a binary choice between defined benefit (DB) pension plans and 401(k)-style defined contribution (DC) plans. Each has its own unique advantages and drawbacks, but both lack the flexibility to match many unique personal situations. A new paper from Reason Foundation’s Pension Integrity Project proposes that public retirement benefits need not be limited to these two choices any longer. In the new report, public retirement benefit experts and senior fellows Richard Hiller and Rod Crane introduce the Personal Retirement Optimization Plan—or PRO Plan—for the public sector. The PRO Plan adds the element of a guaranteed retirement benefit to a DC foundation to build a more secure, customizable, and portable retirement for public workers. The PRO Plan is built around the objectives of risk-managed retirement income adequacy, and unlike traditional public pension plans, does not impose funding risks on government employers. Testing this newly proposed PRO Plan design, Hiller and Crane find that the costs of providing guaranteed annuitized benefits through the PRO Plan would be much lower than an individual purchasing these benefits on their own.

Evaluating North Dakota’s House Bill 1040

Facing $1.8 billion in unfunded pension liabilities, and projections that the pension fund will be depleted within 80 years, North Dakota policymakers are seeking comprehensive reform of the North Dakota Public Employees Retirement System (NDPERS). The newly introduced House Bill 1040 would address many of the issues that have been plaguing the system for decades. Firstly, it would fix the state’s systematic funding deficiencies by switching from a statutory to an actuarial contribution policy. This would ensure that state and local governments are making the payments needed to fulfill all pension promises by a predetermined date. Second, the reform would provide new hires, beginning in 2025, a defined contribution (DC) plan that meets a high standard of benefit design. Reason Foundation’s analysis of House Bill 1040 finds the proposed reforms would effectively halt the accrual of new unfunded liabilities with new hires, and would reduce long-term costs of the pension plan by responsibly paying down its legacy debt.

The Mechanics of ESG-Driven Divestment, Engagement, and Proxy Voting

Environmental, social, and governance (ESG) policies can take many different forms and are applied by a wide variety of organizations, but the foundational goal is to influence investors’ and corporations’ decision-making. In this commentary, Jordan Campbell examines two main avenues used to leverage this influence and how groups are trying to reshape the market through divestment and corporate engagement. Although there is no clear impact of ESG divestment practices, there has been a noticeable rise in ESG engagement practices, namely proxy voting. Data indicates that public pension funds have outpaced other institutional investors—and even ESG-focused funds—in throwing support behind ESG resolutions.

In Search of Higher Returns, Public Pension Systems Dive Deeper into Alternative Investments

Public pension plans saw significant investment losses in 2022, and economic forecasts indicate that more market turbulence is in store for 2023. Facing this increasingly unpredictable and volatile investment environment, and under pressure to achieve often overly-optimistic investment return assumptions, many public pension plans continue to dive deeper into high-risk, high-reward strategies. Reporting on these trends, Reason’s Steve Vu highlights several states, including New York, California, Texas, Ohio, Iowa, and New Mexico, where policymakers are loosening up limits and increasing targeted allocation in alternative investments like private equity, private credit, and real estate.

News in Brief

End-of-Year Update Describes a Tough 2022 for Public Pensions

An update to the State of Pensions report by Equable Institute summarizes the funding status of 228 state and locally administered pension plans at the end of the 2022 calendar year. Their calculations indicate that the aggregate funded ratio of these plans dropped from 83.9% funded the previous year to 77.3% in 2022, marking a significant reversal of the investment gains gathered during a record-breaking year of returns in 2021. They estimate an average return of -6.14% for the last year, which falls dramatically below the average plan assumption of 6.9%. Analysis in the report finds that—facing ongoing challenges in 2023—most state retirement systems remain fragile to a volatile and increasingly unpredictable market. The full update is available here.

