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

The post Modeling methodology and approach to analysis of public retirement systems appeared first on Reason Foundation.

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.

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.

The post Pension Reform News: Montana’s proposed reforms, poor 2022 investment results, and more appeared first on Reason Foundation.

Government pension plans depend on annual investment results to help generate the funding needed to pay for the retirement benefits that have been promised to teachers, public safety, and other public workers. Since investment returns contribute to long-term public pension solvency trends, interested parties keep a close eye on the annual return results of these pension funds to see how they are performing compared to their own assumed rates of return. 

Reason Foundation’s list of public pension investment return results includes all major state pension plans that have reported their 2022 fiscal year results as of this writing.

The distribution of 2022 investment returns shows a significant range of results across all of the state pension plans reporting results at this time.

The Oklahoma Public Employees Retirement System reported a -14.5% return for its 2022 fiscal year, which is the lowest return rate among the public pension plans reporting results.

The New York State and Local Retirement System (NYSLRS) and the New York Police and Fire Retirement System (PFRS) reported 9.5% returns—the highest return rate in the nation for fiscal 2022, although their results are mostly attributed to plans’ 2022 fiscal year ending in March 2022, before the largest market losses in the 2022 calendar year.

Overall, the median investment return result for state pension systems in 2022 is -5.2%, which is far below the median long-term assumed rate of return for 2022 of 7% for the plans included in this list. With return results for the 2022 fiscal year so far below pension plans’ return assumptions, most state pension plans will see growth in their unfunded liabilities and a worsening of their reported funding levels.

With each public pension plan achieving different investment returns, the funding impact will also be different for each pension system.

Methodology

'Estimated Investment Gain/(Loss)' is calculated by taking the plan's FY 2020-21 Market Value of Assets and multiplying it by the difference between '2022 Return' and 'Assumed Rate of Return.' Estimated values are meant to approximate total amounts of investment loss that plans would fully & directly recognize this year due to FY 2021-22 return deviating from the assumption (i.e., not accounting for the smoothing mechanism). Investment returns shown are Net of Fees, if not stated otherwise. ‘Deviation from Assumed Rate of Return’ shows the difference between ‘2022 Return’ and ‘Assumed Rate of Return.' Positive returns are highlighted in light blue, and negative in orange. The distribution of the 2022 investment returns chart is based on the `normalized` probability density function, with all probabilities (i.e., all points on a line graph) summing up to 100%. 

The post The 2022 fiscal year investment results for state pension plans  appeared first on Reason Foundation.

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.

• Full Report—The Personal Retirement Optimization Plan: An Optimized Design for Government Employees
• FAQ: Frequently asked questions about the PRO Plan
• Webinar: Experts discuss the need for the Personal Retirement Optimization Plan

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.

• Testimony to North Dakota House Government & Veterans Affairs Committee
• Examining the Benefits of House Bill 1040
• The Public Pension Gold Standard, North Dakota’s HB 1040, and the Status Quo
• Does HB 1040 Meet the Objectives of Good Pension Reforms?

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.

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.

The post Pension Reform News: Modernizing public sector retirement plans, North Dakota reforms, and more appeared first on Reason Foundation.

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

The post Webinar: The Personal Retirement Optimization Plan appeared first on Reason Foundation.

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

The post Frequently asked questions about the Personal Retirement Optimization Plan appeared first on Reason Foundation.

In This Issue: 

Articles, Research & Spotlights  

• New federal rule puts ESG spotlight on states 
• The shortfalls of ESG investing 
• California’s growing pension debt 
• FTX and crypto warnings for pensions 
• Georgia improves its hybrid plan 
• Pension policies should be set by those who bear the risks

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

Articles, Research & Spotlights 

The Department of Labor’s New ESG Rule Puts the Onus on States 

The US Department of Labor (DOL) has released a new rule that reverses previous limits on what private retirement plans can consider in investment decisions. The move essentially gives plans permission to take environmental, social, and governance (ESG) factors into account, which was traditionally outside the scope of those acting as fiduciaries. The rule applies to private plans through the Employee Retirement Income Security Act (ERISA), which is not applied to public pension plans. The change does highlight, however, the ongoing debate around the politicization of retirement funds. The DOL rule also demonstrates how the answers to this debate will largely be determined through state legislation. Reason Foundation’s ESG resource website outlines issues related to ESG and public pensions and offers model legislation to help protect taxpayers’ funds from political activism. 

Scrutinizing High ESG Fees, Greenwashing, and the Politicization of Public Pension Funds 

Assets that focus on ESG are becoming more popular among investors but come with several challenges for consumers and policymakers. Reason’s Jordan Campbell identifies three growing problems with ESG-focused investing that even supporters are concerned about. First, environmental grading can be arbitrary and easy to manipulate. Second, ESG assets often incur expensive fees with little evidence of advantages in returns. Third, government involvement with this strategy can be a politicization of public funds. 

California’s Public Pension Debt Grows  

The California Public Employees’ Retirement System (CalPERS) recently updated its investment results from the fiscal year ending June 2022, adjusting its actual loss of assets from -6.1% to -7.5%. This new accounting means the nation’s largest pension lost nearly $30 billion in 2022, which will impact state and local government employers with higher annual contribution requirements. In a commentary published in the Orange County Register and elsewhere, Reason’s Jen Sidorova examines the growth of the system’s unfunded liabilities and what it means for California’s governments and taxpayers. 

FTX Collapse Is a Reminder that Public Pensions Should Exercise Caution 

The collapse of the FTX cryptocurrency exchange platform, and a year marked by significant crypto losses, have renewed questions and concerns about the pressures for public pensions to invest in these types of volatile assets. Examining public pension investments in crypto markets, Reason’s Swaroop Bhagavatula finds that some states, including Kansas, Missouri, Alaska, and Washington, have reported FTX-related losses, although not at significant levels, but, generally, public pensions plans seem to have largely avoided significant exposure.

Georgia Reinforces Its Hybrid Retirement Plan 

In what is commonly known as a hybrid approach, Georgia’s retirement plan for state employees uses a combination of defined benefit (DB) and defined contribution (DC) elements to balance portability, cost, funding, and longevity risks. Now, state policymakers are reinforcing their commitment to both this plan and its members with an increase in employer contributions to the DC portion. Reason’s Jen Sidorova outlines these changes, explaining how they will benefit both state employees and taxpayers with a more stable and adequate retirement offering. 

Who Should Be Responsible for a Public Pension Plan’s Risk Management Policy?  

Market volatility and years of growing shortfalls in pension funding raise questions about who ultimately is responsible for the risk-related decisions involved in managing a publicly sponsored retirement plan. As Reason’s Rod Crane explains, risk strategies and policies have largely been left to plan administrators to set and monitor, but the government backing of these plans means the taxpayer is the true bearer of cost-related risks. Crane reviews how industry experts imagine this risk should be balanced between parties, noting the need for pension oversight bodies with the direct authority to set and manage assumption, funding, and investment policies. 

News in Brief 

Policy Brief Examines Application of a New Actuarial Requirement 

In anticipation of a new actuarial reporting standard to be implemented in February of 2023, S&P Global Ratings has released a brief explaining what the new requirement could mean for public pension plans. The new requirement from the Actuarial Standards Board (ASB) will have pensions reporting their low-default-risk obligation measure (LDROM), which will be an accounting of liabilities and funding measurements using a very low discount rate. S&P explains that this measurement will be useful in that it will demonstrate what the costs of a plan could be if they were to eliminate market risk from their investment profile. While neither S&P nor ASB are advocating for such a shift in investment policy, the new reporting could be a valuable way to measure and compare a plan’s exposure to market risk. The full brief is available here. 

New Commentary Revisits the Success of Canadian Public Pensions 

An article posted in the Harvard Law School Forum on Corporate Governance by KPA Advisory Services’ Keith Ambachtsheer examines the history of Canada’s public pension plans, focusing on the adoption of revolutionary funding and governance philosophies in the early 90s that continue to serve the plans to date. The post titled “How Peter Drucker Revolutionized Canada’s Public Sector Pension System: Lessons for Americans” details how a mindset focused on policies that were intergenerationally fair along with unbiased, experienced governance led Canadian pensions to maintain full funding through a volatile and changing market. The plans achieved this through the early adoption of lower, risk-reduced assumptions on returns and inflation protection benefits conditional on how well the plan is funded. The full article is available here. 

Quotable Quotes on Pension Reform  

“Defined benefit pensions ‘are too critically important to the participants to use precious resources to engage in these risky strategies…We need to get back to basics and focus on the promise’ that has been made to participants in these plans.” 

—Russell Kamp, managing director at investment management firm Ryan ALM, on public pensions investing in crypto in “Amid FTX fallout, public pension fund defends its big bet on crypto-related holdings,” MarketWatch, November 29, 2022. 

“The more you limit the investments out there, there is at least a fair possibility that might ultimately impact the return. As a policymaker, I think they’ll need to be aware of that,” 

—Kansas Public Employees Retirement System Executive Director Alan Conroy on proposals to direct the system’s investments in “Kansas Pension Investment Advisers Caution Against Robust Legislative Rebuttal to ESG Activists,” Kansas Reflector, November 22, 2022 

Data Highlight 

Each month, we feature a pension-related chart or infographic of interest generated by our team. This month, Jordan Campbell created a visualization comparing the performance of ESG investments to the rest of the investments in 2022. Access the graph here. 

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. 

The post Pension Reform News: ESG, public pensions exposed to FTX, and more appeared first on Reason Foundation.

According to Department of Labor (DOL) statements, the rule “removed barriers to considering [ESG] factors in plan investments” and will provide more flexibility in “exercising shareholder rights.”

But those critical of using ESG factors to make public pension systems’ investment decisions believe this move exposes retiree savings to oftentimes unexpected or counterproductive social and political agendas when risks and returns should be the sole investment factors. This new rule sets the stage for state governments to establish their own standards, which could prompt state legislatures to set up guardrails against political investing.   

