Post-crisis reforms make pensions sustainable?

A nationwide study, including CalPERS and CalSTRS, projects that huge pension fund losses during the financial crisis will be offset over three decades by a wave of recently enacted cost-cutting reforms — but only if several things happen.

–Pension fund earnings forecasts must hit their target. Critics say the forecasts, 7.5 percent a year for the two California funds, are overly optimistic and conceal massive debt.

–Government employers must make their actuarially required contribution to the pension fund each year. CalPERS has the power to demand full payment. CalSTRS contributions, frozen by legislation, are $4.5 billion a year short of the required amount.

–The cost-cutting reforms must not be rolled back. A state worker pension cut under former Gov. Pete Wilson in 1991 was followed by a major retroactive pension increase under former Gov. Gray Davis, the trendsetting SB 400 in 1999.

The paper issued by the Center for Retirement Research at Boston College, led by Alicia Munnell, is one of the first looks at the long-term impact of the reforms, drawn from a sample of 32 plans in 15 states.

“In short, states have made more changes than commonly thought,” said the paper issued last month. “Whether these changes stick or not is an open question.”

Munnell is not an advocate of the pension status quo. She has said the best retirement plan is a “hybrid” combining a smaller pension with a 401(k)-style investment plan, shifting some of the risk from the employer to the employee.

She has recommended switching the reporting of pension debt to a lower risk-free earnings forecast based on U.S. bonds, rather than a higher but riskier portfolio-based forecast. As Stanford graduate students showed, the change balloons pension debt.

The new study, following an academic format, does not directly engage in the debate about whether public pensions are “sustainable” or will eat up too much of government budgets, shrinking funding for schools, public safety and other programs.

But the findings point to sustainable, if all of the qualifications are met. Under cost-cutting reforms, average pension costs are projected in three decades to take a smaller share of state-local budgets than before the financial crisis in 2008.

The study found that average pension costs before the financial crisis were 4.1 percent of state-local budgets in 2007, jumping afterward to 6.5 percent in 2011. After reforms, pension costs are projected to be 5.3 percent in 2028 and 3.3 percent in 2046.

Before the Boston center sent out a news release about the study last week, Munnell offered a carefully qualified opinion about the findings during a Century Foundation panel discussion on Jan. 31.

“If plans can earn historical returns and if they can stop blowing the tops and if the cuts to benefits that are in place stay in place,” Munnell said, “then I think going forward pensions are not going to be the major culprit in the state-local budget squeeze.”

“But I acknowledge that returns are very uncertain and benefit cuts do not always stay,” she said. “So it’s an area people are going to have to keep monitoring carefully.”

“Blowing the tops” refers to the tendency of pension funds, when flush from a market surge, to cut employer contributions and raise employee pension benefits. (For example, see the Calpensions post on CalSTRS 15 Feb 13)

Alicia Munnell

Alicia Munnell

As in California, the pensions of current workers in the other states studied have legal protection and are difficult to cut. Munnell said she tended to “pooh-pooh” reforms that lowered pensions for new hires because cost savings are delayed for decades.

“But lo and behold, if you think about it, after 35 years everybody’s going to be a new employee,” she said. “So if you look at it over a long time, these changes have a big effect.”

Several of the reforms, including California’s, increased employee pension contributions, regarded by some as a cut in retirement benefits. And some of the reforms cut the cost-of-living adjustments in pensions promised current workers.

“When you get to the area of the COLA,” Munnell said, “a lot of those (cuts) are made for existing retirees, which I found really extraordinary that it happened and that courts have upheld it.”

Munnell said lower compensation can result in attracting lower quality employees, studies show, and cuts should be done carefully. She said pension reform may be needed to address fiscal pressure, imperfect plan design and early retirements.

“The change I would most like to see,” Munnell said, would allow cuts in pension amounts earned by current government workers, giving plan sponsors the flexibility to respond to economic conditions.

She applauded Rhode Island for taking on the issue and triggering a union lawsuit whose outcome will be “very important.” Legislation spearheaded by state controller Gina Raimondo would switch all current employees except police to a “hybrid” plan.

