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City Pension Plans?
by David Stanowski
30 April 2010
Many state and local government pension plans have been finding themselves extremely underfunded since the beginning of the Great Recession. This is due to a combination of overly-generous benefits, poor investment performance, and the use of an outmoded type of pension plan.
The “politically unspeakable reality” is that the pension systems are underfunded by something more than $2 trillion, says Orin Kramer, chairman of the New Jersey State Investment Council, citing independent research that he recently commissioned. Kramer, whose council oversees a $67 billion state pension system, says politicians have deferred action for too long. “Kicking the can down the road is not sustainable,” he says. “The road does not have unlimited duration.”
And this $2 trillion shortfall doesn’t count something called OPEB, for “other post-employment benefits,” mainly health care for retired employees. State and local governments have underfunded those obligations by at least $530 billion, Congress’s Government Accountability Office reported last November. The agency also conceded that its number was an extremely conservative estimate. Other forecasts range up to $1 trillion, which would put states’ total retirement funding shortfall at a breathtaking $3 trillion.
Trillion-Dollar Pension Crisis Looms Large Over America; Institutional Investor, March 2010
LIKE A CALIFORNIA WILDFIRE, populist rage burns over bloated executive compensation and unrepentant avarice on Wall Street.
Deserving as these targets may or may not be, most Americans have ignored at their own peril a far bigger pocket of privilege -- the lush pensions that the 23 million active and retired state and local public employees, from cops and garbage collectors to city managers and teachers, have wangled from taxpayers.
Some 80% of these public employees are beneficiaries of defined-benefit plans under which monthly pension payments are guaranteed, no matter how stocks and other volatile assets backing the retirement plans perform. In contrast, most of the taxpayers footing the bill for these public-employee benefits (participants' contributions to these plans are typically modest) have been pushed by their employers into far less munificent defined-contribution plans and suffered the additional indignity of seeing their 401(k) accounts shrivel in the recent bear market in stocks.
Most public employees, if they hang around to retirement, can count on pensions equal to 75% to 90% of their pay in their highest-earning years. And many public employees earn even more in retirement than their best year's base compensation as a result of "spiking" their last year's income by working ferocious amounts of overtime and rolling in years of unused sick and vacation days into their final-year pay computation.
A survey by the watchdog group California Foundation for Fiscal Responsibility found that some 15,000 Golden State public employees are knocking down $100,000 or more, while some 200, mostly police and fire chiefs and school administrators, are members of the $200,000-a-year-and-up club.
The $2 Trillion Hole; Barron's, 15 March 2010
To a significant degree, the $1 trillion gap reflects states’ own policy choices and lack of discipline: failing to make annual payments for pension systems at the levels recommended by their own actuaries; expanding benefits and offering cost-of-living increases without fully considering their long-term price tag or determining how to pay for them; and providing retiree health care without adequately funding it.
The Trillion Dollar Gap
Some government pension plans have already started to take on additional risk in an effort to close this funding gap!
But states and other bodies of government are seeking higher returns for their pension funds, to make up for ground lost in the last couple of years and to pay all the benefits promised to present and future retirees. Higher returns come with more risk.
“In effect, they’re going to Las Vegas,” said Frederick E. Rowe, a Dallas investor and the former chairman of the Texas Pension Review Board, which oversees public plans in that state. “Double up to catch up.”
Though they generally say that their strategies are aimed at diversification and are not riskier, public pension funds are trying a wide range of investments: commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing. And some states that previously shunned hedge funds are trying them now.
The Texas teachers’ pension fund recently paid Chicago to receive a stream of payments from the money going into the city’s parking meters in the coming years.
Public Pension Funds Are Adding Risk to Raise Returns
What happens to the taxpayers if these added risks turn out badly and the pension plans lose money?
According to the latest compensation survey by the Bureau of Labor Statistics, the average state and local employee out earns his counterpart in the private economy with an hourly wage of $26.11, versus $19.41. That's before benefits (pensions, health care, paid vacations and sick days and leaves) drive the disparity even higher, to $39.60 an hour for public employees and $27.42 for private workers.
Somewhere in 2004, the world changed, and we didn’t realize it. Employers in the private sector put a lid on the cost of benefits (which includes health care, retirement, vacation, and supplemental pay of all sorts). Meanwhile the cost of benefits in state and local govt jobs just kept rising, with barely any break, both before and after the financial bust. This is not good!
To put it another way, the benefits gap between the public and private sectors has widened sharply since 2004.
Now let’s take a look at the two biggest contributors to the benefits gap, health insurance and retirement/ savings. This chart shows the per hour cost to employers in the public and private sectors. For health insurance, state and local governments contribute $4.45 per employee hour, compared to only $2.01 in the private sector. The gap is even bigger for retirement and savings $3.19 per hour in the public sector, more than triple the $0.92 in the private sector.
The Growing Gap between Govt and Private Sector Benefits
This city’s pension plans are Defined-Benefit plans, which means that the City is responsible for certain fixed payouts to retirees regardless of contributions or investment performance. This type of plan is what played a major role in bankrupting the U.S. auto makers, and is outmoded in today's new financial reality. Any shortfalls in City Defined-Benefit Plans will have to be made up by the taxpayers.
For this reason, the City should begin switching to Defined-Contribution plans, as most of the private sector has done, where each employee only receives what is in their own account, regardless of investment returns. This means that there is no liability to the taxpayers to makeup any shortfalls.
Prichard Alabama declared bankruptcy on October 28, 2009 over pension obligations. Since then pensioners have not been paid. Now a bankruptcy court has given the city two more months to figure out how to do so.
You can't pay what you do not have. The problem for Prichard is a declining tax base, loss of population, declining property values, and most importantly a pension plan that was amended by the Alabama legislature more than fifteen times, over the years.
Bankruptcy Court Gives Prichard Alabama 2 More Months To Figure Out How To Pay Pensioners
A bill that would sharply cut pensions for government employees is all of a sudden moving at lightning speed through the Illinois General Assembly.
But, even though it only would apply to newly hired workers, it reportedly would give huge budget relief to Chicago Public Schools, which has threatened mass teacher layoffs to fill a nearly $1-billion hole.
States throughout the country have been engaged in somewhat similar exercises in recent months, with huge government deficits forcing unions to accept cuts that in normal times they would have the power to resist.
Bill to slash pensions for new government workers flying in Springfield
There is a bill (HB1319/SB 1902) moving in Tallahassee that will significantly change the Florida Retirement System if passed.
HB 1319/SB 1902 Will Change Retirement for Public Employees
A package of public-employee pension and benefit cuts expected to save hundreds of millions of dollars in the coming fiscal year and billions over a longer period was signed into law by Gov. Christie yesterday, 35 minutes after winning final legislative approval.
"Today is a great day for the taxpayers of the state of New Jersey," Christie said at an evening ceremony as he approved the bills, the first legislative action he has signed into law.
Those savings will translate into property-tax relief, said Senate Majority Leader Barbara Buono (D., Middlesex).
Gov. Christie signs pension cuts into law
One of the first topics on the agenda for the new City Council must be a complete review of City pension plans. All of their investments need to be marked-to-market so the Council can see exactly where they stand in their ability to meet their future obligations. Their current investments also need to be reviewed for risk and suitability.
Next, reforms must be undertaken on the existing plans with the goal of at least moving all new employees to Defined-Contribution Plans before it is too late!
We just don't know what effect these pension plans could have on City finances.
Plunder: How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation