KEEGAN: Government pensions fix may take time, but time has run out

By   /   November 1, 2012  /   No Comments

By Frank Keegan | State Budget Solutions

TIMELY DECISION: State and local governments should switch to defined contribution plans, but this shift does not alleviate the current pension debt.

Members of a state and municipal workers organization recently got a dose of reality on pension reform at a gathering of public workers who have benefited from defined contribution plans for 40 years.

A key fact from the presentations was stated by Ken Parker, city manager of Port Orange, Fla.: “Note: the only way a governmental entity can truly fix its cost related to retirement is to change from a Defined Benefit Plan and adopt a Defined Contribution Plan.”

One huge problem is the change only fixes future costs while leaving taxpayers on the hook for pension debt — estimated at about $1 trillion three years ago to $5 trillion now — that politicians secretly ran up over decades of looting funds to bypass borrowing restrictions and balanced budget laws.

When the “contributions” governments force from workers and taxpayers cease, the existing debt just gets bigger because many pension funds imprudently use them to pay current benefits instead of investing to pay future benefits as universally required by annuity standards.

That means, in the words of Roger Berkowitz of the Bard College Hannah Arendt Center, politicians turned government workers’ hope for secure retirement into a giant Ponzi scheme.

Center for State and Local Government Excellence officials attended the International City/County Management Association Retirement Corp. annual conference last month that included pension and retirement health-care presentations.

ICMA-RC is a “non-profit independent financial services corporation focused on providing retirement plans and related services for more than a million public sector participant accounts and approximately 9,000 retirement plans” initially formed to provide defined contribution pensions for professional government managers who tend to change jobs a lot more than most other state and municipal employees.

That means they generally get shorted by the back-loaded vesting requirements of government defined benefit pensions. Municipal managers needed portable pensions, such as defined contribution plans.

SLGE, which lists ICMA-RC as an affiliate, says its “mission is to promote excellence in local and state governments so they can attract and retain talented public servants.”

Elizabeth Kellar, SLGE president and CEO, noted in her blog Monday, “Why Pension Reform Takes Years,” that “Decisions made by state governments on retirement age, benefit levels, and how pensions are calculated can be difficult to change, even when a local government has an independent pension plan.”

Among those reasons are legal guarantees, political clout of the workers and their unions, and what Boston University law professor Jack Beermann refers to as pension “pathology.”

But all of those factors could melt in the political heat of a bankrupt pension fund demanding more and more money from beleaguered taxpayers who receive no government services of any kind for the increased cost.

Noting that while pension benefits may be guaranteed, funding is not, Beermann points out “Fairness aside, if the financial situation … does not improve, many state workers and retirees may suffer severe reductions in their pension benefits as public entities find it economically or politically impossible to meet their obligations to retired workers. …

“These possibilities may give pension plan participants strong incentives to negotiate over their pension benefits, perhaps resulting in the acceptance of significant reductions that are less painful than what would have otherwise occurred.”

Kellar notes that wake-up call was repeated at ICMA-RC by Palo Alto, Calif., City Manager James Keene in his presentation, “‘Waking up is hard to do,’ … describing the perfect storm of shrinking revenues, growing service costs, and rising pension and health care costs.”

Getting ahead of the curve, Palo Alto in 2008 “… created a new tier of benefits, increasing the retirement age and reducing benefit levels for all employee groups,” said Kellar.

She cites Michigan Municipal League Policy Development Director Colleen Layton’s presentation that “Michigan political leaders have shown a growing interest in switching government employees from defined benefit to defined contribution plans.”

The state of Michigan launched a defined contribution and hybrid plan 15 years ago. Reform was among the factors cited last month by Fitch in affirming its AA- rating for general obligation bonds despite the state’s decade of economic hardship and ongoing economic uncertainty.

“The state’s defined benefit pension obligations are limited given the state’s conversion in 1997 to defined contribution benefits for newly-hired state employees,” she said.

However, the ratings agency noted the official 72.6 percent funded ratio of the vestigial defined benefit plan drops to 65.4 percent, when a slightly more realistic accounting method is used.

As a result, despite reforms 15 years ago, the average Michigan household is locked in to pay about $1,500 in extraordinary taxes every year for 30 years to receive no government services, according to update of a recent study by economists Robert Novy-Marx and Joshua Rauh.

With continuing investment shortfalls, declining contributions from reduced workforces, increasingly risky investments and a sobering world economic outlook, the probability of public pensions being able to pay full promised defined pension benefits is getting worse every day.

I estimate the total aggregate state and municipal pension debt at more than $5 trillion as of June 30. As markets falter, governments fail to make full contributions, obligations increase and more workers retire, that debt just continues to grow. The day of reckoning accelerates.

A recent congressional committee study found that, based on old data, some public pension plans could run out of money in five years.

Studies by the Federal Reserve Bank of Cleveland this year asked, “Without strong remedies, at what point would pension plans run out of money, leaving financially impaired state and local governments on the hook? That question is not quite settled.”

The study goes on to warn that “At this point, it seems unlikely that any major pension fund will run out of cash in the next few years, barring a general worsening of economic and financial conditions. Indeed, increased public attention on the underfunding problem has motivated pension plan sponsors to work with state legislators to implement substantive reforms. … But most of these changes have only a limited effect on plan funding. …”

In other words, absent a worldwide economic miracle in the next few years, all state and municipal pension funds will run out of money to pay benefits.

This is why when Kellar tries to explain “Why Pension Reform Takes Years,” the only rational response is: Pensions do not have any years left to delay fundamental “drastic reform,” as another recent study demanded.

Those drastic reforms must begin with:

  • Immediate freeze of state and municipal defined benefit plans and shift to defined contribution or hybrid plans to stop the bleeding;
  • Calculation of best amortization schedule to pay off existing pension debt as quickly as possible, but not to exceed 30 years;
  • Explicit determination of how to pay off the debt through shared sacrifice of increased employee contributions, reduced benefits and spending cuts in other areas of government.

Taxpayers and public workers at risk must demand politicians do it now.

Frank Keegan is editor of Statebudgetsolutions.org a project of sunshinereview.org. The State Budget Solutions Project is nonpartisan, positive, pro-reform, proactive and anchored in fundamental-systemic solutions. The goal is to successfully engage political journalists/bloggers, state officials and opinion leaders in a new way of thinking about state government and budgets, fundamental reforms, transparency and accountability.

frankkeegan@statebudgetsolutions.org

 

 

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