Institutional investors, corporations, credit rating agencies, and governments are increasingly adopting an ESG framework into their investment decision-making. The idea behind ESG is to create a more accurate accounting of the negative externalities—be they environmental or social caused by industries, businesses, and individuals and to use this knowledge to positively influence the future. This ESG framework is implemented in a variety of ways.  

ESG investment policies typically seek to avoid assets that are deemed to be harmful to the environment. Some institutional investors adopt and promote ESG principles in hopes of influencing the companies they invest in. ESG ratings are applied to companies to measure—albeit arbitrarily—the negative impact they may impose on various environmental and social areas. All of this is increasingly present in both the public and private sectors. 

Traditionally, those who are tasked with managing collective retirement funds, including either a 401(k) plan or a pension plan, have what is called a fiduciary responsibility to the members of those plans. Fiduciary responsibility is the focused objective of managing and growing investment funds at acceptable levels of risk. Any other interest or objective is supposed to fall outside of the fiduciary’s purview, making it out of bounds for any consideration in investment decisions.  

For privately-run retirement plans, these standards are set by the Department of Labor through ERISA. In the waning months of the Trump administration, the Labor Department issued a rule that reinforced the traditional understanding of what a plan sponsor can consider when making investment choices for its members, specifying that making choices based on ESG factors would be out of bounds. The department also released a proposal that would significantly restrict retirement plan administrators from directly influencing equities through stockholder voting—a process called proxy voting—on ESG-related issues. 

In response to these protections from 2020, the Biden administration’s DOL has reversed course. Through the implementation of this latest rule, specific restrictions on making ESG considerations a part of investment decisions have been removed, allowing 401(k) plans under ERISA to insert ESG metrics into their risk and return evaluations. The rule also reverses the restrictions on proxy voting that were applied in 2020, opening up possibilities for retirement plans to use stakeholder positions to shape the decisions of the companies they are investing in, even if the matter is unrelated to economic outcomes. 

According to a statement on by United States Secretary of Labor Marty Walsh, the rule will “end the chilling effect created by the prior administration on considering environmental, social, and governance factors in investments.”

Walsh added, “Today’s rulemaking is an important step toward a more secure financial future for America’s workers and their families.”

However, his position remains politically polarizing, most evident in the response from Republican senators who have submitted a resolution to reverse the rule. 

What will these latest developments mean for employees and retirees who are counting on their pension plans to act on their behalf as fiduciaries? It indicates that the federal government is not going to get in the way of retirement plan managers who choose to insert political, inconsistent, and often controversial ESG factors into their decision-making. Those looking for protection from politically motivated shirking of fiduciary responsibility will have to turn to state governments. 

With a lot still to be determined in the world of retirement plans and fiduciary responsibility, the full impact of the DOL’s latest rule remains unclear. At the very least, it sets the stage for more debate on the matter, which will ultimately take place at the state level. State policymakers have already begun to set strong definitions of what a fiduciary can consider in making investment decisions.  

For public pension funds, which are not bound by ERISA and therefore largely unaffected by the Labor Department’s recent rule, state policymakers should consider legislation to keep activist campaigns away from taxpayers’ money in keeping apolitical funds from politicization. Setting clear boundaries for what a public pension can consider when making investment decisions—the approach taken by Florida’s State Board of Administration and proposed in a piece of legislation in Michigan—is the optimal way to protect these funds from activism from any political side. 

The post The Department of Labor’s new ESG rule puts the onus on states  appeared first on Reason Foundation.

In This Issue: 

Articles, Research & Spotlights  

• A blueprint for protecting public funds from ESG and politicization 
• Arizona’s innovation for multi-employer pension plans 
• Challenges in inflation protection for Texas teachers 
• Retention trends in the public workforce suggest the need for portability 
• What U.S. pensions can learn from the U.K. margin call 

News in Brief 
Quotable Quotes on Pension Reform  

Articles, Research & Spotlights 

Reason’s New Blueprint for ESG-related Legislation

Reason Foundation’s Pension Integrity Project has developed an ESG Blueprint to help policymakers seeking sound and effective policies for managing public funds, particularly public pension funds. The website provides an overview of what ESG is, its potential impacts on public pension systems, and model legislation to strengthen the boundaries of fiduciary responsibility, ensuring that policymakers keep public funds out of political influence campaigns. Reason’s ESG blueprint is available here, and our full archive of ESG-related analysis is here. Recent pieces include:

Arizona Creates Prefunding Program for State Retirement System

Many state-run public pensions are multi-employer plans, meaning local cities and counties participate and contribute to a single fund and share liabilities. This allows smaller governments to reap the investment benefits of a larger asset-pooled plan, but it can also mean less flexibility in paying down the unfunded pension liabilities that are impacting annual budgets. State legislators in Arizona recently passed a bill that aims to improve this flexibility for employers participating in the Arizona State Retirement System (ASRS). As outlined by Reason’s Ryan Frost and Truong Bui, Senate Bill 1082 offers a vehicle for local governments to apply extra payments to a separate account, which can be used to offset rising contributions at a later time. This is an innovation that other state-run multi-employer plans should consider employing. 

Is Texas’ Definition of an “Actuarially Sound” Public Pension System Outdated?

With high inflation continuing to degrade the value of fixed pension benefits, there is significant attention being placed on the cost-of-living adjustment policies that are supposed to cushion the blow from retirees’ losses of purchasing power. In Texas, there is a strict hurdle set in law that must be achieved before giving retired public workers a so-called “13th check.” The state must be able to demonstrate that it is “actuarially sound.” Reason’s Steven Gassenberger explains the current understanding of this hurdle, noting that it would be prudent to adjust this standard with shorter debt-payment requirements. 

More Portable Retirement Plans Would Help Public Employers Attract and Keep Workers 

Increased rates of resignation in the post-pandemic world are a continuation of a decades-long evolution in the modern workforce, with the current generation of workers switching jobs at much higher rates. This phenomenon is even more pronounced among public workers and teachers. Examining some of the latest shifts in public employee retention, Reason’s Jen Sidorova offers ways that policymakers can shape retirement benefits to better fit today’s workers, including shorter vesting requirements and increased portability. 

The U.K.’s Margin Call Offers Warning Signs for Public Pension Funds in the U.S.

A sharp increase in bond yields recently put United Kingdom pensions in a difficult position where they needed to sell off assets, resulting in what was called a ‘doom loop’ scenario that prompted intervention from the Bank of England. Reason’s Swaroop Bhagavatula looks at how this market scare was associated with liability-driven investing (LDI), which is a strategy not often used by pensions in the United States. Still, there are some valuable lessons that can be applied, namely avoiding over-leveraging and maintaining adequate levels of cash to manage any major market shocks. 

News in Brief 

Paper Rediscounts Public Pension Liabilities 

A paper from economics professors Oliver Giesecke and Joshua Rauh of Stanford University asserts that public pension liabilities should be discounted in a way that reflects the guaranteed nature of these promised benefits, which would mean using zero-risk rates based on treasury yields. Their analysis of 647 state and local pension plans in 2021 finds that, while these plans report unfunded liabilities of just over $1 trillion and an aggregated funded ratio of 82.5%, rediscounting the same plans to the proposed specifications would mean unfunded liabilities of $6.5 trillion and a funded ratio of 43.8%. The full paper is available here, and an interactive dashboard of its results is available here. 

New Survey Asks Public Employees How The Current Market Has Impacted Their Retirement 

MissionSquare Research Institute has published results from a survey of 1,003 state and local government workers focusing on how current market turbulence has impacted the perception of retirement security as well as saving behavior. The survey indicates that most (84%) of respondents feel anxious about their personal financial security. Nearly half (48%) have reduced the amount they save for retirement, naming high inflation as the cause. Over half (58%) of the polled public workers indicated that the retirement plan offered to them was a factor in their decision to stay in the job, while 33% said that this made no difference. The full report is available here. 

Quotable Quotes on Pension Reform  

“In some cases, the [midterm election] campaign rhetoric not only dismissed the danger of climate change, it went so far as to mischaracterize a strategy we believe in strongly: examining the risk factors of the environment, of social inequality, and of good governance […] But let’s be clear: Applying the lens of ESG is not a mandate for how to invest. Nor is it an endorsement of a political position or ideology. Those who say otherwise are actually advocating for investors like CalPERS to put on blinders…to ignore information and data that might otherwise help build on the retirement security of our 2 million members.” 

—CalPERS CEO Marcie Frost quoted in “CalPERS CEO Pushes Back Against Politicization ESG Investing,” Pensions & Investments, Nov. 16, 2022 

“Regardless of your view on climate change or inclusion or human rights, Mississippi’s pension system, taxpayer dollars, and college savings programs are the wrong place to experiment with investment strategies that push balance sheets to the side. Moreover, many of the policies ESG promotes tie directly to higher costs for consumers, a weaker Mississippi job market, increased inflation, and smaller investment returns – all while undermining the free market and our economic liberty.” 

—Mississippi Treasurer David McRae in “Guest Column: Protecting Mississippi’s Finances,” The Vicksburg Post, Nov. 2, 2022 

“It does limit us…We, I believe, have been successful in trying to minimize any kind of cost that might bring to you, but eventually, it’s going to bite us in the butt if we continue. So we just have to be careful and prudent about it…Our bank list is getting short.” 

—Lamont Financial Services Founder Bob Lamb on Louisiana Treasurer John Schroder pulling the state’s investments from BlackRock over their ESG approach in “Pulling Louisiana’s Investments Could ‘Bite Us in the Butt,’ Adviser Tells Treasurer,” Louisiana Illuminator, Oct. 18, 2022 

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. 

