Tuesday, August 08, 2006

The Public Employee Pension Mess

Continuing her fine reporting on pension issues, Mary Williams Walsh turns her attention to state and local government pensions in "Public Pension Plans Face Billions in Shortages" in today's New York Times. In a nutshell, the accounting standards are even more lax with public plans than with corporate plans, and there actually seem to be laws that bar oversight entities from blowing the whistle on bad practices. The size of the problem is staggering:

It is hard to know the extent of the problems, because there is no central regulator to gather data on public plans. Nor is the accounting for government pension plans uniform, so comparing one with another can be unreliable.

But by one estimate, state and local governments owe their current and future retirees roughly $375 billion more than they have committed to their pension funds.

And that may well understate the gap: Barclays Global Investments has calculated that if America’s state pension plans were required to use the same methods as corporations, the total value of the benefits they have promised would grow 22 percent, to $2.5 trillion. Only $1.7 trillion has been set aside to pay those benefits.

So this may be an $800 billion problem, compared to the $450 billion problem in the corporate sector. Lovely. And how did we get this way? Here's one method, favored by those in the Garden State:
Still, officials in Trenton have been shortchanging New Jersey’s pension fund for years, much as San Diego did. From 1998 to 2005, the state overrode its actuary’s instructions to put a total of $652 million into the fund for state employees. Instead, it provided a little less than $1 million. Funds for judges, teachers, police officers and other workers got less, too.

To make up the missing money, New Jersey officials tried an approach similar to one used in San Diego. They said they would capture the “excess” gains they expected the pension funds’ investments to make and use them as contributions.

Clever. Too bad Enron isn't around to hire these officials. Another culprit has been (absurdly) long funding schedules, which serve to reduce the required contribution in each year:
Illinois officials say the state’s 50-year schedule is actually an improvement; before adopting it in 1995, the state had no funding schedule at all. In Colorado’s most recent legislative session, lawmakers enacted pension changes that they hope will make the plan solvent in 45 years.

And the National Association of State Retirement Administrators says it is unrealistic to expect all public plans to be fully funded, because they do not have to pay all the benefits they owe at once.

I'm guessing there's no financial literacy requirement to be a spokesperson for NASRA.

Wishing won't make this problem go away. At some point, state and local taxes go up or benefits to public employees or retirees get cut. There is no ERISA coverage for these plans, so I presume that attempts to cut benefits will wind up in court.


doc said...

This has been going on for a long time. When I left a state institution of higher education in Illinois in 1987, the first thing I did was remove as much as possible of my "retirement" account from Illinois's Teacher Retirement Fund and place it in a mutual fund.

It's this sort of underfunding that have made me much more favorably disposed to defined-contribution, immediate-employee-owenership retirement plans.

Thank heaven for TIAA-CREF.

PGL said...

Excellent post on a very good NYTimes piece (Dean Baker applauds this piece as well). You have it exactly right - the solution requires not only better accounting but also the hard choice of raising taxes and/or cutting public employee compensation.

save_the_rustbelt said...

I follow events in Michigan closely, and aparrently many of the local governments have been giving UAW-like benefits without much funding.

Now that the Michigan economy looks like the Titanic this will get worse.

Detroit and the first two rings of suburbs are all in a real mess, economic deterioration plus an aging workforce.

A couple of the 'burbs have already gone into receivership and Detroit is headed in that direction, before the pension crisis really hits. Ouch.

Time for reality therapy. Of course, pulling out of the 2001 recession would help.

Jim Dannis said...

The NYT series has been very good. There is too little public awareness of the public pension issues.

There are serious problems right here in New Hampshire, but so far they have escaped public scrutiny.

The NH retirement system (the pension plan for state and local employees, including teachers) has a funding ratio of only 66%. This puts the NH pension plan in the worst decile of public plans nationwide. The NH plan has a funding hole of $2 billion, which is real money in a state with a GSP of less than $50 billion.

The NH plan uses its share of financial legerdemain, including a current 9% assumed investment return and discount rate. The effect is likely to understate the problem. In other words, if the plan used a long-term bond rate or even a more generally accepted forward equity return rate (say 7%), the funding gap would be substantially larger.

Under the NH tax system which relies on local property taxes, it is easy to guess where the pension bailout costs are flowing. Public employers (towns, cities, school districts) are the pocket of last resort for the bailout, and these costs get passed on in local property taxes. NH towns have seen their mandatory pension contributions double in recent years. The current estimate is that it would take another "double" of employer contributions -- for a 15 year period -- to bail out the plan.

This issue requires some leadership from the state legislature.

I have posted about the NH plan in some detail on http://jimdannis.blogspot.com.

Thanks, Jim

Rob Lawrence said...

In Michigan the state teachers retirement fund has an accrued deficit of over $24 BILLION (nearly $10 billion on the benefit side and $14 billion on the health care benefit promise). I ran across your blog and found the post on Pension Mess, see mine at http://roblawrence.blogspot.com/2007/03/24-billion-problem-in-school-funding.html
to support your post from my state.