Looming Trouble with State and Local Employee Pensions

Mary Williams Walsh brings us all up to date on the problem in today's New York Times:

Across the country, government workers’ pensions are protected by guarantees even stouter than those on pensions in the private sector. The legal promises, often backed up by union contracts, cover more than 15 million people.

Years of supporting court interpretations have enshrined the view that once a public employee has earned a pension, no one can take it away. Even during New York City’s fiscal crisis 30 years ago, no existing pension promises were reduced.

But now a number of state and local governments are quietly challenging those guarantees. Financially troubled San Diego is the highest-profile example, but a handful of states, cities and smaller government bodies have also found ways to scale back existing promises and even shrink some current payments.

While still only scattered cases, these examples may be an early warning sign of what could be coming elsewhere. As local officials take stock of unexpectedly large obligations to retired public workers, some are starting to question whether service cuts, sales of government property and politically acceptable tax increases can ever go far enough to bring things into balance.

And it's not just retirement income benefits:

Governments are also studying the guarantees on retiree health benefits because of a new accounting rule that is now requiring them to calculate, for the first time, the total value of the health benefits they have promised to retirees.

The numbers now being disclosed are daunting. Mercer Human Resource Consulting estimates that when all the calculations are done, the nation’s states and cities will find they have promised a total of about $1.4 trillion, said Derek Guyton, a senior consultant.

Little, if any, money has been set aside to fulfill these obligations.

We'll be hearing more about this issue in the coming years, as the bills come due in more places and other localities join San Diego in its financial woes. (For example, see Walsh's earlier article from August.)

If there were anything with which to take issue in the article, it would be the title, "Once Safe, Public Pensions Are Now Facing Cuts." Safety comes from direct ownership or a binding guarantee. Public sector employees are in a situation where they thought they had more of a guarantee than they do. If you were open to attack but weren't attacked, were you really "safe?"

As a matter of policy, when focused on replacing income in retirement beyond Social Security, I'd much prefer the transparency and ownership of a defined contribution or 401(k) plan to the vague promises of a defined benefit plan, acknowledging that running such a plan effectively requires thoughtfulness applied to plan design and participant education.

A Surprising Place for a Run

I have from time to time had the pleasure of commenting on the reporting of Mary Williams Walsh of The New York Times, where she covers pensions, state and local governments, and some other topics. Over the holiday, I read her excellent article, written jointly with Kirk Semple, on the burden that poor investments by the state of Florida have had on local communities. The opening paragraphs:

PORT ST. LUCIE, Fla. — On Nov. 28, Marcia L. Dedert, finance director of this rapidly growing city, called the administrators of Florida’s state-run investment pool to ask whether it was still safe to park her city’s money there. She was hearing talk of urgent withdrawals by others worried about the pool’s investments in debt related to subprime mortgages.

After the pool’s manager told her the money would be all right, Ms. Dedert recalled, she deposited $135 million in bond proceeds. But less than 24 hours later, the administrators froze the pool and blocked withdrawals to halt a full-blown run.

Now the city cannot touch the money. And rest of the $371 million it has in the pool is also off-limits unless the city pays a 2 percent penalty.

Port St. Lucie is among hundreds of local governments in Florida that were drawn to the pool by its air of reliability and the promise of higher returns than banks offered. They now find themselves grappling with the consequences of having their money frozen.

Some have had to borrow money to meet day-to-day obligations. Others have had to shift money around for the time being or consider postponing long-planned projects.

For Port St. Lucie, the timing of the freeze could not have been worse. The city is trying to recreate itself as a center of the biotech industry and had just issued $155 million worth of bonds to lay roads, water pipes and sewer lines in a planned “jobs corridor,” where it hopes to house the companies it is courting from out of state.

I question why localities actually need this service from the state. Given investment amounts in the hundreds of millions, there are any number of banks and financial service companies with whom they could contract directly. People with accounts as small as 0.1% of Port St. Lucie's account get treated very well by financial service companies. Why tie up your money with a state fund that thinks it's doing you a favor instead of going to the professionals who would actively compete for your business?

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.

Pension Reform Gets up off the Canvas

When last we discussed pension reform, the prospects for any meaningful increase in pension funding requirements seemed bleak. But sometimes five months can make a difference, and the intrepid Mary Williams Walsh is back on the case:

Earlier this year, as Congress inched toward a broad overhaul of the nation’s troubled corporate pension system, experts said the bill was so fraught with escape clauses that it could become easier for companies to shortchange their pension funds than under the current, flawed law.

But under the version just approved by lawmakers, companies appear to get a break in putting money into their pension funds for only a couple of years before the rules start to tighten. Within a decade from now, according to a new analysis by the Congressional Budget Office, companies will be putting substantially more money behind their pension promises.

The CBO's cost estimates can be found here. The higher contributions take about five years to kick in. I don't see the rationale for waiting so long (and even making the contributions lower in the next couple of years), but I suppose I'll take what I can get. Ditto for the special extensions granted to the airlines (a lot to Northwest and Delta, somewhat less to American and Continental) and to GM and the UAW.

A big win in the legislation is that the variable rate premiums to the Pension Benefit Guaranty Corporation--the extra amounts proportional to plan underfunding--go up to the tune of roughly $5 billion over ten years.

Read more coverage of the legislation's provisions here.

Pass the Spittoon, Pension Reform Edition

For the trouble of having to wade through all of the details of the pension reform bill now being gutted in House-Senate conference, Mary Williams Walsh gets a Voxy. I remember working on the early stages of this reform effort while at CEA. It started out simply enough:

With a strong directive from the Bush administration, Congress set out more than a year ago to fashion legislation that would protect America's private pension system, tightening the rules to make sure companies set aside enough money to make good on their promises to employees.

Enter the Congressional porkfest, and what do we now have?

Then the political horse-trading began, with lawmakers, companies and lobbyists, representing everything from big Wall Street firms to tiny rural electric cooperatives, weighing in on the particulars of the Bush administration's blueprint.

In the end, lawmakers modified many of the proposed rules, allowing companies more time to cover pension shortfalls, to make more forgiving estimates about how much they will owe workers in the future, and even sometimes to assume that their workers will die younger than the rest of the population.

On top of those changes, companies also persuaded lawmakers to add dozens of specific measures, including a multibillion-dollar escape clause for the nation's airlines and a special exemption for the makers of Smithfield Farms hams.

As a result, the bill now being completed in a House-Senate conference committee, rather than strengthening the pension system, would actually weaken it, according to a little-noticed analysis by the government's pension agency. The agency's report projects that the House and Senate bills would lower corporate contributions to the already underfinanced pension system by $140 billion to $160 billion in the next three years.

Two excerpts from the article say it best:

"It takes a better economist than me to understand how reducing contributions by that much is going to protect benefits and put the system on a sounder footing," said Jeremy I. Bulow, an economist at Stanford University.

That's actually funny, since there are no demonstrably better economists than Jeremy Bulow. And then we have the author's own attempt to make sense of this:

Someone must pay for this. Currently, the pension agency finances itself in part through the insurance premiums that companies are required to pay into the system. Raising the premiums to support pilots or help other victims of corporate bankruptcies, some companies in other industries are starting to say, would be unfair.

This is the contemptible legislative impulse to favor the special interest over the general interest. Read the whole thing and be amazed at how unprincipled the House and Senate are being.

The President has been losing credibility on several issues related to finances as of late. He could get some of it back if he would simply VETO this monster and send it back to the sty. If for no other reason, he should do it to show respect for the many people in his administration who worked diligently on a much better blueprint for reform.

For my own views on how to reform the defined benefit pension system, see these earlier posts.