The post Pension Reform News: ESG blueprint, Arizona’s pre-funding, and more appeared first on Reason Foundation.

In This Issue: 

Articles, Research & Spotlights  

• What ESG policies mean for public pension systems 
• 2022 investment results for state pension plans so far
• Using hybrid retirement plans to balance risk 
• Examining effective amortization policies 
• Preparing public pension systems for a recession 

News in Brief 
Quotable Quotes on Pension Reform  
Data Highlight

Articles, Research & Spotlights 

Webinar: ESG Trends and Impacts on Public Pensions 

The emergence of environmental, social, and governance (ESG) strategies has elicited several responses from state lawmakers, some of whom are concerned with outside interests overcoming the primary fiduciary obligations of the governments managing public pensions. In this webinar hosted by the Pension Integrity Project, former U.S. Securities and Exchange Commission Commissioner Paul Atkins, former CKE Restaurants Chief Executive Officer Andy Puzder, and Reason’s Leonard Gilroy discussed how ESG strategies impact taxpayers and public pensions. They also evaluated the types of anti-ESG laws that are emerging in various states. 

You can watch the webinar here and read coverage of it at Institutional Investor and The Bond Buyer, amongst others.  Here is some of Reason Foundation’s recent ESG-related analysis:

• Politics can endanger public workers’ retirement 
• Democratic treasurers defend ESG investing 
• The differences between individual and institutional investors considering ESG factors 
• The public pension systems signing on to politicized ESG investment efforts 
• The difficulties of assigning ESG ratings 

The Investment Results State Pension Plans Are Reporting for the 2022 Fiscal Year 

After breaking investment return records last year, most state-run pension plans are reporting significant investment losses for 2022. These losses will negatively impact unfunded liabilities and the costs of public pension plans in the coming years. The Pension Integrity Project has compiled all of the 2022 state plan investment results reported thus far, along with estimates of what these returns will mean for each plan. While there is a wide range of investment returns so far, the overall results show the median investment return for state pension systems in 2022 is -5.4%, with nearly all plans reporting returns well below what they were assuming to earn. 

Best Practices in Hybrid Retirement Plan Design 

A hybrid retirement plan combines the defined benefit structure commonly offered to public workers with a 401(k)-style individual account. While this is a novel concept to some, splitting retirement benefits between the two different types of plans has been a valuable way for public employers to balance the risks involved in retirement saving between the employer and employee. This policy brief by Reason’s Ryan Frost details the policies that will ensure a public hybrid plan achieves the goal of adequate retirement savings while appropriately allocating risks between all participating parties. Using examples of the federal government and states like Washington and Tennessee, policymakers can better understand the long-standing value and effectiveness of hybrid plans. 

Best Practices for Pension Debt Amortization 

With unfunded liabilities growing beyond $1 trillion for state and local pensions, U.S. governments have a steep hill to climb and a limited timeframe to raise the funding needed to fulfill the retirement benefits promised to public workers. Every pension plan has an amortization policy, which details how they intend to close whatever funding shortfall arises. These policies not only have a major impact on annual debt payments, they also determine how long a plan will hold expensive pension debt and how resilient it will be amidst unpredictable market outcomes. This new policy brief from the Pension Integrity Project outlines a few of the major decisions policymakers must make when it comes to the amortization of public pension plans, including the way that payments are calculated and acceptable timelines for eliminating debts. 

Most State Pension Plans Are not Adequately Prepared for a Recession 

The warning signs of a major recession continue to rise, which ought to be a significant concern to public pension plans. With significant levels of underfunding reported among state and local retirement plans, and too little progress made to reduce these shortfalls since the Great Recession, another economic recession would mean significant challenges for public pensions and potentially huge costs to taxpayers. Reason Foundation’s Anil Niraula and Zachary Christensen use the Teacher Retirement System of Texas to illustrate what a major recession could mean for many other public pension systems around the country. Unless policymakers make significant changes to the way governments contribute to these plans, they’ll remain especially vulnerable to periods of market turbulence. 

News in Brief 

New Report Indexes National Retirement Systems 

Mercer and Chartered Financial Analyst (CFA) Institute’s 2022 Global Pension Index ranks retirement systems globally in terms of adequacy, sustainability, and integrity. Adequacy is evaluated by the plan design and overall benefit levels. Sustainability examines the funding levels of the plan. Integrity is understood as the regulations and protections around the plan. According to this analysis, the highest-ranking countries were Iceland, Netherlands, and Denmark. The U.S. graded around the middle of the pack, with below-average marks in “integrity.” The report acknowledges a significant drop in “adequacy” from previous years for nearly all countries, likely due to the high inflation experienced across the world. The full report is available here. 

Study Finds Difference in Spending Habits from Supplemental DC Participants 

A new study from the Public Retirement Research Lab examines the spending and saving habits of public employees, finding some notable differences in how those with a primary defined benefit (DB) plan and a supplementary defined contribution (DC) plan spend compared to others with standalone DB or DC plans. According to the analysis, employees who have a primary DB plan with a flexible DC supplemental option tend to spend more and save less, which could indicate a misguided level of confidence among these members. The authors suggest that this phenomenon highlights a need for better education for new members of these types of plans. The study is available here. 

Quotable Quotes on Pension Reform  

“The majority of investment experience for people managing money, be it asset management firms or pensions, endowments, and foundations, has been with tailwinds in the last 40 years…I would say now, the environment is that tailwind may become a headwind and is likely more challenging.” 

—Los Angeles County Employees Retirement Association Chief Investment Officer Jonathan Grabel in “Are California’s Public Pension Funds Headed for Another Crisis?,” Los Angeles Times, Sept. 29, 2022 

“The state will have to pay those pensions regardless if we make that return on our investments or not. If we don’t make a return on those investments, it means higher taxes for the business community and all of us. For that reason alone, we should not be doing this” 

—New Jersey Business and Industry Association’s Ray Cantor on legislation to divest state pension funds from the fossil fuel industry in “N.J. Pension Fund Would Stop Investing in Fossil Fuels Under Bill Advanced Thursday,” New Jersey Monitor, Oct. 6, 2022 

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 Anil Niraula and Jordan Campbell created an interactive distribution of the 2022 market returns from state-run pensions reported so far. You can access the map and data here. 

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. 

The post Pension Reform News: ESG debates, public pension plans’ worrying investment results, and more appeared first on Reason Foundation.

Recessions can hit retirees and public pension plans hard, so public pension plans reporting large investment losses for 2022 could just be a prelude to rough times for public pension systems.  A continued market downturn could potentially add trillions to public retirement systems’ existing pension debt, and most public pension plans are poorly positioned to withstand a major recession.

The largest pension system in the country, the California Public Employees Retirement System (CalPERS), reported a -6.1% return for 2022. The Oklahoma Public Employees Retirement System (PERS) recently posted a -14.5% loss for its 2022 fiscal year. 

The good news: A single year of returns generally has a limited impact on a pension plan’s long-term horizon, whether that be the great double-digit investment returns that many pension systems reported in 2021 or the losses that many plans are reporting for 2022. 

What matters most to the long-term funding of public pension systems is the ability to average out to, or come in above, the set investment return target so the plan has the money to pay for promised benefits. 

The next investment return prospects over the next 10-to-15 years for institutional investors look slim. Stubbornly high inflation and other economic factors may be increasing the likelihood of a recession in the near term, but for several years forecasts have been warning pension systems to lower their long-term investment return expectations. In 2022,  J.P.Morgan Asset Management, for example, has retained muted average return projections for U.S. public equities, the largest investment category for pension plans, at 4.1% for the next 10-15 years.

The Teachers Retirement System of Texas (TRS) is a good example of what could happen if a major recession scenario occurs over the next year and investment returns are low for a few years. TRS has already accrued $47.6 billion in pension debt since 2002. Most of TRS’ debt is due to investment returns falling below the plan’s lofty expectations, which were set at 8% until 2018. 

Since then the retirement system was wisely started to lower its investment return assumptions. In July, the TRS Board of Trustees prudently decided to lower its assumed rate of return from 7.25% down to 7%. An actuarial projection reveals, however, that TRS is still quite vulnerable to a major market downturn.

The analysis below (figure 1) applies -26% investment losses in the year 2023 and another in the year 2038, with each of those years followed by three years of a positive 11% rebound. Under that scenario, TRS’ unfunded liabilities, inflation-adjusted, are projected to grow from $44 billion in 2022 to $386 billion by 2052, leaving the plan roughly 52% funded.

Constant 7% returns, the system’s own baseline expectations, and 6% return scenarios are also shown for comparison. This forecast demonstrates that despite recent moves to better shield the system, TRS remains very vulnerable to major recessions. Even though the plan’s debt is currently expected to fall, the investment return assumption that was recently lowered to 7% could still set the plan up for future debt. TRS’ debt is expected to grow steadily if the plan realistically produces 6% returns each year.

Figure 1.  Forecast of Texas TRS Unfunded Liabilities: Current Statutory Contribution Policy

Further analysis (figure 2) suggests that Texas policymakers could greatly reduce the impact of a recession on the teachers’ plan by adhering to the contributions calculated by the plan’s actuaries— rather than continuing to base these payments on rates set in statute. If Texas were to transition to actuarially determined employer contributions (ADEC) for TRS, it could shave hundreds of billions off the state’s unfunded liabilities by 2052 (the debt would grow by just $92 billion instead of $340 billion) in the two recession scenarios described.

Figure 2.  Forecast of Texas TRS Unfunded Liabilities: ADEC vs Statutory Contribution Policy

The Teachers Retirement System’s lowered investment return assumption does position the plan to be more resilient to lower future returns, but most 10-to-15-year projections suggest that TRS needs to continue to reduce its investment return expectation. 

