Jane the Actuary Retirement

Forbes post, “From The Archives: The Chicago Teachers’ Pension Fund Was Unfunded From The Start”

Originally published at Forbes.com on November 16, 2019.

 

Why are public pension plans so poorly funded? Sure, you can blame politicians’ meddling, or irresponsible benefit increases, or decisions to take contribution holidays, but, to take the Chicago Teachers’ Pension Fund as a case study, it was not designed to be funded in the first place.

Here’s the story, as assembled from articles in the Chicago Daily Tribune from 1894 and 1895:

The Chicago teachers’ pension was the result of enabling legislation passed on June 1, 1895, which permitted Illinois cities with populations greater than 100,000 to set up pensions for their teachers and school employees. The legislation provided for benefits for women with more than 20 years of service and men with more than 25 years, with no minimum retirement age specified – which meant that teachers as young as 38 would be eligible (because only a high school diploma was required). However, to receive a pension was not automatic; the Board of Education controlled who would and wouldn’t be given the pension, either by accepting or denying requests or initiating retirements themselves. The benefit was fixed at 50% of final salary, up to a maximum of $600 (the original proposal was $1,000), and would be funded by an employee contribution of 1% of pay, plus any fines the Board of Education might levy for neglect of duty and any donations they might receive.

In the run-up to the vote, promoters of the bill cited its strong support among teachers, 3,500 out of 4,000 of whom had signed a petition in favor. A Miss E.K. Burdick of the Teacher’s committee objected to claims that this amounted to “charity” or “State socialism” and supported giving the Board of Education the relevant decision-making authority since

“it is reasonable to assume there would always be fair-minded people on the board, and, unfettered by any bias or selfish interest in the matter, they certainly would deal justly in all cases” (”Proposed Teachers’ Pension Law,” March 9, 1895, p. 16).

A separate letter to the editor labels the pensions as equivalent to being “honorably discharged from active service” and insists that teachers will fund the program themselves and that

“Should any expense connected with this fund be necessary, I think the teachers are willing to assume all the responsibility and see that such accounts are met and settled from direct tax” (letter to the editor from Mrs. S. Mather Gibbs, Jan. 5, 1895, p. 14).

The Tribune, however, provided skeptical commentary.

“It is evident that it will take some years to accumulate enough money to pay a comparatively small number of pensions. But there must be at this time a number of teachers who have served their twenty years, many of whom would be glad to retire on half pay if they had a chance. . . .

“How far the board would use wisely its power to retire teachers cannot be told in advance. If the pension fund were small, as it will be for some years to come, and the number of teachers who wanted to be pensioned was large, there might be a good deal of log-rolling to get these coveted positions, where there was a steady income with nothing to do. . . .

“If all the teachers were starting in fresh this 1 per cent and the money collected from other sources might make a sufficient pension fund. For there would be a great many lapses among the female teachers. Many would die and more would get married. But the proposed system will start off with numerous candidates for retiracy, and it may be that after a short time the young teachers who will have to way from fifteen to twenty years for pensions will not like to be paying out a hundredth part of their salaries for the benefit of pensioners who may live for thirty years after they have been retired.

“Very possibly one of the first demands made on the board if the bill passes will be for a small increase in pay sufficient to cover, and a little more than cover, the 1 per cent withheld. Then the taxpayers would be called on to pay the pensions rather than the teachers. Or if the number of deserving applicants for retiracy was large and the fund was not large enough to provide for them all the taxpayers would be called on to contribute to the fund in some other way” (”Pensions for School Teachers,” Dec. 21, 1894, p. 6).

The Tribune also published a letter from a teacher among the minority who objected:

“Only a few teachers remain in the employ of the board for twenty years. For the benefit of these all are to be taxed” (”A teacher,” Mar 11, 1895, p. 4).

