Here’s why it’s important to fund public pensions. Published by Jane the Actuary View all posts by Jane the Actuary
9 thoughts on “Forbes post, “Why Public Pension Pre-Funding Matters (An Explainer)””
When did the taxpayer ever get a pension holiday? Did you ever get a statement from your local taxing bodies stating that you do not have to pay for pensions because we (Gov’t) declared a “Pension Holiday”. Property taxes are paid yearly and if you do not pay you will lose your home to a tax sale and when you paid your property taxes money that should had been allocated to pension payments were “Diverted” to higher salaries or some political pet project yet the taxpayer is still on the hook line and sinker. The problem lies between the pension recipient and the people who diverted the funds not the taxpayers! We paid and paid again and are tapped out!!!
Great article and explanation. I suggest supporting pictures – this topic evades the average citizen’s ability to understand. When have you ever heard an incumbent accused of being a spendthrift because he raised pensions while using an 8% rate of return in calculating contributions. Here is one of the next “black swans” – when boomers retire to empty pensions and taxes have to be raised the pay for all the “cans” kicked down the road.
Having lived in IL for years my children attended school there, where the school board would routinely give large salary increases to teachers and administrators after they announced that they intended to retire in three years. Their salaries would be spiked, for the next three years, and the board would congratulate them and thank them for their service, and communicate to the district that the salary increase would not burden the district, but would improve the retirements of the employees as their pensions were provided by the state, not the district. I realized that I was a member of both the district and the state. Since the teachers didn’t pay into SS system they rely on the state retirement plan for their benefits, which are virtually always more generous than SS, in terms of payouts, early retirement terms, and the ongoing 3% guaranteed increase every year for life. Most teachers retire at or around 55 years old, with full benefits, and pensions that are close to their final salary three years prior to retirement. With the COLA and time, their benefits continue to rise. IL has the worst credit rating of all states, and is also one of the states with very high tax burdens. In Lake County, my property taxes were excessive, and residents often paid 10k per year for property tax. As for now, the state can’t reduce any benefits for an employee, not even cap them, but can increase them. Since the pension liabilities are so high, and the taxpayers already so burdened, it remains to be seen how these pensions can be paid. Short of a radical change in politics and funding, I see no alternative other than a federal bailout.
Thank you for this clear and concise explanation! It’s rare to find an actuary who can also explain the concepts to a general audience, and I appreciate your insights!
Great article Jane. As a reformed actuary (I started rounding and was thrown out of the Society 😀) I truly appreciate simplicity and clarity.
But I think you didn’t go far enough. State and local governments should be banned from sponsoring defined benefit pension plans (DB). The political pressures are such that they will never have sufficient fiscal discipline and integrity to properly fund their promises.
The solution is defined contribution pension plans (DC). Back when I was working in pensions, there were two components to the cost: a “Normal Cost”and a “Past Service Cost”. (Today, there is an interest adjustment and the names are different, but I digress. The Normal Cost was what you would normally put in the plan (typically as a percent of pay) if the plan had been in effect from the time benefits began accruing; there were no changes to the plan; and all assumptions made in figuring the Cost were accurate. The Past Service Cost was an amortization of any change, variations in assumption, and the cost of granting credit for service that occurred before the plan was started. If the Normal Cost is 6%, you could replace a DB plan with a 6% DC plan, without hurting the participant – assuming all the components of that 6% Cost are correct. The beauty of this approach is that politicians can’t screw with it. You have to tuck away the 6% each year just like you have to pay salaries. If the unions want a higher benefit, they have to negotiate for a bigger percentage to be paid in the succeeding year. No sweetening last service.. None of this promise more and maybe we will pay for it in 20years. Also, no pension spiking. In short, fiscal discipline. Which is also why these plans are unpopular in public employment.
What’s the down side of DC plans? Well they transfer risk to employees – primarily investment return and mortality. That used to be a problem. Today, there are many ways to mitigate that risk through annuities and guaranteed investment contracts. These guarantees cost money, but that just has to be priced into the 6% Cost.
It would probably take a US constitutional amendment to outlaw State and local DB plans. We’ve passed amendments that are a lot dumber.
Looks like a no-win situation. I have always believed that a properly run DB system is far superior to a DC system. In California, as in other states, that would probably mean more conservative assumptions, i.e., lower pension formulae and/or higher contributions. But, even in the best run systems, that may be a problem.
According to a Nov. 2017 article, CalPERS had $326 billion in assets, and was roughly $153 billion short of fully funding the retirement promises earned to date.
The concern is that another downturn would both decrease assets and increase the the unfunded liability. But a properly funded (100%+) $480 billion + fund would create it’s own problems. As normal state revenues shrink and expenses increase in a down business cycle, that pension fund is a tempting morsel. “Why should taxpayers suffer from reduced services and higher taxes when CalPERS is sitting on $500 billion?”
It was way too much temptation for Pete Wilson in 1991.
“I have always believed that a properly run DB system is far superior to a DC system”
The key words in your response are “properly run”
Pensions served a purpose at one time, but today bankrupt municipalities and squeeze taxpayers through backroom dealing exemplified best by (fill in a or city or state). Public pensions put too much power in the hands of too few individuals that cannot be trusted nor are they subject to any checks and balances. Defined contribution plans that must be funded on a real time basis are the only way to save government from itself.
Here’s my solution: