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The Gathering Public Pension
Storm: Now It’s Raining
State of Louisiana
Joint Retirement Committee
October 19, 2009
Adam B. Summers
Policy Analyst
Reason Foundation
www.reason.org
Public Pension Study
The Gathering Pension Storm: How
Government Pension Plans Are Breaking
the Bank and Strategies for Reform (2005)
– George Passantino and Adam B. Summers
www.reason.org
Background

2004: $326 billion cumulative state government pension
deficit (127 plans)
– National Association of State Retirement Administrators &
National Council on Teacher Retirement

2008: $237 billion shortfall (59 plans)
– Up from $113.5 billion in 2007 (Wilshire Associates)

Louisiana: $12 billion total unfunded pension liability

Blame stock market downturn after “dot-com” boom and
current recession
– $1 trillion in losses to state and local governments
– Try to borrow way out of debt with pension obligation
bonds (POBs)
– Won’t solve underlying problems
State Pension Funding Levels (2004)
Louisiana Pension Funding Levels
 LASERS
– 2003: 66%
– 2008: 68%
 TRSL
– 2003: 69%
– 2008: 70%
Defined-Benefit Plans

Make up vast majority of govt. plans
– 90% of state and local government workers

DB plans guarantee employees a set level of benefits when
they retire
 Benefit levels determined by formula
 Funded with employer contributions, employee
contributions (in public sector), and pension fund returns
 Pension board invests assets
 If pension fund does well, employer contributions are
small and vice versa
Causes of the Pension Crisis

Not the stock market
 Problems inherent to DB plans and government
management
– Volatility
– Moral hazard

Underfunding
– Simply not making full amount of contributions
– “Contribution Holidays”
– “13th Check” for “excessive” gains
Unrealistic Actuarial
Assumptions
“In my experience, every pension fund I’ve
ever seen has an actuarial assumption that is
more akin to wishful thinking than what is
reasonably foreseeable.”
– Edward Siedle, former SEC attorney
Louisiana Pension Fund
Investment Assumptions

LASERS & TRSL: 8.25% return
 50-state median: 8%

Warren Buffet: 6%
 Pensions are “ticking time bombs”

Virginia: Funds at or near full funding in 2003
– Now projected at 60% funded by 2013
– PWC: Even if public pensions funds make 8% every
year, will be less than 50% funded by 2025
Retirement Trends
People are retiring sooner
Life Expectancy
People are living longer
Demographics
During 20th Century, average life span increased
by more than 30 years
 Typical man spends twice as much time in
retirement now as in 1950
 Ratio of current to retired workers in DB system
has fallen from 3.5:1 in 1980 to 1:1 today
 Baby Boomers are starting to retire

Rising Retiree Health-Care Costs

Health-care costs are consuming an ever-larger
portion of employee retirement costs
 Double-digit year-over-year cost increases for
most of the last decade
 Costs rose another 9.9% in 2008 and 9.2% in 2009
 Expected to rise 9.0% in 2010
Source: PricewaterhouseCoopers Health Research Institute report,
June 2009.
Excessive Benefits

Deferred Retirement Option Plans (DROPs)
– San Diego: Would-be pension benefits earned 8%-8.5%
+ COLA

“Air Time” Purchases
– Generally supposed to be revenue-neutral, but often
aren’t

Unused sick and vacation time abuse
 Disability pension abuse (Chief’s Disease)
 Generous benefits formulas
Public- vs. Private-Sector Wages
and Benefits
Average Hourly Public-Sector and Private-Sector
Compensation Cost Comparison
Private Industry
State and Local
Government
Wages and Salaries
$19.39
$26.01
Benefits
$8.02
$13.65
Total
$27.42
$39.66
Source: U.S. Department of Labor, Bureau of Labor Statistics, “Employer
Costs for Employee Compensation—June 2009”
The Alternative: History of DC Plans


Private sector shift to 401(k)-style DC plans over past 30
years
Employee Retirement Income Security Act of 1974
(ERISA)
– Established tax-deductible individual retirement account (IRA) for
those without pensions

Revenue Act of 1978
– Created Internal Revenue Code Section 401(k)
– Est. individual tax-deferred retirement plans


DC plan: employer/govt. & employee each make
contributions to a retirement fund managed by the
employee
Benefit level determined by investment performance
The Rise of DC Plans:
Number of DB and DC Plans
800
700
600
500
400
300
200
100
0
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
Number of Plans (Thousands)
Number of Defined-Benefit and
Defined-Contribution Plans, 1975-2005
Year
Defined-Benefit Plans
Defined-Contribution Plans
DC plans: 208,000 in 1975  631,000 in 2005
DB plans: 103,000 in 1975  48,000 in 2005
The Rise of DC Plans: Number of
Participants in DB and DC Plans
80
60
40
20
05
02
20
99
20
96
19
93
19
19
90
19
87
19
84
19
81
19
19
19
78
0
75
Millions of Individuals
Total Participation in Defined-Benefit and DefinedContribution Plans, 1975-2005
Year
Defined-Benefit Plans
Defined-Contribution Plans
DB plans: 33 million in 1975  42 million in 2005
DC plans: 12 million in 1975  75 million in 2005
Governments Shifting to DC Plans
 Michigan
switched to DC plan starting in
1997
 Alaska switched to a DC plan in 2005
 At least 8 states, including Florida, offer
both a DB plan and a DC plan
 Starting in 2003, Oregon state employees
participate in both a DB and a DC plan
Public-Sector DC Plans

Mandatory DC plans:
– Alaska
– Michigan

Mandatory DC + DB plans:
– Indiana
– Oregon

Optional DC plans:
–
–
–
–
Colorado
Florida
Montana
North Dakota
– Ohio
– South Carolina
– Washington
– Vermont
Benefits of DC Plans

Predictability of contribution levels
– No actuarial liabilities!

Flexibility
– Can change compensation to match economic conditions

Portability
– Typically not the case with government DB plans
– Important for increasingly mobile workforce
– 2000: Average work tenure = 4.7 years (2.6 years for
workers aged 25 to 34)
– Quicker vesting


Freedom of choice
Ability to change investment strategy over time, risk
levels
– People have different needs and risk tolerances
Investment Returns of
DB and DC Plans
Public-Sector DC Plan Structure

Mandatory enrollment
 Vesting requirement: 1 year
 Range of investment options
– But not too many (no more than 15 to 20)
 Target wage replacement rate: 75% – 85%
– Translates to ≈ 10% – 12% total contribution with
Social Security (18% – 20% without)

Provide basic retirement investment information
– Investment advisory services
Source: TIAA-CREF Institute, “Defined Contribution Pension Plans
in the Public Sector: A Best Practice Benchmark Analysis,”
April 2008
Solutions
 Scale back benefits
– Close DB plans to new employees
 Voter approval requirements
– San Francisco vs. San Diego, Orange County
 Switch
to DC plans (not a cure-all!)
 Avoid pension obligation bonds
– Sold as simple refinancing, but actually risky
arbitrage
Solutions (continued)

Budget reforms to address existing liabilities
– Eliminate unnecessary, poor-performing, and low–
–
–
–
–
–
–
priority programs
Consolidate similar government agencies and functions
Privatization
Outsourcing
Asset divestiture
Spending limit
Debt limit
Priorities of government (POG) budgeting approach
The Gathering Public Pension
Storm: Now It’s Raining
State of Louisiana
Joint Retirement Committee
October 19, 2009
Adam B. Summers
Policy Analyst
Reason Foundation
www.reason.org