Tag Archives: Pensions

Strong words from the SEC on Public Sector Pensions

As state and local governments begin to pull back the curtain on the true value of their pension liabilities with the implementation of GASB 68, Daniel Gallagher, Commissioner of the SEC issued an important statement last week, noting in plain terms that how governments measure their liabilities would have serious repercussions in the private sector. Here’s part of the remarks worth considering:

 …for years, state and local governments have used lax governmental accounting standards to hide the yawning chasm in their balance sheets…

The riskiness of a pension obligation depends on state law.[32]  If pension obligations have the same preference as general obligation debt, then the municipality’s own municipal bond yield (generally around 5%) would be the proper discount rate.[33]  Or, if as we’ve seen from Detroit, pensions will be saved before all else, then we should use a default-free measure to discount the liability:  specifically, the Treasury zero-coupon yield curve.[34]  This would result in a discount rate in the low 3% range.

Obviously, the higher the discount rate, the lower the present value of the liability.  The difference between a discount rate in the range of seven percent and one in the range of three percent is in large part responsible for the hidden $3 trillion in unfunded liabilities that are currently going unreported.

This lack of transparency can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees,[35] or not to make the promises in the first place.

In the private sector, the SEC would quickly bring fraud charges against any corporate issuer and its officers for playing such numbers games.  And, we would also pursue and punish the so-called fiduciaries who recklessly seek yield to meet unrealistic accounting assumptions.  We should not treat municipalities any differently.”

GASB 68 asks that sponsors use a high- yield, tax exempt 20-year municipal GO bond only on the unfunded portion of the liability. This will reveal bigger funding gaps in public sector pension plans. But it does not reveal the full value of the liability since it allows sponsors to continue using the higher discount rates on the funded portion of the liability.

 In addition to using the new GASB standards, Commissioner Gallagher advises that governments should also disclose their pension liabilities on a risk-free basis. This would have the effect of showing the value of these promises on a ‘guaranteed-to-be-paid’ basis. Commissioner Gallagher’s suggestions are extremely sensible and a call to basic transparency in public sector liability reporting.

Ignoring the value of pension benefits is not going to make them cheaper to fund, and the longer a state waits to accurately measure the liabilities and payments, the worse it gets. Just ask New Jersey –  which is struggling to balance its budget and meet a fraction of a fraction of the required annual pension contribution to its state pension system. The situation is so dire that it could trigger yet another downgrade for the Garden State.

 

Municipal pension news: Baltimore to offer DC plan

Earlier this month, Baltimore’s city council approved a measure to give the city’s workers a choice between a defined contribution or defined benefit plan plan. According to Pensions and Investments, new hires will contribute 5 percent of their salary to whichever plan they choose, a significant increase from the 1 percent that workers were required to begin contributing to the city’s pension system last year. (Previously, workers had not contributed to their pension). As the article notes, the choice between a DB and a DC plan is a compromise. Mayor Rawlings-Blake preferred to move all newly hired employees to a DC plan, but this was not agreed upon by unions. In total, Baltimore two pension systems have an unfunded liability of $1.4 billion on a GASB-basis.

Baltimore’s proposed reforms are a bit stronger than the plan currently considered by Chicago mayor Rahm Emanuel, which is largely focused on filling in very daunting funding gaps in the city’s multiple plans. The Wall Street Journal reports that the mayor’s plan to raise property taxes by $250 million represents an increase of about $50 a year for the owner of a $250,000 home. And, it’s not enough to cover the gap. The state will demand an additional $600 million in annual payments for the city’s police and fire funds by 2016. In addition, Mayor Emanuel proposes benefit cuts, such as  increased employee contributions and reduced COLAs. But structural reforms aren’t being pushed too strongly, instead, the focus in Chicago appears to be a search for more revenues. Consider a proposal floated by The Chicago Teachers Union. They would like to see a per-transaction tax levied on futures, options, and stock trades processed on the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange.  Both the CME and Mayor Emanuel oppose the idea recognizing that it will simply drive the financial industry out of town.

