Symposium on public pensions.
Public pension funds continue to face challenges from economic factors and demographic changes. Governments that offer defined benefit plans to their employees promise fixed payments upon retirement and must fund the promised payments through contributions to a pension plan and growth of pension assets throughout the employee's working life. In general, yearly contributions to the investment fund are based on anticipated, often optimistic, investment returns. Although the stock market indices have recovered from the 2008 financial crisis, the low interest rate environment since the recession has limited fund performance. When actual returns deviate consistently from expected, pension plans become underfunded, that is the promised payouts or liabilities exceed the actuarial value of the fund's assets. Demographic trends, such as longevity, further strain a pension fund's sustainability as plan participants are living longer than that assumed for calculating payment contributions.
Consider state- and locally-administered defined benefit pension plans in the U.S., where the membership is close to 20 million individuals. From 2013 to 2014, total membership increased 0.6 percent; however, those receiving benefits increased by 3.2% (United States Census Bureau Annual Survey of Public Pensions: State and locally administered defined benefit data summary report: 2014. (1) Also in all 50 states, there were less than 2.5 active members per beneficiary--five states have less than one active member per beneficiary. According to data available through a 2015 report issued by the PEW Charitable Trusts, the average funding ratio for state administered plans is 72%; and, almost 2/3 of all plans are funded at less than 80%. Collectively, the liabilities are $3.4 trillion while assets equal $2.5 trillion. Just as troubling is the percentage of plans which contributed the recommended payment--slightly more than half of the total plans contributed the actuarial required contributions or ARC (data for 2013). (2) The United States may represent the problem faced by many developed economies as underfunding issues relate to other countries as well.
Canada's Auditor General announced (2014) that public service pension plans face a $152 billion liability. (3) During the last few years several provinces, such as Alberta and Prince Edward Island, have announced changes to their government worker pension plans due to underfunding. Some of the suggested changes include longer work-lives and higher employee contributions, moving to a career average earnings formula (away from best of last five years), and providing cost of living adjustments when the plan performs well. One additional change, implemented by both some Canadian provinces and some U.S. states is to migrate from defined benefit plans to defined contribution plans for new employees.
Underfunded defined benefit plans remain, though, a potential problem if, and when, a plan's benefit payments exhaust its assets. Taxpayers may face increased taxes, states or local governments may cut services, or employer's contractual obligations may be breached (as in the case of Detroit). The debate on the future of defined benefit plans in the public sector continues. Why do some local governments adequately fund their plans while others teeter towards disaster? How do politics, policies and demographic trends differ among states such that outcomes vary to the extreme? Does the solution to retirement funding lie with a conversion of defined benefit plans to defined contribution plans? Or, do defined contribution plans shift risks and costs to the individual inefficiently?
Given the severity of the potential public pension crisis, and the ambiguity surrounding the causes, this symposium is designed to provide: additional insights into the effect of public pension underfunding on state and local government budgets; a review of on-going reforms, including changes to existing systems and changes to structure; policies to enhance participant's contribution; and policy recommendations for future pension system reforms. The included articles provide insights into the causes of underfunding and suggest changes that could mitigate underfunding without changing the structure of the plan.
Faulk, Hicks, and Killian, the first article, focus on smaller units of government--the county level of one state--in order to untangle the causes of underfunding. The authors' database is constructed post GASB Statement No. 68, Accounting and Financial Reporting for Pensions, which requires a more conservative discount rate. Because Statement 68 became effective June 15, 2014 their study is exploratory as it consists of one year of data. They report lower average community income and higher tax levy per capita with more underfunding. Less underfunding is associated with intergovernmental aid levels and retirement income per capital. It is an interesting observation that, statistically, higher levels of retirement earnings in a community inhibits underfunding.
In the second article, Maher, Park, and Harrold continue to study municipal pension plans but focus on the effects of institutional factors (whether a mayor or manager runs the city) and tax and expenditure limitations (TELS) on plan funding during the 2008 recession. They report an interesting interaction between the form of city management and tax/expenditure limitations: during stressful economic periods a mayor-council form of government is associated with less underfunded pensions.
Roza and Jonovski, in the third article, suggest and provide support for a policy change to teacher late-year compensation which could help pension fund managers reduce underfunding. Currently, yearly raises are fixed- percentage increments. And pension payout on retirement is determined by teachers' final salary. Therefore, final year raises significantly affect the pension liability. An incremental $1 of pay in the final working year creates a $10 pension liability. The authors therefore suggest that a career average pay determination of retirement payments is a much more effective way of controlling pension liabilities than raising employer/employee contributions.
In the final paper, Jog and Lee, provide a broad perspective on the overall retirement systems in Canada, a five pillar system in which the defined benefit component is just one part. They argue that additional government pension proposals would reduce savings and investment choice for Canadians and may negatively affect the economy. In addition, they argue that recent announced changes by the government--increasing the eligibility for federal public servants, for example--ameliorates the unfunded liability in the federal pension plan for federal public employees.
Associate Professor of Finance, University of Dayton
Associate Professor of Finance, University of Dayton
(1.) Report and data available at: http://www. census. gov/govs/retire/
(2.) The State Pensions Funding Gap: Challenges Persist, Issue Brief, The Pew Charitable Trusts, July 14, 2015, available at: http://www.pewtrusts.org/en/research-and-analysis/issuebriefs/2015/07/the-state- pensions-funding-gap-challenges-persist
(3.) For one summary of the Auditor General's comments see: "Canada's $152 public pensions aren't prepared for work force changes, AG warns", available at http://news.nationalpost.com/news/canada/canadas-152b-public-pensions-arent-prepared-forwork-force-changes-ag-warns
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|Author:||Mohan, Nancy; Zhang, Ting|
|Publication:||Public Finance and Management|
|Date:||Mar 22, 2016|
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