Forecasting shows that state policymakers should also consider paying actuarially required contributions (ADEC) to ensure adequate funding. Additional ways to bolster the funding of TRS would be to pay down pension debt faster and to consider alternative risk-reduced options for new hires:

These recommendations apply to most public retirement systems as well, as many pensions carry similar risks and would face equally difficult funding challenges were they to see a recession over the next year. 

Seeing the heightened risk of a major recession in the near term, not to mention the many credible economic forecasts of muted investment returns over the next decade, policymakers need to actively seek out reforms that bolster the long-term funding projections of public pension plans. A failure to fully prepare for potential recessions opens public pension systems—and therefore taxpayers and future government budgets—to significant long-term funding and cost challenges.

The post Most state pension plans are not adequately prepared for a recession appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Webinar: Former SEC Commissioner Paul Atkins, former CKE Restaurants CEO Andy Puzder, and Reason Foundation on the impact of ESG policies
• Best practices for pension COLA design
• Which states and pension systems have adopted ESG policies?
• Cash flow challenges and solutions for public pensions
• Evaluating Alaska’s defined contribution and annuity plans
• Texas counters politicized ESG efforts with more politics
• Participation, not equity, should be the focus of retirement plans

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

Articles, Research & Spotlights

Webinar: What Does ESG Mean for Public Pension Systems and Taxpayers?

Environmental, social, and governance (ESG) trends are impacting public pension systems, retirees, and taxpayers. Join former SEC Commissioner Paul Atkins, former CKE Restaurants CEO Andy Puzder, and Reason Foundation’s Leonard Gilroy for a webinar on September 20 at 1 pm ET to discuss how ESG policies and politicized public investments may impact investment returns and saddle taxpayers with additional costs. The panel discussion will also examine if legislators pushing broad anti-ESG laws could unleash unintended negative consequences and will explore potential reforms that would help keep politics out of public pensions.

Best Practices for Cost-of-Living Adjustment Designs in Public Pension Systems

Extended periods of high inflation can be particularly challenging for pensioners, whose promised benefits usually come in the form of fixed payments. To protect retirees from losing too much purchasing power, many public employers provide a cost-of-living adjustment (COLA) benefit. Like any other retirement benefit, this brings additional costs and requires appropriate funding and limitations. A new report from the Pension Integrity Project identifies a set of best practices that policymakers should consider when structuring or reforming the COLA benefits offered to public retirees. Among those principles are the recommendations that COLAs should be pre-funded and aligned with explicit retirement plan objectives.

The Public Pension Systems Signing on to Politicized ESG Investment Efforts

Several state and local public pension systems have signed on to global climate change accords and/or formally joined activist investment groups focused on reducing climate change. This interactive map by Reason’s Jordan Campbell shows the state and local pension plans, treasurers, and investment boards taking such actions to date.

Policy Brief: The Impact of Cash Flow on Public Pensions

Because public pension plans are designed to combine annual contributions with investment returns to fulfill retirement promises, it is crucial to monitor the money flowing in and out—also known as the cash flow—of public systems. In this new policy brief, Reason’s Truong Bui uses the Montana Public Employee Retirement System (PERS) as a case study to examine the impact of cash flow, both historically and in long-term forecasts. The analysis demonstrates some of the risks that can arise when a plan has more money leaving its fund than going in.

How Alaska’s Defined Contribution Plan and Supplemental Annuity Plan Compare to the Gold Standard

Alaska’s defined contribution and supplemental annuity plans are the primary retirement offerings to the state’s public workers. In this analysis, Reason’s Richard Hiller and Rod Crane partner with the Alaska Policy Forum to evaluate these plans according to best practices for defined contribution plans. They find that the plans fulfill some of the best practices of well-structured retirement plans, while also finding that there is still room for improvement in areas such as a formal statement of plan objectives and contribution adequacy for both teachers and public safety workers.

Texas Dangerously Inserts Politics into Pension Investing

In accordance with Senate Bill 13 from the 2021 legislative session, the Texas Comptroller of Public Accounts recently released a new list identifying 10 financial firms and 348 investment funds that Texas claims are boycotting the fossil fuel industry. This means the state’s public pension funds must remove them from their investment portfolios. Reason’s Marc Joffe highlights some of the implications of this new policy and considers how this reaction to ESG investing also elevates politicized investments over core fiduciary decision-making and risks higher costs for taxpayers.

Policymakers Should Focus on Improving Participation Rates in Retirement Plans

Recent reporting from the National Institute on Retirement Security (NIRS) identifies economic inequities caused by tax incentives in retirement savings, but this analysis overlooks some key facets of how the laws promoting savings operate. Reason’s Rod Crane asserts that tax incentives are working exactly as they are meant to by benefiting those who are closer to retirement. Instead of focusing on retirement benefit inequities between the upper- and middle-classes, policymakers should simply seek to maximize the number of employees that are participating in retirement saving programs.

News in Brief

New Report Underscores Volatility for State Pensions

A new paper published by the Center for Retirement Research looks at the impact of declining stock market returns and rising inflation on pension funds. The paper shows that, despite the market drop, pension funds have still seen a net increase in funded ratios by one percentage point between 2020 and 2022. The paper goes into more depth as to how this affects amortization payments and overall contribution rates. Regarding inflation, the only types of COLA plan offered by pension plans affected by inflation are CPI (Consumer Price Index) linked. Other types, such as ad-hoc and invested-based COLAs, are unaffected. CPI-linked COLAs typically have caps of around 3.5%. Due to these caps, increases in amortization payments from inflation will be relatively limited (estimated to be between 0.4% to 1.6% of payroll). The full brief is available here.

Paper Examines Purpose and Effectiveness of ESG ratings

A new working paper from the Rock Center for Corporate Governance at Stanford University reviews the stated purpose of ESG ratings and how effective they are at achieving these goals. The paper identifies the shortcomings that exist in both the objectives and execution of current methods in grading the nonfinancial impact of companies. It also asks if the motivations of fund managers are aligned to produce accurate and reliable reports, which are crucial for calibrating ESG ratings that the market can confidently apply to decision-making. The working paper is available here.

Quotable Quotes on Pension Reform

“Starting in FY 2024, the budget will start reflecting the impact of adverse financial market conditions on pension returns.”

—New York City Comptroller Brad Lander cited in “NYC Will Need to Chip in an Extra $6 Billion to Shore up Pension Funds — Comptroller” in Pensions & Investments, September 7, 2022

“For a while, ESG looked like a good bet, and values seemed cheap. In a down market, though, ESG’s true cost is starting to reveal itself—and in a more volatile, energy-scarce market, it will only get more expensive. Politics aside, few people or fund managers will tolerate funds that underperform, and this may be the real reason ESG funds have peaked.”

—Manhattan Institute Senior Fellow Allison Schrager in “The ESG Bubble Is Bursting” in City Journal, August 30, 2022

“The concern for most investors now is ‘how do I find exposures that are going to help me stabilize the portfolio vs. investing with my values?’”

—Managing Director at FLX Networks Jill DelSignore cited in “The ESG Crown Is Slipping, and It’s Mostly the Fund Industry’s Own Fault” in Bloomberg, September 2, 2022

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 created an interactive map showing the state and local government pension plans that have signed on with the Ceres Investor Network on Climate Risk and Sustainability and Climate Action 100+. You can access the map here.

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.

The post Pension Reform News: Join our ESG webinar, best practices for addressing inflation, and more appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Who benefits most from defined benefit and defined contribution plans?
• California’s public pension losses will impact local governments.
• A new survey suggests retirement plans are poor tools for recruitment and retention.
• More transparency is needed on public pensions’ private equity investments.

News in Brief

Quotable Quotes on Pension Reform

Data Highlight

Articles, Research & Spotlights

Examining the Populations Best Served by Defined Benefit and Defined Contribution Plans

Research by some pension advocacy groups suggests that defined benefit pension plans enjoy a cost efficiency advantage over defined contribution plans (e.g., they generate a greater value for the same cost), but this conclusion is based on too narrow of a perspective. In a new analysis, Reason Foundation’s Swaroop Bhagavatula, Rod Crane, and Richard Hiller posit that there are many more factors that need to be considered to evaluate the efficiency of a public retirement plan. They introduce the concept of benefit efficiency, which measures how well a plan distributes its benefits to all of its members. Using hypothetical pension plans, their analysis shows that a standard defined benefit plan maximizes “efficiency” for only a narrow group of plan members, making it a less optimal option for the vast majority of public workers.

California’s Unfunded Pension Liabilities Will Burden State and Local Governments

Reporting a -6.1% return for its 2022 fiscal year, California’s pension system serving most state and local public workers—CalPERS—is bracing for growth in its unfunded liability and the inevitable hike in annual costs. Reason Foundation’s Marc Joffe notes that while CalPERS may have outperformed some institutional investors, the nation’s largest pension system’s losses in the last quarter may not have been fully captured in this figure due to the standard lag in reporting on private equity assets. Either way, Joffe notes the growth in California’s public pension debt will impose higher costs on already cash-strapped local governments and taxpayers in the state.

Retirement Plans’ Impact on Recruiting and Retention in the Public Market

A new survey of 319 government respondents by the MissionSquare Research Institute sheds some light on a common question in the sphere of public employment: Does the quality or type of a retirement plan impact a government’s ability to recruit or retain workers? Reason’s Richard Hiller argues the survey results suggest pension plans have little to no impact on a public employer’s ability to attract or keep their employees. The survey results do suggest, however, that employees respond to their perceived wellness and overall happiness. Hiller says public employers should focus on providing effective retirement plans that are optimal for as many employees as possible to improve their perceived well-being.

As Public Pension Plans Take Risks, SEC Wants More Transparency from Private Equity Funds

With economic uncertainty and shifting investment strategies, many public pension systems are now relying heavily on alternative investments to help secure the investment returns they need to fund promised retirement benefits. Reason’s Jen Sidorova outlines some of the key challenges that arise from alternative investing, including a lack of transparency and predictability. She also notes how the Security Exchange Commission’s newly proposed reporting requirements could help public pension investors better evaluate the risks involved in this opaque asset class.

News in Brief

New Report Underscores Volatility for State Pensions

A new report from S&P Global Ratings highlights the impact volatile markets are having on the funded ratios of public pension plans across the country. On average, after last year’s excellent returns, pension plans went from 69% funded in 2020 to 81% funded in 2021. According to this report, however, pension plans will likely drop back to 2020’s funded levels after this year. The report also highlights the states that used 2021 to shore up their unfunded liabilities. Thirty-eight states met their minimum contribution requirements, and 16 states exceeded them, the report finds. States like Washington, Indiana, and Utah had some of the highest contributions above what was required in 2021. The report concludes that with an economic recession likely looming, many state-level public pension reform efforts have been put on the back burner. The full brief is available here.

Quotable Quotes on Pension Reform

“Larger public pension funds fared better than smaller ones over the past year, with those managing more than $1 billion returning a median minus 6.6% and plans over $5 billion returning a median minus 5.1%, the data showed.”

—Heather Gillers, citing data from Wilshire Trust Universe Comparison Services in “Market Rout Sends State and City Pension Funds to Worst Year Since 2009,” The Wall Street Journal, August 9, 2022

“Implementing programs that enhance corporate profits is the age-old guiding principle for corporate management and no new ESG [environmental, social, and corporate governance] management principles are required to achieve these ends. Therefore, ESG as a management paradigm is only necessary when the proposed ESG programs are financially harmful to the company—the company would not adopt the program without explicit pressure from ESG advocates. Implementing programs that reduce profitability is a serious violation of management’s fiduciary responsibility.”

—Wayne Winegarden, in “Proxy Advisory Firms and The ESG Risk,” Forbes, July 25, 2022

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 created an updated interactive map showing aggregated state pension funding levels from 2001 to 2022. You can access the map here.

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by email 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.

The post Pension Reform News: Comparing different pension plans, CalPERs reports negative returns and more appeared first on Reason Foundation.

Articles, Research & Spotlights  

• Previewing the Impact of 2022 Returns on State Pension Plans 
• Arizona and Michigan Dedicated to Closing Unfunded Liabilities 
• Texas Teacher Plan Considering Another Return Assumption Adjustment 
• Window Closing for Pension Obligation Bonds 

News in Brief
Quotable Quotes on Pension Reform
Data Highlight

State Pensions Again Exceed $1 Trillion in Unfunded Liabilities in 2022 

Following last year’s record-breaking investment returns, 2022 is shaping up to be a tougher year for public pension plans. A new interactive analysis from the Pension Integrity Project forecasts that poor market results from the 2022 fiscal year are likely to push the aggregate unfunded liabilities of state-run pension plans over $1 trillion, signaling that the vast majority of these plans have not stabilized and still need significant reforms to reverse the course on their funding shortfalls. The 2022 State Pension Forecaster allows users to see how various 2022 investment return rates and scenarios would impact the unfunded liabilities and funded ratios of 118 major state pension plans. For example, if the Teacher Retirement System of Texas (TRS) posts annual returns of -6% for the fiscal year, its unfunded liabilities will jump to $40 billion, and its funded ratio will drop to 83.4%. While exact reports on investment returns are not out yet, the early indicators suggest that the latest fiscal year saw most public pensions miss their assumed rates of return. While a single year of poor results will not make or break a plan’s ability to achieve long-term funding stability, this forecaster shows how most of the ground gained with great returns in 2021 will likely be lost just a year later, further illustrating the environment of high volatility that state pensions face. The forecaster is available here and our webinar demonstrating the tool is here.

Reformed Pensions in Arizona and Michigan Receiving Supplemental Payments 

Following major efforts to apply risk- and cost-reducing reforms to their pension plans, lawmakers in both Arizona and Michigan are now directing part of their state budgets to close long-standing unfunded public pension obligations. Arizona first enacted meaningful reforms for state-run public safety pensions in 2016 and has been improving nearly every year since then. Now a set of bipartisan bills will dedicate $1.17 billion to these pension plans, adding to the $1.5 billion paid last year. Similarly, Michigan passed a series of reforms to its public-school employees and state police pension plans over the previous several years and will now see a supplemental $2.5 billion go toward reducing its unfunded pension liabilities. These examples demonstrate the importance of comprehensive pension reform. In both cases, state lawmakers took prudent steps to reduce the growth of pension debt, which—now years later—makes it easier to devote state funds to eliminate the shortfalls in retirement obligations that were generated from the now resolved issues. 

Texas’ Teacher Retirement System Needs to Adjust its Investment Return Assumptions 

In line with national trends of government-sponsored pension plans, the Teacher Retirement System of Texas (TRS) is considering another reduction to its assumed rate of return. Assumptions on market returns play a significant role in a pension plan’s ability to accurately calculate the annual contributions that are needed to fulfill the retirement benefits promised to its members. To ensure that contributions aren’t falling short, TRS actuaries are suggesting the pension plan reduce its investment return assumption from 7.25% to 7.00%. In response to this potential change, Reason Foundation’s Anil Niraula and Zachary Christensen evaluate the impact that overly optimistic assumptions have had on TRS historically and apply actuarial modeling to project the long-term impact that the assumption reduction will have on the system’s funding. 

The Risks of Issuing Pension Obligation Bonds are Rising with Inflation, Interest Rates 

Many state and local governments issue pension obligation bonds (POBs) to reduce the long-term costs of holding pension debt, but this maneuver only works if the assets acquired yield more than the bond’s interest plus issuance cost. Essentially, a successful POB relies heavily on timing the market to issue the bonds when interest rates are low. As Reason’s Marc Joffe notes, the window for taking advantage of low rates appears to be closing. The Federal Reserve’s efforts to curtail inflation and deteriorating equity market conditions are putting the prospect of governments being able to reduce long-term costs through pension obligation bonds very much in doubt. 

News in Brief 

Examining the Purpose and Application of COLAs 

A new issue brief from the National Association of State Retirement Administrators (NASRA) reviews the types of inflation protection provided to retirees by government-run pension plans. They find that most plans use some form of cost-of-living adjustment (COLA), although the structure and application of this type of benefit vary greatly from plan to plan. Some governments apply an automatic COLA, meaning the adjustment is predetermined. Others use an ad hoc COLA, which requires legislative approval every year before it is applied. Some systems use performance-based policies to make adjustments only when other returns or funding requirements are met. This brief looks at reforms that have altered COLAs for state-run systems. They find that 17 states have made changes to their COLAs since 2009, eight of which impacted not just new hires, but existing employees as well. The full brief is available here. 

Quotable Quotes on Pension Reform  

“The funded ratio is back to levels not seen since the initial recovery from the global COVID shutdown” 

—Wilshire Managing Director Ned McGuire on the aggregate funding of state pension plans, cited in “State Pension Plan Funding Plunges 11.3 Points in Q2 – Wilshire,” Pensions & Investments, July 8, 2022 

“It’s like going to the ATM in Vegas and then going to the roulette wheel and it comes up red and you go back to the ATM…With pensions, you either pay now or pay more later. If you take on a strategy of increasing your risk exposure but you bet the wrong way, you’re really going to get hurt” 

– Former City Manager of Pasadena Steve Mermell on using municipal bonds toward unfunded pension liabilities, cited in “Pension Funds Plunge Into Riskier Bets—Just as Market Are Struggling,” The Wall Street Journal, June 26, 2022 

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 Truong Bui created the interactive 2022 Public Pension Forecaster that allows users to test a variety of potential funding results for all major state-run pension plans, illustrating what the latest year of market experience will mean for plans’ unfunded liabilities and funded ratios.

Contact the Pension Reform Help Desk 

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

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. 

The post Pension Reform News: Forecasting state pension plans’ unfunded liabilities, some states make supplemental pension payments, and more appeared first on Reason Foundation.

Through legislation and supplementary contributions over the past two years, state and local employers in Arizona dedicated an extra $2.67 billion in supplemental contributions to reduce the significant unfunded pension liabilities within state pension systems.

Similarly, Michigan policymakers have provided around $2.5 billion in relief payments for several of their underfunded pension plans in the recently enacted 2022 budget.  

These major payments mark a dedication to fulfilling promised retirement benefits, and they signal to taxpayers and public workers that these states are confident in the risk-reducing reforms enacted in recent years. 

Arizona 

Arizona lawmakers took their first meaningful leap into pension reform in 2016 by enacting major changes to the pension system for public safety workers. The bipartisan reform established a new risk-managed tier of benefits for new workers and more stable inflation protection for retirees. This comprehensive approach reduced the chances of the state facing unpredictable costs on promised benefits for incoming police and firefighters. In 2017, a parallel reform accomplished the same for the state’s corrections officer pension system. 

Now, with several years of results demonstrating the improved outlook of these systems, lawmakers are taking the next crucial step by making significant payments into the retirement funds to accelerate the paydown of unfunded obligations. Governor Doug Ducey’s 2021 state budget included $1 billion in extra appropriations dedicated to the public safety and corrections officer plans as part of a budget focused on tax cuts and debt reduction. Additional contributions totaling $500 million from local and state employers were also included.  

In 2022, three separate pieces of legislation passed in the Arizona Legislature and were signed into law by Gov. Ducey, instantly eliminating another $1.17 billion in unfunded pension liabilities for the state’s public safety systems. House Bill 2862 made a supplemental payment of $1.07 billion, Senate Bill 1086 secured $40.8 million, and Senate Bill 1002 added another $60 million to be applied to unfunded pension liability.  

These significant payments reinforce the state’s commitment to the retirement promises made to public safety workers while reducing long-term costs to future taxpayers. Much like any other debt, paying down Arizona’s unfunded pension obligations faster will save tremendous amounts down the road. For some perspective on how much savings will be generated from these supplemental payments, the Pension Integrity Project estimated a $1 billion payment would save the state as much as $564 million over the next 30 years. 

Michigan 

Michigan’s pension systems have gone through numerous reforms over the past 25 years and it was the first state to institute a defined contribution plan for its public workers in 1997. After the Great Recession, the state reformed its underfunded public school and state police employee plans, ultimately passing a series of bills that have put the state’s pension funding outlook on solid ground. Most notably, a 2017 reform of the public school pension system established a hybrid plan for all new members that balances risks and costs equally between employees and the state, slowing the growth of runaway debts and costs. 

The 2022 Michigan legislative session included a wave of supplemental pension payments in its final 2022-23 budget (HB 5783), totaling around $2.5 billion, into three of its underfunded pension systems. Just over $1.7 billion of those funds were allocated to the public school employees’ pension system (MPSERS). The seven university employers in MPSERS received $300 million to pay down their unfunded liabilities, $425 million was allocated to the broader MPSERS plan to offset the costs associated with reducing the plan’s payroll growth assumption to 0%, and $1 billion was earmarked for distribution into the plan’s asset pool. Of note is that this payment is not to be used for any debt or normal cost payments.  

The municipal employee’s retirement system was also given $750 million to start a grant program that will award dollars to qualified local governments, with the goal of reaching a 60% funded ratio. $170 million of those funds, the largest individual chunk for any one governmental unit, will make its way to Flint where the city’s pension system is facing over $400 million in unfunded liabilities. The third system receiving funds is the state police pension system, which will have the plan’s entire unfunded liability paid off through a $100 million supplemental payment.  

Arizona and Michigan’s recent treatment of funding for pension systems is an example of the value of comprehensive pension reform. Other state and local governments should note their success in tackling the challenge of reducing pension debt. The clearest lesson to be learned from these successes is that when real risk-reducing reform is adopted, it makes it much easier for policymakers to work and reduce unfunded obligations. If lawmakers see that a plan has addressed the problems that created the funding shortfall, it can alleviate their reluctance to dedicate the necessary share of the budget to resolve the legacy costs of those problems.  

The post Reformed pensions in Arizona, Michigan receiving supplemental funding to pay down debt faster  appeared first on Reason Foundation.

Based on a -6% return for fiscal 2022, the aggregate unfunded liability of state-run public pension plans will be $1.3 trillion, up from $783 billion in 2021, the Pension Integrity Project finds. With a -6% return in 2022, the aggregate funded ratio for these state pension plans would fall from 85% funded in 2021 to 75% funded in 2022. 

The 2022 Public Pension Forecaster below allows you to preview changes in public pension system funding measurements for major state-run pension plans. It allows you to select any potential 2022 investment return rate to see how the returns would impact the unfunded liabilities and funded status of these state pension plans on a market value of assets basis.

The nation’s largest public pension system, the California Public Employees’ Retirement System (CalPERS), provides a good example of how much one bad year of investment returns can significantly impact unfunded liabilities, public employees, and taxpayers.

If CalPERS’ investment returns come in at -6% for 2022, the system’s unfunded liabilities will increase from $101 billion in 2021 to $159 billion in 2022, a debt that would equal $4,057 for every Californian. Its funded ratio will drop from 82.5% in 2021 to 73.6% in 2022, meaning state employers will have less than three-quarters of the assets needed to pay for pensions already promised to workers. 

Similarly, the Teacher Retirement System of Texas (TRS) reported $26 billion in unfunded liabilities in 2021. If TRS posts annual returns of -6% for the fiscal year 2022, its unfunded liabilities will jump to $40 billion, and its funded ratio will drop to 83.4%. The unfunded liability per capita is estimated to be $1,338. 

The table below displays the estimated unfunded liabilities and the funded ratios for each state if their public pension systems report -6% or -12% returns for 2022. 

Estimated Changes to State Pension Unfunded Liabilties, Funded Ratios

The first three quarters of the 2022 fiscal year clocked in at 0%, 3.2%, and -3.4% for public pensions, according to Milliman. The S&P 500 is down more than 20% since January, suggesting that the fourth quarter results will be more bad news for pension investments.

Considering the average pension plan bases its ability to fund promised benefits on averaging 7% annual investment returns over the long term, plan managers are preparing for significant growth in unfunded liabilities, and a major step back in funding from 2021. 

The significant levels of volatility and funding challenges pension plans are experiencing right now support the Pension Integrity Project’s position last year that most state and local government pensions are still in need of reform, despite the strong investment returns and funding improvements in 2021. Unfortunately, many observers mistook a single good year of returns—granted a historic one—as a sign of stabilization in what was a bumpy couple of decades for public pension funding. On the contrary, this year’s returns, as well as the growing signs of a possible recession, lend credence to the belief that public pension systems should lower their return expectations and view investment markets as less predictable and more volatile. 

State pension plans, in aggregate, have struggled to reduce unfunded liabilities to below $1 trillion ever since the Great Recession, seeing this number climb to nearly $1.4 trillion in 2020. Great results from 2021 seemed to finally break this barrier, with the year’s historically positive investment returns reducing state pension debt to about $783 billion. Now, state-run pension plans will again see unfunded liabilities jump back over $1 trillion, assuming final 2022 results end up at or below 0%. 

It is important not to read too much into one year of investment results when it comes to long-term investing. But during this time of economic volatility, policymakers and stakeholders should recognize that many of the problems that kept public pension systems significantly underfunded for multiple decades still exist. And many pension plans are nearly as vulnerable to financial shocks as they were in the past.

Going forward, state and local leaders should continue to seek out ways to address and minimize these risks, making their public retirement systems more resilient to an uncertain future. 

Webinar on using the 2022 Public Pension Forecaster:

The post Unfunded public pension liabilities are forecast to rise to $1.3 trillion in 2022 appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Florida Law to Improve State DC Plan
• Alaska Avoids Attempt to Unwind Pension Reform
• Examining NIRS’ Cost Efficiency Report
• Jacksonville’s Successful Reform Leads to Credit Rating Boost
• Proxy Voting May Be a Distraction to Pension Investors
• Lack of Focus on Lifetime Income Among Retirement Plans

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

Articles, Research & Spotlights

Major Florida Legislation Improves the State’s Default Defined Contribution Plan 

Adopting the long-time recommendation of the Pension Integrity Project, Florida lawmakers have now made much-needed improvements to the state’s defined contribution plan that serves the majority of new teachers and public employees. House Bill 5007—recently signed by Gov. Ron DeSantis and proposed as an element of his 2022 budget —will increase government contributions into public employees’ individual defined contribution accounts by 3%. This increase brings the state’s flagship vehicle for retirement benefits up to general standards for adequate savings, reinforcing the Sunshine State’s dedication to providing competitive retirement options. Now with this success solidified, Florida policymakers should continue to seek out ways to improve both defined contribution and defined benefit components of its retirement system.

Alaska Avoids Attempt to Roll Back 2005 Pension Reform 

Alaska was an early adopter of the defined contribution plan, which has been an effective plan design for providing valuable retirement benefits to public employees while not taking on additional unpredictable costs and risks. This last legislative session, two bills to replace the state’s defined contribution plan with poorly structured pension plans made it through the state House of Representatives, but eventually failed in the state Senate. The failed legislation was ostensibly introduced to help the state with its challenges with recruiting and retaining public workers, but little actual research was done to explore the fiscal effect this reform would have had, and it is unlikely that the change would actually improve the state’s ability to attract and keep employees. Seeing the need for informed analysis on these proposals, the Pension Integrity Project at Reason Foundation stepped in to educate key stakeholders of the potential risks and costs that could arise from the proposed changes. 

NIRS’ Assessment of the Retirement Efficiency Gap Leaves Out Some Key Details

Research from the National Institute on Retirement Security (NIRS) claims that an “efficiency gap” exists when comparing defined benefit (DB) and defined contribution (DC) plans. Theoretically, this gap suggests that, for the same amount of money, DB plans are able to generate more in retirement benefits. This analysis takes too narrow of a view, however, argues Reason’s Swaroop Bhagavatula. First, by only applying scenarios in which plans accurately predict actuarial outcomes–most notably returns–NIRS’ analysis seems to overlook the significant funding challenges that have plagued public pensions. Second, the analysis applies too much importance on cost efficiency, while not addressing other important factors in retirement policy, like what is optimal to the modern workforce. Devoting one’s entire attention on cost efficiency is missing the bigger picture when the majority of new workers will not remain long enough to enjoy the benefits of a DB plan.

Jacksonville’s Public Pension Reform Helps the City Get an Improved Credit Rating

Citing a package of pension reforms from 2017, Moody’s Investors Service just improved the credit rating for the city of Jacksonville, Florida. Five years ago, Jacksonville’s city council directed a major shift in retirement policy, electing to use a defined contribution plan for all new hires to slow the growth of costly and unpredictable pension debts. This, along with prudent payments to accelerate the elimination of legacy pension debt, has greatly improved the city’s financial standing. Reason’s Jen Sidorova explains the benefits that Jacksonville will enjoy thanks to its retirement reform and the improved credit rating that came about from these efforts.

Proxy Battles Are Usually an Inefficient Use of Public Pension Systems’ Resources

As major institutional investors, public pension plans can influence the companies they invest in. This influence is formally realized in the way a pension engages in what is called proxy voting, which is when a corporation allows its investors to vote on board membership decisions and other resolutions. Reason’s Marc Joffe examines some trends in how pensions have participated in this process, finding 81 recorded instances of funds formally making a case to their fellow shareholders to vote a particular way. California’s main pension for public workers, CalPERS, was the source of more than half of these, and they used their shareholder status to advance official positions ranging from climate change to board diversity. Joffe questions the purpose and effectiveness of this practice, and notes that public pensions usually have more pressing matters related to risk and funding that should take priority.