Brief Examines Pension Contribution Behaviors of Governments

A new brief by the National Association of State Retirement Administrators (NASRA) focuses on the contributions that state and local employers made to fund the pension benefits promised to public workers through 2021. They find that of the more than $10 trillion in pension revenue generated since 1992, $2.5 trillion came from employer contributions, $1.1 trillion came from employee payments, and $6.5 trillion (64%) came from investment returns on those gathered funds. The brief recognizes the efforts of governments to reach actuarially determined contribution rates, finding that the average percentage of actual to actuarial contributions to be 99.3% in 2021, the best rate since 2001 and a major improvement from the below 80% paid in 2012. The brief attributes much of this improvement to reforms of contribution policies and supplemental payments from general government funds. The full brief is available here.

Quotable Quotes on Pension Reform

“There’s going to be acute fiscal pain and pressure the more you ignore the cost…If you’re not paying it down, you’re chasing it.”

—Leonard Gilroy, managing director of Reason Foundation’s Pension Integrity Project, on unfunded pension liabilities in “State Pension Plans Were Hammered in 2022. Next Year Will be Worse,” Politico, Dec. 28, 2022.

“Chicago government-worker pensions are massively underfunded. So in typical Chicago-land fashion, the City Council is betting on casino revenue to plug the pension gap. Do taxpayers and workers feel lucky?… The police and firefighter pension funds are only about 20% funded—among the worst in the country—even though 80% of city property tax dollars go toward pensions. The city’s annual pension payments have risen by $1 billion over the past three years.”

The Wall Street Journal Editorial Board on the move to build a casino to generate tax revenue dedicated to the police and fire pension funds in “Chicago’s Big Pension Gamble,” The Wall Street Journal, Jan. 2, 2023.

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell, using Morningstar data, created a visualization comparing how public pensions and other institutional investors voted on ESG shareholder proposals. You can access the graph here.

Pie chart of esg shareholder support in 2021

Contact the Pension Reform Help Desk

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

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

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Does the defined contribution plan in North Dakota’s HB 1040 meet gold standards? https://reason.org/backgrounder/defined-contribution-plan-north-dakota-hb-1040-gold-standard/ Tue, 24 Jan 2023 05:30:00 +0000 https://reason.org/?post_type=backgrounder&p=61444 Will the defined contribution reforms outlined within North Dakota's House Bill 1040 make a positive impact?

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Download PDF: Does the defined contribution plan in North Dakota’s HB 1040 meet gold standards?Download

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Does North Dakota House Bill 1040 meet the objectives for good pension reform? https://reason.org/backgrounder/does-north-dakota-house-bill-1040-meet-the-objectives-for-good-pension-reform/ Tue, 24 Jan 2023 05:15:00 +0000 https://reason.org/?post_type=backgrounder&p=61459 Absent reforms, NDPERS is projected to continue accruing unfunded liabilities in the coming decades.

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Download PDF: Does North Dakota House Bill 1040 meet the objectives for good pension reform?Download

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Examining the pension reform benefits of North Dakota House Bill 1040 https://reason.org/backgrounder/examining-the-pension-reform-benefits-of-north-dakota-house-bill-1040/ Tue, 24 Jan 2023 05:01:00 +0000 https://reason.org/?post_type=backgrounder&p=61452 HB 1040 would shift NDPERS to an industry standard and actuarially sound method of funding.

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Download PDF — Pension Reform Alert: The Benefits of House Bill 1040Download

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Comments on Montana House Bill 226 (2023) https://reason.org/testimony/comments-on-montana-house-bill-226-2023/ Mon, 23 Jan 2023 23:38:04 +0000 https://reason.org/?post_type=testimony&p=61633 The changes offered in HB226 would address how PERS is only optimal to a fraction of public employees at an ever-rising cost, and turn the system towards best practices in public retirement benefit design.

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Prepared for: House Committee on State Administration, Montana State House of Representatives

Chair Dooling and members of the committee:

Thank you for the opportunity to offer our analysis of House Bill 226 (HB226).

My name is Steven Gassenberger, and I serve as a senior policy analyst for the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way.

We received our first invitation to provide research and feedback to legislative members in 2019 and have closely monitored and commented on the condition of Montana’s largest public pension funds since, including during recent consideration of HJ8 (2021) by SAVA this interim.

HB226 makes two updates to the PERS system:

1. Rearranges the way the state funds PERS-DB benefits.

Every year, PERS-DB actuaries calculate the contribution amount needed to keep the fund on track to achieve full funding within the established debt payment—or amortization—schedule. This figure is commonly called the actuarially determined employer contribution, or ADEC.

Rather than using an ADEC approach to funding retirement benefits, the state’s contribution rate has historically been set in statute, making payments into the fund controlled and predictable but often rigid and unresponsive to year-to-year needs. Only when system administrators find that the current statutory rate results in the system taking more than 30 years to become fully funded, is the statutory rate increase requested and legislatively adjusted. According to a 2020 Legislative Fiscal Division report the “…current funding policies leave the systems heavily reliant on investment earnings and unable to adjust contributions to maintain an actuarially sound basis in times of significant financial declines.”

HB226 commits the state and participating employers to fully funding benefits by a set date, regardless of investment performance or political trends. During an August 2020 hearing of the Legislative Finance Committee, PERS actuaries pointed out that “states are getting away from the old statutory funding method” and that “an actuary’s dream funding policy” is a system that adjusts “to keep up with how the plan is doing.” ADEC funding is a clear way policymakers can protect retirement benefits in bad times while finally tackling an important and expensive debt on behalf of taxpayers.

2. Sets the PERS-DC benefit as the default benefit for new employees.

Upon starting their career in public employment, new hires are offered a choice between the PERS Defined Benefit (PERS-DB) retirement benefit and the PERS Defined Contribution (PERS-DC)

retirement benefit. Currently, if an employee does not make a choice within their first year of employment, they are defaulted into the PERS-DB option. Both DB and DC plans can be adequate retirement options, but the DC plan (with its portability and steady benefit accrual) tends to be more advantageous for workers who do not continue to work with their public employer for multiple decades. Since most new workers fall into that category, it is best practice to make the DC option the default.

According to PERS data, regardless of the benefit chosen, 70% of all newly hired public employees will find other job opportunities outside of public employment within five years. An additional 15% will leave within ten years. Less than 10% of employees hired between the ages of 22 and 32 will stay in public employment for the 30 years required to earn an unreduced PERS-DB retirement benefit. As designed, the current PERS-DB default policy leaves the vast majority of public employees in a nonoptimal retirement plan, subsidizing the benefits for those employees who do stay 30+ years.

What HB226 does not do.
  1. HB226 does not change the PERS-DB benefit at all.

When changes to a pension system are suggested, anxiety and fear over the loss of post-employment income increases. However, HB226 does not change the PERS-DB benefit for retirees, current members, or future employees who will choose the PERS-DB benefit option going forward. In fact, the switch to ADEC funding included in HB226 should make those retirees and current members breath a bit easier as the state would now be committing to making whatever payments are necessary to fulfill the pension benefits promised to them.

2. HB226 does not make PERS benefits more expensive.

When a system and its employers move from a statutorily set contribution rate to one determined by actuarial necessity, model projections of future contribution rates are likely to show an increase in contribution rates in the short term, with a gradual decrease over time. Some misinterpret this initial increase as an increase in cost when it is in fact a reflection of the true cost of offering a guaranteed life-time benefit payment. The alternative has been a relative increase in unfunded retirement benefits (i.e. pension debt), which now total over $2.2 billion according to PERS data. The lower statutory rate has not adequately recognized this growing unfunded liability, whereas the proposed ADEC contribution would. HB226 would not only make the employer rate more proactive going forward from a debt reduction perspective, but more transparent in its acknowledgment and mitigation of accrued yet unfunded retirement benefits.

The changes offered in HB226 would address how PERS is only optimal to a fraction of public employees at an ever-rising cost, and turn the system towards best practices in public retirement benefit design. Having retirement benefit options aligned with employee trends, and on a sustainable funding regimen, empowers public employees to choose the best retirement path for themselves and their families with confidence.

Thank you again for the opportunity to speak today, and I would be happy to answer any questions.

Steven Gassenberger
Policy Analyst, Pension Integrity Project at Reason Foundation
steven.gassenberger@reason.org

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Testimony: Montana House Bill 228 (2023) https://reason.org/testimony/testimony-montana-house-bill-228/ Fri, 20 Jan 2023 23:19:00 +0000 https://reason.org/?post_type=testimony&p=61626 Montana House Bill 228 would help improve governance and give stakeholders even more confidence in their system for future generations.

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Prepared for:  House Judiciary Committee, Montana State House of Representatives

Chair Regier and members of the committee:

Thank you for the opportunity to offer our brief perspective on House Bill 228 (HB228).

My name is Steven Gassenberger, and I serve as a policy analyst for the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way.

We received our first invitation to provide research and analysis to legislative members in 2019 and have closely monitored and commented on the condition of Montana’s largest public pension funds since, including during recent consideration of HJ8 (2021) by SAVA this interim.

Over the last two decades, public pension systems in Montana and across the country have experienced a clear shift in their investment portfolios away from public assets like blue chip stocks to more private and opaque—and often, higher risk—“alternative” assets like private equity and hedge funds. An asset class comprising less than 6% of the Montana PERS portfolio in 2003 now accounts for nearly 30% of all assets held by the fund, making PERS and other public pension funds some of the largest, most active investors in the world.

Although it is reasonable and prudent at times for pension administrators to expand or contract the fund’s investments in various assets over time, the shift to private assets presents a new risk for policymakers and pension fund stakeholders—politicization of pension fund investments.

Nearly every lawmaker has heard at least one call for the state to invest in, or divest from, one particular company or industry sector based on political concerns of one type or another. Sometimes—like the recent calls by some pension systems to divest from Russian companies in the wake of the Ukraine invasion—geopolitics and other national security concerns may dictate certain shifts in investment strategy. Most investment or divestment calls, however, do not involve national security, but rather narrow political interests of various factions seeking to reward or punish particular industries via the investment policies of taxpayer-backed public trust funds.

Montana has two major pension systems that are underfunded by billions of dollars today, and both face a long-term challenge of hitting unrealistically high investment return assumptions in order to generate sufficient returns to fully fund promised pension benefits. Given such a difficult challenge, placing political constraints on pension fund investments would make the goal of fully funding earned benefits harder for administrators. By providing more explicit guidance and boundary setting to public trust fiduciaries with the intention of preventing politicized investment decisions, HB228 would improve governance and give stakeholders even more confidence in their system for future generations.

Thank you again for the opportunity to speak today, and I would be happy to answer any questions.

Steven Gassenberger
Policy Analyst, Pension Integrity Project at Reason Foundation
steven.gassenberger@reason.org

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Testimony: North Dakota’s HB 1040 would address many challenges facing NDPERS https://reason.org/testimony/north-dakota-hb-1040-challenges-ndpers/ Sat, 14 Jan 2023 02:28:10 +0000 https://reason.org/?post_type=testimony&p=61439 A version of this testimony was originally given to the North Dakota House Government and Veterans Affairs Committee on January 13, 2023.

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A version of the following testimony was originally given to the North Dakota House Government and Veterans Affairs Committee on January 13, 2023.

Thank you for inviting me to provide our technical analysis of House Bill 1040 based on our experience evaluating pension solvency and design quality nationally, as well as answer any questions the committee may have. Reason Foundation’s Pension Integrity Project operated as pro-bono technical assistants during the interim committee process that led to this bill, building an actuarial model for the North Dakota Public Employees Retirement System (NDPERS) to help inform the process. We’ve thoroughly examined the details of this legislation, as well as the funding history of NDPERS. I have provided several supplemental materials to the committee that I hope are helpful in your consideration of this bill. 