But the skeptical voices did not carry the day, and in November the Board of Education turned its attention to implementing the system, first by electing the teacher-representatives to the Board of Trustees (the remainder of the board was comprised of the Board of Education and the Superintendent of Schools), and then by identifying the potential retirees, so as to set the actual assessment on the teachers, a number that climbed from 10 teachers (November 10, 1895) to up to 225 eligible teachers (November 26, 1895), based on reports from school principals – among whom were a woman hoping to take her pension and start a “literary career” and another hoping to “retiree” and get a new job out-of-state.

So from the lack of advance funding, to the lack of vested rights, to double-dipping, there truly is nothing new under the sun.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Counting Chickens Before They’re Hatched: Will Illinois Botch Pension Consolidation?”

Originally published at Forbes.com on November 14, 2019.

 

Not much more than a month ago, Illinois Gov. JB Pritzker’s task force released its report recommending that asset management at the 650-odd pension funds be consolidated, while leaving benefit administration (and jobs, and decision-making about disability-eligibility) to the local entities.

And when Illinois doesn’t drag its feet on making changes due to inter- or intra-party squabbles or the desire to avoid making any hard choices, when its politicians think they’ve found a free lunch, they rush headlong into it. The Chicago Tribune reported last night that

“The Illinois House voted overwhelmingly Wednesday to approve Gov. J.B. Pritzker’s plan to consolidate nearly 650 local pension funds for suburban and downstate police officers and firefighters.

“The measure, which was approved on a bipartisan vote of 96-14, now goes to the Senate. If that chamber approves the bill before adjourning Thursday, it would hand another victory to Pritzker after he accomplished nearly all of his legislative priorities in the spring.”

Now, the fundamental concept of consolidation is entirely reasonable – as it is, the smallest of pension plans see lower asset returns because of investment restrictions and comparatively high expenses, which should be solved with consolidation. In the best case, they should see returns of as much as 2 percentage points higher in a consolidated system due to economies of scale.

But Ted Dabrowski and John Klingner at Wirepoints point to a serious concern not being reported elsewhere, an additional boost in benefits:

“[I]t makes sense to pool the funds of the 650 pension plans in an attempt to increase investment returns and lower transaction fees. Everything else equal, not doing so would be irresponsible.

“But the consolidation bill being debated on the floor today isn’t just about consolidation of fund assets. It’s also become a vehicle for changes to pension benefits, with increases for Tier 2 public safety workers. Pensions are the biggest issue that the state faces – and lawmakers are about to make significant changes with no debate as to their merits and no public actuarial analysis calculating their cost.”

More specifically, the bill – by means of deleting two words and changing two numbers – changes the averaging period for Tier 2 worker (hired 2011 and later) from 8 years to 4 years, and modifies the pensionable pay cap increase rate from half of CPI to the full CPI (with a maximum of 3%). (See page 73 of the Amendment 5 text.) This latter change in particular remedies an element of Illinois pensions which would otherwise, over time, have a particularly harsh impact as the real, inflation-adjusted level of the cap declines from year to year.

And I’ve written repeatedly that Tier 2 benefits for all Illinois workers need reform. But, as Dabrowski and Klingner write,

“For sure, benefits for Tier 2 workers – those who started work after January 2011 – will at some point have to be fixed. We’ve written about that in the past. It’s a real mess.

“But this bill is not the place to do it. If Tier 2 is changed, it should be part of a dedicated pension reform bill that fixes all the funds at once, not snuck in as part of unrelated legislation.

“Supporters of the Tier 2 reform in the bill argue that the costs of the increased benefits – estimated at some $70 to $95 million over the first five years – are covered by the expected higher investment returns generated as a result of consolidation.

“But higher returns aren’t guaranteed by the bill. Yes, the consolidated funds will be able to take more risks in the stock market – but those greater risks can lead to better returns or bigger losses.”

The pair also point out that this sets a precedent for simply increasing Tier 2 generosity in other systems without any sort of funding. What’s more, this was done without any concrete analysis of the degree to which the various Tier 2 benefits – for teachers, state and municipal workers, and public safety worker statewide – are in violation of Social Security’s “safe harbor” laws, analysis which has never taken place for any of these benefits.