 

Governors’ Priorities in 2013: Medicaid Funding, Pension Reform

As the month of March draws to a close, most governors have, by this point, taken to the podiums of their respective states and outlined their priorities for the next legislative year in their State of the State addresses. Mike Maciag at Governing magazine painstakingly reviewed the transcripts of all 49 State of the State addresses delivered so far (Louisiana, for some reason, takes a leisurely approach to this tradition) and tallied the most popular initiatives in a helpful summary. While there were some small state trends in addressing hot-button social issues like climate change (7 governors), gay rights (7 governors), and marijuana decriminalization (2 states), the biggest areas of overlap from state governors concerned Medicaid spending and state pension obligations.

Medicaid Spending

Judging from their addresses, the most common concern facing governors this year is the expansion of state Medicaid financing prompted by the Supreme Court’s ruling on the Affordable Care Act last year. While the ACA originally required states to raise their eligibility standards to cover everyone below 138 percent of the federal poverty level, the Supreme Court overturned this requirement and left up to the states whether or not they wanted to participate in the expansion in exchange for federal funding or politely decline to partake.  The governors of a whopping 30 states referenced the Medicaid issue at least once during their speech. Some of the governors, like Gov. Phil Bryant of Mississippi, brought up the issue to explain why they made the decision to become one of the 14 states that decided not to participate in the expansion. Others took to defending their decision to participate in the expansion, like Gov. John Kasich of Ohio, who outlined how his state’s participation would benefit fellow Buckeyes suffering from mental illness and addiction.

Neither the considerable amount of concern nor the markedly divergent positions of the governors are especially shocking. A recent Mercatus Research paper conducted by senior fellow Charles Blahous addresses the nebulous options facing state governments in their decision on whether to participate in the expansion. This decision is not one to make lightly: in 2011, state Medicaid spending accounted for almost 24 percent of all state budget expenditures and these costs are expected to rise by upwards of 150 percent in the next decade. The answer to whether a given state should opt in or opt out of the expansion is not a straightforward one and depends on the unique financial situations of each state. Participating in the Medicaid expansion may indeed make sense for Ohioans while at the same time being a terrible deal for Mississippi. However, what is optimal for an individual state may not be good for the country as a whole. Ohio’s decision to participate in the expansion may end up hurting residents of Mississippi and other states who forgo participating in the expansion because of the unintended effects of cost shifting among the federal and state governments. It is very difficult to project exactly who will be the winners or losers in the Medicaid expansion at this point in time, but is very likely that states will fall into one of either category.

Pensions

Another pressing concern for state governors is the health (or lack thereof) of their state pension systems. The governors of 20 states, including the man who brought us “Squeezy the Pension Python” himself, Illinois Gov. Pat Quinn, tackled the issue during their State of the State addresses. Among these states are a few to which Eileen has given testimony on this very issue within the past year.

In Montana, for instance, Gov. Steve Bullock promised a “detailed plan that will shore up [his state’s] retirement systems and do so without raising taxes.” While I was unable to find this plan on the governor’s website, two dueling reform proposals–one to amend the current defined benefit system, another to replace it with a defined contribution system–are currently duking it out in the Montana state legislature. While it is unclear which of the two proposals will make it onto the law books, let’s hope that the Montana Joint Select Committee on Pensions heeds Eileen’s suggestions from her testimony to them last month, and only makes changes to their pension system that are “based on an accurate accounting of the value of the benefits due to employees.”

Generational Unfairness in Pensions

California Governor Jerry Brown has led an effort to pass some changes to current state employee pension benefits that will affect new employees by raising their retirement age, capping their potential benefits, and requiring both new employees and some current workers to pay at least half of the cost of their pensions.

At Public Sector, Inc. Steve Greenhut explain that the savings from these changes won’t be felt for years to come:

It’s clear the reform would do little to touch current unfunded pension liabilities, estimated in California at as much as a half-trillion dollars, but will bring in reforms in decades after new hires start retiring.