The context for the current discussion is the looming insolvency of the North Dakota Public Employees Retirement System. Today, NDPERS is estimated to be about $1.8 billion underfunded. Even according to a recent report from the National Conference on Public Employee Retirement Systems, an organization that represents and advocates for defined benefit public pension plans, North Dakota is one of just five states that has an unsustainable public pension debt trajectory. 

Without any changes, the North Dakota Public Employees Retirement System will continue to accrue unfunded liabilities, ultimately exhausting its assets in approximately 80 years. HB 1040 would meaningfully address many of the longstanding challenges facing NDPERS, help turn it away from a path of perpetual underfunding and set it on a course to be fully paid off in the next 20 years. 

First and most importantly, House Bill 1040 fixes the systematic underfunding that the North Dakota Public Employees Retirement System has undergone over the past two decades by swapping from contribution rates set in statute to an “actuarially determined rate,” or ADEC for short. ADEC is a calculation performed during the pension valuation process that shows what plan contribution rates need to be to pay for both benefits and debt service costs. The pension benefits promised to members of NDPERS are ultimately the responsibility of the state, local governments, and taxpayers. Continuing to fall short of fully funding these pension promises unfairly passes on the cost of today’s public services to future generations. Adopting an ADEC funding policy is a crucial first step in getting North Dakota on the path to living up to its pension obligations. 

Second, this bill closes the current structurally underfunded defined benefit plan to all future new hires and instead offers them a defined contribution retirement plan that our analysis finds meets the high standards of best practices in retirement system design. The proposed reform would avoid the accrual of new unfunded liabilities related to future hires and would, in most cases, offer a more generous benefit than the current NDPERS pension. 

Our analysis, along with research from the Teachers Insurance and Annuity Association (TIAA), a Fortune 100 financial services organization, presented to the interim committee, showed that for almost any age an employee begins work, the proposed defined contribution plan’s benefits would be more generous than the current NDPERS defined benefit plan’s benefits. This is due to the extremely low multiplier of 1.75% that the NDPERS defined benefit uses for calculating benefits and the high rate of turnover in the plan. I’m unaware of any other fully defined benefit pension plan with that low of a benefit multiplier. 

While the cost of offering the current defined benefit should be low, it is saddled by years of underpaying contributions and the high-interest rate on the pension system’s accruing debt. Those are the two main factors that have moved NDPERS from being overfunded in 2000 to being $1.8 billion in debt. 

To help you visualize the thought process behind this bill, think of the North Dakota Public Employees Retirement System’s unfunded liabilities as an oil spill. The two most urgent actions are: (1) to cap the spill and (2) to clean up the oil that’s spilled already. The transition to the defined contribution plan for future hires caps the spill because no new hire would ever have the risk of an unfunded liability attached to them in the future. The second course of action is to clean up the oil already spilled, which is what the shift to proper actuarial funding does. Over the next 20 years, the state and, on a smaller scale, its local governments would be able to pay off the pension system’s $1.8 billion in debt by making full actuarial contributions to the NDPERS defined benefit plan. 

To assist that paydown, the state has also put other cash infusions into this bill, beginning with $250 million in year one and another $70 million per biennium until the plan reaches full funding. Our modeling forecasts show that these added funds, coupled with the swap to a proper actuarial funding method, would save North Dakota $1.1 billion dollars over the next 20 years relative to the status quo and finally put NDPERS back on proper financial footing. 

Lastly, I’d like to make it clear to this committee that if you hear discussions about the costs associated with this bill, those costs are not the inevitable consequence of shifting to a defined contribution plan for future hires. Instead, the costs reflect the state needing to make an overdue commitment to fully pay for the retirement benefits it has already promised generations of public workers and retirees of North Dakota, who understandably expect to have the pensions promised to them adequately funded. 

Swapping to a different retirement plan design has a negligible impact on the overall costs of any pension reform bill. No new workers are needed to “fund” previously granted benefits; pensions do not operate as Ponzi schemes and should not be treated as such. The cleanup of years of underfunding is where the costs of this bill—and most pension reform bills across the country—come from.  