In California, the watchdog Little Hoover Commission urged the Legislature to allow cuts in pension amounts current state and local government employees earn in the future, while protecting pension amounts already earned.

Gov. Brown’s pension reform did not cut pensions for current workers or most COLAs. But AB 340 did reduce pensions for new hires, increase contributions for some current workers, extend retirement ages and cap big pensions.

The new study said the financial crisis will boost the pension share of California state-local budgets from 5.5 percent to 8.2 percent. By 2046 the pension share is projected to drop to 5.7 percent, with the assumed earnings, contributions and reforms.

Because the California Public Employees Retirement System has been receiving its actuarially required contribution, the study said, the financial crisis increased the amount needed to pay the debt or unfunded liability from 5 to 6 percent of pay.

But because the California State Teachers Retirement System, with its frozen rates, has not been receiving its required contribution, the financial crisis more than tripled the amount needed to pay the debt, from 4 to 15 percent of pay.

In a Wall Street Journal article last week, Munnell discussed a new documentary by Canada’s Ontario Teachers Pension Plan about the need for flexible pension systems that can evolve and adjust to changing economic conditions.

A Dutch model that can increase employee contributions and cut retiree pensions is being adopted by a plan in the Canadian province of New Brunswick with the support of some unions.

“In public plans in both the U.S. and Canada, the money is not there to pay the current level of promises in the future,“ Munnell wrote, describing the documentary in which she appears several times. “The message is that we need to recognize and accept this fact and set up a new system with sustainable benefits.

“Sustainability has two dimensions. The benefits must be affordable, in the sense that people cannot receive benefits for longer than they work. And the pension system must have some flexibility so that orderly reductions can be made in bad times and increases provided when times are good.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 11 Mar 13

9 Responses to “Post-crisis reforms make pensions sustainable?”

  1. Tough Love Says:

    All of this discussion of “funding” begs the root cause of the problem …..

    WHY with Public Sector workers earning no less in “cash pay”, are they entitled to ANY greater Taxpayer-funded pensions (and better benefits) than that typically granted Private Sector workers ?

    RIGHT NOW, when you factor in not only the MUCH richer formula factors (per year of service), but the much younger full retirement ages, the inclusion of post-retirement COLA increases, the heavily subsidized early retirement factors, and the very loose definition of “pensionable compensation”, the Taxpayer paid-for share of Public Sector pensions are 2-4 times (5-6 times for safety workers) greater in value at retirement than that of their Private Sector counterpart making the SAME pay, retiring at the SAME age, and with the SAME years of service.

    This is clearly an unjustified financial rape of Private Sector Taxpayers.

    Taxpayers ….. DEMAND change !

  2. Michael Genest Says:

    Wow Ed, talk about looking at the bright side! Sustainability is on track, but only if target earnings are met, “reforms” stay in place, things are done that might help other states but have yet to be tried in California (COLA changes for current employees, hybrid systems) and then the biggee, if all systems charge true actuarial rates. You note that would require an additional $4.5 billion per year for CalSTRS, but does anyone have a plan to find that kind of money? And, let’s not overlook UCRS and all those county and independent systems that also have yet to find a source of funding to pay even normal costs.

    Rough and Tumble introduces the article thusly, “Post-crisis Reforms Make Pensions Sustainable?” The article makes it quite clear that the answer for California is, Not Yet and Maybe Never.

    But, Ed I love your blog and this article is very informative. I just hope your readers get what it truly says. Rough and Tumble’s header will not help them get there.

    P.S. for my fellow commenters: Nothing written above is in any way intended to denigrate, downgrade or diss public employees or the very important work they do; I’m just looking at the long-term bottom line and it is very frightening; we have to do more now to achieve sustainability or the day may come we can’t do anything.