The Case for In-Plan Lifetime Income Solutions for DC Plans Is Clear, So Why the Reluctance to Implement? 

Annuity options offer an excellent solution to the largest critique of defined contribution plans, a lack of guaranteed lifetime income. But there is still a stark reluctance among retirement plans to offer these options to their members. Reason’s Rod Crane explores some of the barriers to providing annuities, namely the complexity of these options and a misaligned focus on wealth accrual over retirement income.

News in Brief

Proposed Funding Policies for Legacy Pension Debt

Jean-Pierre Aubry at the Center for Retirement Research at Boston College has published follow-up research on his previously introduced concept of legacy debt in public pensions. A number of pension plans began without policies to prefund promised benefits. As nearly all plans eventually changed this practice, a good deal of debt was generated that—as the author of this brief postulates—should not be under the same expectation of payment by the current generation. Aubry advises plans change the way they account for and pay down both legacy and new debt. For legacy debt, plans should adopt amortization policies that pay down the liability over multiple generations. For new debt they should adopt lower risk return assumptions and maintain amortization that ensures payment within the current generation. These changes would decrease annual contributions required for legacy debt, but would also reduce future funding risks with higher required contributions for new debt. The full brief is available here.

State Unfunded Liabilities Over $8 Billion When Discounting at Risk-Free Rates

The American Legislative Exchange Council (ALEC) releases an annual report that recalculates unfunded pension liabilities using a discounting method that accounts for the guaranteed nature of benefits backed by state governments. Using a risk-free rate, unfunded liabilities held by states have now exceeded $8.2 billion by 2021, which is a significant increase from the previous year. Much of this jump is attributed to declines in the risk-free rate. The report also examines the states that have enacted reforms, naming Alaska, Michigan, and Oklahoma as standouts for adopting effective changes that have significantly reduced taxpayer and budget risk. The analysis finds that 25 states have yet to adopt major contribution or plan design reforms. The full brief is available here.

Quotable Quotes on Pension Reform 

“Market volatility is the prevailing headwind for public pension funding, and over the first three months of 2022 we saw the majority of the plans in our study decline in asset values, ranging from losses of 5.52% to a mild gain of 0.50%…Given the continued fixed income and equity volatility in April and May, we expect this downward funding trend to continue in the near-term” 

– Author of Milliman’s Public Pension Funding Index Becky Sielman, cited in “Milliman Analysis: Rocky Markets Cause $167 Billion Drop in Public Pension Funded Status During Q1,” PR Newswire, May 20, 2022

“If you look at reasonable expectations going forward, it’s going to be very hard to maintain current asset/liability funded ratios in public pensions without making significant changes…Pensions have had a good decade-long run of strong investment returns, recently combined with higher liability discount rates. But those trends will eventually reverse, placing renewed downward pressure on funded ratios. If you combine that with boards that aren’t willing to make structural changes to their business model, it’s a Catch-22.”

– Co-founder of CEM Benchmarking and CEO of KPA Advisory Services Keith Ambachtsheer, cited in “Governance Issues Loom Over US Pension Funds,” Chief Investment Officer, June 2, 2022

Contact the Pension Reform Help Desk

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

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.

The post Pension Reform News: Florida improves defined contribution plan, Alaska pension reform roll back blocked, and more appeared first on Reason Foundation.

The turbulence across financial markets to this point in 2022, with virtually all U.S. companies in the S&P 500 index in the red, means TRS will likely be among the public pension plans missing annual investment return targets this year. Just as strong, double-digit investment returns in 2021 greatly enhanced TRS’ funded status, this year’s investment losses are expected to lower the plan’s funding level.  

This dramatic up and down following the COVID-19 pandemic illustrates the folly of reading too much into pension funding measurements based on a single year of reported returns. Prudent public pension plan managers need to maintain a longer perspective and continue lowering investment return assumptions to accurately reflect what most market prognosticators expect to see over the next 10-to-15 years. 

Maintaining an overly optimistic investment return assumption is costly. Doing so raises the risk of significant growth in pension funds’ unfunded liabilities, which historically tend to spiral into colossal costs for taxpayers and take decades to remedy.

The Teachers Retirement System of Texas is a perfect example of this. The plan has accrued $47.6 billion in pension debt since 2002, and most of it, around $25 billion, came from investment returns falling below the plan’s assumptions (displayed in Figure 1 as “Underperforming Investments”). The primary contributor to this was TRS maintaining an unrealistic 8.0% rate of return assumption until 2018, well past the time most other pension plans had started adjusting their return rate targets downward in reaction to a lower yield return environment on financial markets. Policymakers’ failure to be nimble with return assumptions ended up contributing to the system’s current funding challenges, and it would be wise to not repeat that mistake. 

Figure 1. The Causes of the Texas TRS Pension Debt (Cumulative 2002-2021) 

It is critical for Texas policymakers to consider improving the TRS contribution policy by changing “statutorily-set” to “actuarially determined” rates. As the Pension Integrity Project has covered, annual contributions capped by statutory rates have generated significant funding challenges for the system. Since 2004, contributions have routinely fallen below the interest accrued on TRS’ unfunded liability that year (a situation called negative amortization). This has led to the Teachers Retirement System falling further behind in its ability to pay for promised obligations.  

An adjustment of the assumed rate of return down to 7.0% means the plan will recalculate pension debt upwards in 2023, but will also be better positioned to avoid future debt growth over the longer run. The forecast in Figure 2 compares the growth of TRS’ unfunded liabilities under three scenarios: 

1. Returns meet TRS assumptions;

2. TRS experiences two major recessions over the next 30 years;

3. And, TRS makes actuarially determined contributions (also using the two-recession scenario).

With this actuarial modeling of the system, it is clear that statutorily limited contributions will continue to pose funding risks for TRS that will be borne by Texas taxpayers. A proposed 7.0% assumed return will readjust 2023 unfunded liabilities upwards by $6.5 billion, but the plan will suffer fewer investment losses over the next 30 years when the plan inevitably experiences returns that diverge from expectations. TRS’ unfunded liabilities will remain elevated under the rigid statutorily-set contributions. If, however, TRS was to transition to Actuarially Determined Employer Contributions (ADEC) each year, then even by recognizing higher 2023 debt (under a 7.0% assumption) TRS could shave billions off its unfunded liabilities by 2052 ($74.7 billion down from $81.3 billion with current 7.25% assumption).  

Figure 2. Texas TRS Stress Testing: Unfunded Liabilities (2021-2052) 

The lower return target should improve TRS’ ability to withstand turbulent market periods like we are seeing today.  

A switch to an actuarial (or ADEC) contribution policy is what lawmakers did with the state’s other major pension plan—the Employees Retirement System of Texas (ERS)—just last year in a landmark pension reform. Unlike rigid contributions set in statute, actuarial contributions adjust and respond according to needs. This means that in situations of volatile market conditions (as tested and confirmed in the analysis above) contributions adjust automatically to ensure that the state’s unfunded obligations do not get out of control. This change in the ERS contribution policy is projected to save state taxpayers billions in long-term costs, and now would be a good time to consider similar reforms to how the state funds TRS. 

Seeing the obvious reduction in funding risks through actuarial modeling, it is clear that lowering the Teachers Retirement System’s assumed rate of return is a step in the right direction to safeguard the pensions for the state’s teachers. In addition to heeding the advice of the pension system’s actuaries, Texas policymakers should also consider addressing the rigid statutory contribution policies, which currently prevent Texas from meaningfully cutting down existing unfunded liabilities and curbing future pension debt. At a time when market results appear to be extremely unpredictable and volatile, the state’s teachers and taxpayers need to ensure that TRS is positioned to weather whatever storms may come.  

The post The Teacher Retirement System of Texas needs to adjust its investment return assumptions  appeared first on Reason Foundation.

But in the 2021-22 legislative session, HB55 and HB220 both advanced through the state House of Representatives policy and fiscal committees with strong political support despite no apparent scrutiny and actuarial analysis. These bills would have opened new and financially risky tiers of the now-closed legacy pension systems for all new government workers. A Pension Integrity Project analysis found that implementing HB55 alone could have easily exposed the state to over $200 million in new unfunded liabilities by allowing current DC plan participants to switch to the proposed plan. 

There were two major arguments for the swap to a DC plan in 2005. First, the pension funds’ unfunded liabilities had already started ramping up to unsustainable levels, meaning the paydown of those debts were starting to eat too much into the state budget. Second, the state greatly feared another revenue shortage like it had in the 80s and 90s, impacting the legislature’s ability to fund already accrued and future benefits.  

The arguments from bill supporters centered around a desire to recruit and retain more public employees. Yet there is little, if any, evidence that a defined benefit pension is a relevant factor that helps drive employee recruitment and retention. A Reason Foundation working paper examining teacher retention in Alaska finds that retention rates did not change when the state swapped from a DB to DC in 2005. In addition, 86% of police stations across the country are facing a shortage of members and every one of those stations, outside of Alaska, has a pension with some defined benefit component. 

While the fiscal note analysis performed by Alaska’s pension system actuaries presented only a five-year cost projection, based on the assumption that the proposed pension tier would meet all of its actuarial assumptions, even that analysis raised some major concerns for state policymakers. It stated: “Adverse plan experience (due to poor asset returns and/or unexpected growth in liabilities) or changes to more conservative assumptions will increase the PERS DB (defined benefit) unfunded liabilities, resulting in higher contribution rates.”  

Lacking any meaningful actuarial or fiscal analyses, legislators and staff uncertain about the impacts of these bills sought an independent evaluation of potential outcomes, prompting several organizations—including the Pension Integrity Project at Reason Foundation, Americans for Prosperity, Alaska Policy Forum, Americans for Tax Reform, the American Legislative Exchange Council, and the Heritage Foundation—to provide technical assistance, policy analysis, and legislative testimony. 