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Designing an optimized retirement plan for today’s state and local government employees https://reason.org/policy-study/designing-optimized-retirement-plan-for-state-local-government-employees/ Thu, 12 Jan 2023 05:04:00 +0000 https://reason.org/?post_type=policy-study&p=60425 This study presents a new retirement plan design, the Personal Retirement Optimization— or PRO Plan, which is built on a defined-contribution foundation but designed to operate more like a traditional pension.

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Executive Summary

With most private firms shifting workers to 401(k)-style defined contribution (DC) retirement plans since the 1980s, the state and local government market is effectively the last bastion of traditional defined benefit (DB) pension plans. However, even among governments, the ubiquity of traditional pension plans has been slipping. And much of the movement away from traditional DB plan designs has been caused by accumulated unfunded liabilities that are fiscally burdening both the pension plan and jurisdictions’ budgets.

Public pension reform has been seen as a binary choice: the traditional DB or a 401(k)-style DC plan, with the latter option frequently presented as a standalone retirement option. In practice, a traditional 401(k) on its own will rarely comprise a core, or primary, retirement plan. This is because this type of plan was designed, and functions best, as a supplemental, employer-sponsored, tax-deferred savings plan.

This study presents a new retirement plan design, the Personal Retirement Optimization— or PRO Plan, which is built on a DC foundation but designed to operate more like a traditional pension. The DC foundation for the PRO Plan was chosen because it allows more public employees to accrue valuable retirement benefits regardless of length of service compared to defined benefit approaches. The design uses cutting-edge financial technologies to focus on providing plan participants with a predictable and customizable retirement income. It uses a liability-driven contribution (LDC) approach, tailored to individual situations and needs, for determining necessary contribution levels. Primarily concerned with risk-managed income adequacy in retirement, it addresses wealth accumulation only as a secondary objective. The PRO Plan provides participants the flexibility to choose an asset distribution methodology but uses several types of currently available annuities as a default method. The annuity default, combined with proper financial education and advice, tailor the PRO Plan income to an individual’s unique situation.

This study illustrates the effectiveness of the PRO Plan design in meeting individual retirement needs while effectively managing employer workplace expectations. To do so, the study elaborates on various scenarios that are relevant for the public sector. This analysis compares the relative funding requirements for three separate longevity scenarios:

  • Scenario 1: Do-It-Yourself (DIY) – the individual self-insures their personal longevity for the entire period until age 95.
  • Scenario 2: QLAC (deferred annuity) – the individual purchases an IRS Qualified Longevity Annuity Contract to address longevity risk from 85 to 95.
  • Scenario 3: 100% Immediate Annuity – the individual purchases an immediate life annuity at retirement age 67 for the entire stream of payments.

Each scenario’s funding requirement is based on an actuarial analysis of net present value of a stream of inflation-adjusted payments starting at age 67 until age 95 (or death). We found that a DIY scenario was the costliest PRO Plan alternative. Our analysis shows that a typical mid-level earner at age 67 would require $1,050,000 under the DIY scenario. The QLAC scenario requires 28% less funding, or only $760,000. The 100% Immediate Annuity scenario requires 38% less funding than the DIY scenario, or $652,000, to achieve the same retirement income.

To show how the PRO Plan would work when the target benefit accumulation is greater or lesser than needed, we analyzed both a shortfall and excess $100,000 in plan accumulations at age 50. These scenarios showed that PRO Plans would better protect individuals by positioning them to adjust savings rates up or down as needed. Similar to the baseline scenarios, the QLAC and 100% Immediate Annuity options require lower additional contributions to allow participants in shortfall situations to reach the target retirement benefits.

This study serves as a hands-on tool for public fund managers willing to implement the PRO Plan option. In addition to providing the reader with various scenarios, it details all the plan features necessary for its successful implementation. The PRO Plan is an innovative way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans that give their workers flexibility and predictability of their benefits.

A state or local government employer seeking to implement a new retirement plan or redesign their existing retirement plan should always begin by clearly identifying sound retirement benefit design principles and using those principles to determine and articulate the objectives of that plan. The principles and resulting design should include as the primary objective providing a share of lifetime income, attributable to the employee’s tenure, enabling the employee to maintain their standard of living in retirement. The design of the plan should provide the flexibility to meet the needs of employees in varying circumstances. Of course, other workplace objectives of the employer and financial realities for plan sponsors should also be considered.

Standard DB and 401(k)-type DC plans are often compared with little regard to the simple question of what design elements provide the greatest utility to the greatest number of employees while still serving the employer’s workforce management objectives. Many arguments have been advanced on all sides of the issue, some valid, others not so much. The real answer to the question of what type of plan most aids recruiting and retention is a plan that best meets the varying needs of most employees.

This analysis concludes that providing retirement benefits and savings solutions that adjust to meet the different and changing needs of employees is what will more likely aid employers in attracting and retaining quality employees.

The PRO Plan design is specifically crafted to be adaptable to the needs of the broadest cross-section of employees possible. The focus of the plan is on providing employees with the target retirement income replacement ratio determined by the employer. Income replacement is the primary objective, with wealth accumulation a secondary consideration. Importantly, the plan, based on employer-specific criteria, can have a longevity annuity default that can be opted out of by employees meeting certain specific criteria. The mandatory contribution rates for both employer and employee, as defined by the employer, combined with the investment design and distribution controls, are all designed to minimize risks for the employee while meeting employer workplace objectives.

The Personal Retirement Optimization Plan: An Optimized Design For State And Local Government Employees

Frequently asked questions about the Personal Optimization Retirement Plan

Webinar: The Personal Retirement Optimization Plan

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Webinar: The Personal Retirement Optimization Plan https://reason.org/commentary/webinar-the-personal-retirement-optimization-plan/ Thu, 12 Jan 2023 05:00:00 +0000 https://reason.org/?post_type=commentary&p=60994 The PRO Plan is an way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans.

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A discussion about the new Personal Retirement Optimization Plan, or PRO Plan, a new retirement plan design that is specifically crafted to be adaptable to the needs of the broadest cross-section of public employees possible.  

The PRO Plan is built on a defined contribution foundation but is designed to operate more like a traditional pension plan. The DC foundation for the PRO Plan was chosen because it allows more public employees to accrue valuable retirement benefits regardless of the length of service compared to defined benefit approaches. 

This discussion and study serves as a hands-on tool for public fund managers willing to implement the PRO Plan option. The Personal Retirement Optimization Plan is a way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans that give their workers flexibility and predictability of their benefits.

Full Study: The Personal Retirement Optimization Plan: An optimized design for state and local government employees

Frequently asked questions about the Personal Optimization Retirement Plan

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Frequently asked questions about the Personal Retirement Optimization Plan https://reason.org/faq/frequently-asked-questions-personal-retirement-optimization-plan/ Thu, 12 Jan 2023 05:00:00 +0000 https://reason.org/?post_type=faq&p=61032 The Personal Retirement Optimization Plan (or PRO Plan) is a new framework for public worker retirement benefits that delivers post-employment security in a cost-effective way.

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The Personal Retirement Optimization Plan (or PRO Plan) is a new framework for public worker retirement benefits that delivers post-employment security in a cost-effective way that is attractive for both employees and employers and provides a viable alternative to traditional public pension plan designs, which have proven vulnerable in many cases to underfunding and politicized decision making.

Built on a defined contribution foundation, the Personal Retirement Optimization Plan described fully in this new study improves on traditional designs with clear and measurable objectives on maximizing benefits for a wide range of individual situations, flexibility in both investment and benefit distribution options, and an emphasis on guaranteed lifetime income through annuities.

In short, the PRO Plan blends the risk management benefits to employers associated with DC plans with the lifetime income protections public workers value in pension plans. Executed correctly, the PRO Plan could provide a more secure DC benefit at a lower cost to governments and taxpayers.

Full Study: Designing an optimized retirement plan for today’s state and local government employees

Webinar: The Personal Retirement Optimization Plan

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