The changes are projected to save state taxpayers between $40 billion and $60 billion. With these changes, California’s pension fund will still be underfunded by about $450 billion, calculated using the risk-free discount rate (pdf). If policymakers refuse to make further changes to the system, this remaining debt will require greater sacrifices from new workers and future taxpayers.

This unfunded liability represents generational unfairness. Today’s taxpayers are paying for current retirees who provided state services in the past. Likewise, the new reforms require sacrifices primarily from new workers. They will be receiving fewer benefits while paying into a system that benefits current workers and retirees.

States have unfunded pension liabilities due to management mistakes of the past. However, the costs of these mistakes are being felt today. Going forward policymakers should see the pain they impose on younger workers and make every effort not to repeat this pattern.

The longer that reforms are delayed, the greater inter-generational inequity grows. While California has the largest unfunded pension liability, it is not alone. Because Illinois has failed to take significant actions to address the state’s debt and pension liabilities, S&P downgraded its bond rating to A-plus with a negative outlook. This makes it S&P’s second-lowest-rated state above only California. Moody’s ranks Illinois’ bonds the lowest of all states. These ratings will be accompanied by higher bond yields on Illinois’ debt for future taxpayers. This will saddle them with more of their tax dollars going to debt service rather than current state services.

Policymakers have every incentive to engage in policies that benefit current voters at the expense of future voters because they want to receive credit for providing services that exceed their cost in the present. The only way to correct this tendency is for voters to demand that lawmakers do not force the cost of current programs onto those who do not have a voice in today’s elections.

Pensions in Paradise

NPR’s Caitlin Kenney reports:

Ruth Tighe is [a] former employee of the commonwealth’s energy office. She says the law that allowed her to retire with so little government service should never have been passed.

She’s referring to the pension plan of the Northern Mariana Islands. The small U.S. Commonwealth was once known for having the most-generous government pension plan in the country. You could work for the government for just 3 years and then retire with a pension at age 62.

When hard times hit in 2006 and 2007, the government stopped paying into the fund. Now the fund is trying to declare bankruptcy. Since states and territories are not allowed to declare bankruptcy, the legal question turns on whether the pension and the Commonwealth are one and the same or whether the pension can be considered a separate entity.

Pension managers on the mainland are closely following the case. So should pensioners. As Ms. Tighe’s story indicates, unsustainable promises benefit no one, least of all those who come to depend on them.

Bill Gates Gets It

In the Wall Street Journal, John Fund reports on the Aspen Ideas Festival, a large gathering of innovators and creative policy thinkers. Discussing education reform, he points out that Bill Gates seems to agree with Eileen and Veronique on the problems of fiscal illusion.

Mr. Gates said a big part of the problem [with education spending] is “fraudulent” state budgeting systems, which fail accurately to account for the cost of pension promises. A legislator who “says ‘yes’ doesn’t feel any pain at all,” he said. Thus the “accounting fraud” that lets politicians treat generous teacher pensions as a free lunch rewards them for spending more on retired teachers than on current students.

As Eileen and co-author Andrew Biggs put it:

Given the costs and risks inherent in the defined benefit plan to taxpayers, as well as the political incentives for legislators to over promise benefits to public sector workers while shirking on the state’s contributions, the state should close the current defined benefit plan to new workers and expand the existing defined contribution plans for all new state and local workers. Shifting employees to a defined contribution plan would ensure that New Jersey’s pension system for its public sector workforce is sustainable in the long term and reward younger workers with a guaranteed employer contribution to their individual retirement.

As Mr. Gates is well aware, this problem isn’t some Sopranos-state anomaly, it’s common practice at all levels of American governance. If we want to move forward on fixing our institutions, we have to get an accurate picture of how badly they’re being mismanaged, and eliminate those harmful practices. Students, parents, teachers, and taxpayers are all in this together.