  3. John Moore Says:

    The problem is that she treats all plans the same. Here in Pacific Grove, including the principal owing on pension bonds, the city’s deficit exceeds 50% of liabilities. All we need is the unrestricted right to file a Chap 9 in bankruptcy. And then the BK court can treat pensions just like other creditors. There is no other out for many cities. The alternative is decades in a city debtors prison

  4. spension Says:

    The Fix Pensions First report:

    Click to access Full_Report.pdf

    on page 85 makes a comparison that doesn’t support Tough Love… says the typical public sector worker makes $5,000 less in cash pay per year than that in the private sector.

    The public sector worker makes $13,400 more per year in post-employment benefits, of which $8,000/year retiree health care, which is both distant, uncertain, and subject to cancellation by the state legislature. Take that away (as has already happened in some cities), and the public sector makes $5,400 more in post-retirement benefits, which roughly cancels the $5,000 less in cash pay.

    Of course it is always possible to cherry-pick the data and compare huge public pension benefits (say, in the City of Bell, or for various high-up safety employees like Fire Chiefs, Police Chiefs, and Prison Dentists, or, UC Chief Mark Yudof) to worst cases in the private sector.

    Or, one could look at 21 private sector (although their companies get lots of taxpayer-paid-for public contracts) CEO golden parachutes >$100 million:

    Click to access GMI_GoldenParachutes_012012.pdf

    Nobody in the public sector gets $100 million payouts.

    As for this posting by Ed, it never ceases to amaze me how otherwise well-educated academics and actuaries fail to understand the enormous fluctuations in securities markets. Yes, the 200-year average return (*above inflation*) is 6.5% or so. But the fluctuations are wild… 1929, inflation in 1980 or so, and of course, 2008.

    The result of ignoring fluctuations has been: giving away the store when the securities markets are high, and panicking when 1929/2008 events happen. What should happen is: assumption of a modest return rate… not 6.5% above inflation… which is safe enough to never need taxpayer bailouts. And then intense computer modeling of the fluctuations providing the foundational info so nobody is tempted to increase benefits or reduce contributions when the stock market is high.

  5. spension Says:

    Well this is interesting….

    Illinois didn’t make its proper pension contributions, and didn’t accurately portray their decision on disclosures… whose fault is that? The employees who felt they had a signed agreement for the pensions? Their representatives who probably argued or higher pensions? The voters for voting innumerate legislators into office?

  6. Tough Love Says:

    Spension …. will you ever stop distorting the truth ?

  7. spension Says:

    Tough Love, will you ever provide documentation for your assertions?

  8. spension Says:

    I got around to watching Alicia Munnell’s talk… quite good. Clearly identifies the `blowing the top’ issue of increasing benefits/reducing contributions when the stock market is high… but in addition she notes that the desire for higher benefits means the public sector has invested in much riskier assets than they ever used to do.

    And so the ups and downs are accentuated, and then the bad behavior of increasing benefits/reducing contributions hurts even worse.

    She also is quite clear.. see 40 minutes into the presentation… that on average in the US, public compensation is about equal to private compensation. She nicely identifies: lower wage jobs have better compensation in the public sector, and higher wage jobs have poorer compensation, on average.

    She also identifies that California is a `high benefits’ state, with an average record of funding… but because of the high benefits, the portion of state budget devoted could rise into the 15-20% level if returns end up being 4% or so in the future.

    Well run states with good funding and lower benefits (Florida and Delaware) could have to contribute about 1/2 that in a low-return future.

    Illinois is just a bad actor in her opinion… never respected funding rates, still doesn’t. A train wreck.

    Very good presentation.

  9. Merah Says:

    Can’t dazzle them with brillance then baffle them with BS. Jealousy and self entitlement by those who chose to work in a job with perks and high salaries. My great job of 35 yrs plus with the county got me: bitten by dogs; cursed and spit at by clients; rudeness by the police and angry management who dumped on actual workers doing their job. So, put out all your nonsensical statements. I worked for my retirement and benefits many times over. Too bad others didn’t plan for the future. Good thing I shopped at thrift stores, went without, drove the same car for 12 years, limited my outings. Yet I was still expected to give to charities, the “church” and other “fundraisers”. Poor decisions on others part does not and should not consititute an emergency on my part!

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