Reintroducing Risk Via New Pension Tiers 

Pension Integrity Project’s analysis found that while the pension designs proposed under HB55 and HB220 did include a few modest improvements relative to the original legacy pension tiers, the designs still left far too much financial risk on the table.  

A key problem is the proposals’ use of a 7.38% assumed rate of return on investments, far higher than the national median—and higher than previous iterations of these proposals put forth by public employee stakeholders. This assumption is vital to get correct. Soon after the proposed inception of this new tier, the pension systems would have up to 15 years of liabilities already on their books because the bills stipulated that, for any member who chooses to enter the new tier, all their previously earned service in the DC plan will be transferred into the new defined benefit pension at the current 7.38% discount rate. This sets up a pension obligation bond-like situation where any downturn in market performance or lowering of investment return assumptions—both situations being almost a certainty based on 10-15 year market forecasts—would immediately create unfunded liabilities in the pension system. 

So why would a new pension proposal go the opposite direction on investment risk when all other public pension systems are rapidly dropping their assumed rates of investment return, and market forecasts predict returns more than 1% lower than the Alaska bills envisioned? The only possible explanation is that the use of a lower assumption would raise the cost of these proposals to a level that would make the supporters’ arguments of these bills being “cost neutral” an impossibility. The supposed “cost neutrality” argument from supporters is especially important due to the way Alaska funds its pension systems. Alaska has, for all intents and purposes, capped its employer contribution at 22% of pay. This new proposal, using faulty assumptions that hide the actual cost of the plan, would have eaten into the portion of that 22% that’s used to pay down legacy pension debt. If the plan was properly priced, even less would go toward paying down Alaska’s pension debt which would introduce significant risk to the promises the state has made on accrued benefits. 

Additionally, the pension systems’ actuaries noted a critical point—the current DC plan (DCR) offers nearly the same retirement benefit as proposed under HB 55 (PERS DB). Increasing employer contributions in the current DC plan and adding more annuity purchase options could yield an equivalent benefit and provide lifetime income options. In the fiscal analysis of HB55, the plan actuaries found, “On average, approximately 94% of DCR service as of June 30, 2021 was credited to PERS DB.”  

Evaluation of Alaska’s Current Retirement Offerings 

An actual state-by-state comparison of the retirement benefits earned by Alaska employees versus other statewide public employees would be prudent, because they have possibly the most generous post-employment benefits in the country. Not only does the state offer a solid contribution rate to its DC members, a Social Security replacement plan, the Supplemental Annuity Plan (SBS-AP), that puts the amount that would have gone into Social Security instead into a 401(a) account is also offered. Anyone relatively familiar with Social Security knows the poor benefit it offers for the dollars contributed into it, meaning Alaska’s employees will almost certainly earn more through the SBS-AP, if they are eligible, than they would have if they were paying into Social Security.  

Between the 12.26% of pay going into the SBS-AP (6.13% each from employee and employer) and the 13-15% of pay going into a member’s DC account (split depending on employee classification), an employee of Alaska has between 25.26% and 27.26% of pay going toward their retirement benefits each year. 

The Future for Alaska Retirement Policy 

While HB55 and HB220 fell short this legislative session, efforts to upend the state’s previous reforms will likely arise again in future legislative sessions. Recruiting and retaining public employees continues to be challenging for all states, not just Alaska. Despite misguided reasoning, there will be pressure to address these challenges with concessions in public retirement benefits. But reopening the doors to the beleaguered pension plan will resurrect major unacceptable risks while doing little to improve the state’s retention issues. Alaska policymakers will need to look elsewhere to address these challenges. 

That is not to say that there are no reforms Alaska lawmakers could consider to improve the state’s retirement systems. The legacy $7.4 billion in unfunded pension liabilities are still generating major costs in state budgets, and accounting of these debts is suboptimal, understating their magnitude with outdated market assumptions that need to be brought in line with broader industry trends. Policymakers should direct their attention to eliminating this debt as quickly as possible. Several other states have recently committed supplemental payments to address pension funding shortfalls, and Alaska would be wise to do the same.  

In 2005, Alaska policymakers made the prudent decision to recalibrate their retirement systems in a way that better served the mobility of the modern workforce and ceased any future exposure of unexpected costs for state budgets, blazing a trail for the rest of the country. Since Alaska’s landmark reform, several other states have adopted similar risk reducing measures. Instead of unraveling the state’s progress from the last 17 years, policymakers should seek to bolster the policies that brought resiliency and reliability to the retirement benefits of public workers. 

The post Alaska avoids attempt to roll back 2005 pension reform   appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Louisiana’s Hybrid Pension Proposal Falls Short
• Shortcomings of ESG Scores
• A Chance for New Hampshire to Reduce Pension Debt
• Texas Needs to Reform Teacher Pensions
• Past Pension Missteps Should Be a Warning to California

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

Articles, Research & Spotlights

Evaluating the Potential Impacts of Louisiana Senate Bill 438 

Recognizing the need to better accommodate an increasingly mobile workforce, Louisiana legislators are considering a proposal to create a hybrid pension plan for new workers in the Louisiana State Employees’ Retirement System (LASERS). Senate Bill 438 would place all new hires into a plan that combines a risk-reducing individual investment account with a defined benefit pension structure. Despite the bill’s intentions, Reason’s analysis and testimony find that the structure of the new plan would offer little risk mitigation, add costs, and be a poor fit for the modern worker. 

The Difficulties of Assigning ESG Ratings

Despite concerns with fiduciary priorities, an increasing number of public pension plans are applying environmental, social, and corporate governance (ESG) policies to their investment strategies. A major part of this trend is the emergence of ESG ratings that attempt to quantify the environmental impact of companies. In an examination of this scoring, Reason’s Jordan Campbell finds companies with a higher market capitalization tend to receive better ratings, raising some questions about the validity of ESG scoring. Do bigger companies truly have a lower impact on the environment, or are they just better equipped to comply with demanding reporting requirements?

Why Paying Down New Hampshire Pension Debt Faster Would Be a Win for Taxpayers 

New Hampshire’s state government holds over $800 million in unfunded pension obligations to public workers and retirees, but lawmakers have an opportunity to significantly reduce this costly debt. With state government revenues currently $382 million above expectations, policymakers should consider using this surplus to close the funding gap of its retirement system to reduce long-term costs and risks to taxpayers. The Pension Integrity Project’s new one-page explainer outlines the benefits of paying down New Hampshire’s pension debt sooner rather than later.

Teacher Retirement System of Texas Can Improve Funding Policies and Plan Design to Benefit Taxpayers, Employees 

Texas policymakers have adopted several major reforms to improve funding and reduce runaway costs associated with the state’s pension plans in recent years. Most notably, 2021 legislation adopted an improved funding policy and established a risk-managed retirement plan for all new workers in the Employee Retirement System (ERS). Now, as Reason’s Steven Gassenberger testified to the State Senate Committee on Finance, Texas policymakers need to make similar reforms to the Teacher Retirement System (TRS), which is still chronically underfunded and remains very vulnerable to overly optimistic market assumptions. TRS benefit offerings also need to expand to better serve the mobile nature of educators today.

California Should Learn from Past Mistakes Made with Unfunded Pension Benefit Increases 

California Senate Bill 868 would increase pension benefits for teachers who retired over 20 years ago. The bill aims to counteract the degrading effects that inflation has had on retirees’ pension benefits, but as Reason’s Marc Joffe warns, this benefit increase would come with a high price tag. The pension plan’s actuaries indicate that the move would cost the state $592 million, but this estimation could be too low because it depends on the plan achieving optimistic returns over the next few decades. The proposal would also add to California’s unfortunate history of giving out pension benefit increases without properly funding them, which has generated significant unexpected costs to public employers and taxpayers.

News in Brief

Forensic Analysis of Pension Funding: A tool for Policymakers

A new study conducted by Boston College’s Center for Retirement Research (CRR) looks at the role legacy debt plays in the solvency of pension plans in Illinois, Massachusetts, Pennsylvania, Ohio, and Rhode Island. The inception of many public pensions occurred in the early to mid 1900s and there were not the same established norms in funding practices that we see today. Many pension plans had a “pay-go” system where the funding for benefits was not saved in advance. Even those that used an actuarial funding method approached unfunded liabilities very differently, not always including legacy debt as part of the calculation for required contributions. These old funding policies, combined with underperforming investment returns and benefit increases during the 1980s and 1990s, have resulted in several plans holding significant unfunded liabilities that accrued more than half a century ago. On average, CRR reports that legacy debt is 40% of total unfunded liabilities for the five focus states, with some as high as 74% in the case of Ohio. The full brief is available here.

Quotable Quotes on Pension Reform 

“We have a lot of counties and cities that are struggling right now with inflationary costs, and every time the plan doesn’t perform, they have to put in more money.”

— North Carolina Treasurer Dale Folwell in “Pensions’ Bad Year Poised to Get Worse,” The Wall Street Journal, May 10, 2022

“Ultimately at a fiduciary level, if a pension fund’s total worst-case exposure to all earnings and income derived from autocratic nations is an insignificant fraction of its total portfolio, the composite risk is probably not worth losing sleep over, on purely financial grounds. But politics could still enter the theater stage for pension boards that ignore this issue”

– Former GASB board member and ICMA Retirement Corp. President Girard Miller in “Public Pensions’ New Quandary: Coping With Geopolitical Turmoil,” Governing, May 10, 2022

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 created a visualization of ESG risk ratings for the nation’s largest companies, showing the difference between the S&P 500 and the Russel 2000. 

Contact the Pension Reform Help Desk

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

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.

The post Pension Reform News: Hybrid pension proposal falls short in Louisiana, shortcomings of ESG scores, and more appeared first on Reason Foundation.