Now, I myself should acknowledge that in my prior article on the pending consolidation, I was perhaps overly excited by the task force’s acknowledgement of this issue, so as to not recognize at the time the danger of pairing the consolidation with a benefit enhancement.

But the folks at Wirepoints are right – this has the potential from going from a success story to yet another cautionary tale of Illinois’s bad governance.

UPDATE:

As of this (Thursday) morning, the State Senate has now approved the pension consolidation bill. However, as the State Journal-Register reports, various Republican Senators did object to the Tier 2 enhancements, and specifically, the lack of analysis:

“The cost of those changes is estimated at $75 million to $90 million over a five-year period.

“‘I have not found any taxpayer who wants to enhance pension benefits,’ said Sen. Jason Barickman, R-Bloomington. ‘The IRS has not told us we have to do this.’

“He also said the estimated cost of the enhancements did not come from an actuary and thus may not be accurate.

“’We are going to continue to pass enhancements without knowing how much they cost,’ he said.

“’It’s a classic Springfield solution that has led to underfunding of pensions across the board,’ added Sen. Dale Righter, R-Mattoon. ‘Increase benefits, but not put in place any mechanism to require contributions to increase. The difference is going to be made up by a savings figure given to us by the governor’s Office of Management and Budget.’”

There are also two ways in which the cost of these enhancements is not as simple as a liability increase figure.

In the first place, all these pension systems are placed on a funding schedule to reach 90% funding at some point in the 2040s or 2050s, varying by plan. But the Tier 2 liabilities will become an ever greater share of the liabilities, so the relatively small portion of the liability attributable to them in 2019 is not a meaningful measure of the long-term impact of restoring the benefit reductions for new hires.

In the second place, the “savings” due to increased investment earnings will not be shared by all police and fire plans uniformly; plans for larger cities will gain less because they are now in a better position than the smaller-asset plans. This means that the rationale that “we’re just applying some of the increased investment revenue to fund better benefits” only works for those smaller plans, rather than all plans statewide.

So good job, Illinois – in confirming you still don’t have your act together.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Who Should Pay For Healthcare And Social Insurance? Sorry, Elizabeth Warren, The Answer is ‘All Of Us'”

Originally published at Forbes.com on November 4, 2019.

 

Elizabeth Warren just released her proposal for funding the single-payer healthcare system she calls “Medicare for All” but which is far more generous than the existing Medicare system, promising all medically necessary/appropriate services/treatments not just with respect to traditional healthcare but also dental, hearing, vision, and long-term care, both in-home and institutional, all without any premiums or direct cost to recipients, and without any wait (”care when they need it”). (See Warren’s just-released proposal, in which she references the Medicare for All Act of 2019 as a guide for details, a summary of which is at sponsoring Representative Pramila Jayapal’s website.)

I’ve written previously on another platform that, however often supporters of a national healthcare system claim that this is “what every other country does,” this is in fact not the case, that even the most generous of Social Insurance-based healthcare systems top out at covering 85% of expenditures, with the remaining 15% coming from out of pocket costs or private health insurance, and that either directly through required cost-sharing or non-covered treatments, or indirectly as wait times lead those who can afford it, to supplement or replace the state-provided benefit. As an example, in Australia, which literally calls its state program “Medicare,” the public system covers 67% of healthcare spending.

And now, not only does Warren promise unheard-of generosity in benefits, but she promises that this can be done in a way that’s “free” for everyone but the wealthy. There’s a lot of smoke and mirrors here, including a substantial understatement of the actual cost of her plan ($20.5 trillion over 10 years rather than the $30 trillion that both Bernie Sanders and progressive supporters of the plan estimate), claims that she can hold administrative costs down to the figure Medicare reports for its existing program for the elderly, simply by fiat, and a tax on employers that’s meant to represent the equivalent of what they currently pay in their share of the premiums but becomes after a phase-in something more akin to a (very large) tax on headcount (and a lot more – which I griped about elsewhere), but her bottom line consists of substantial tax hikes on the wealthy and corporations.

And, in the same way as no other country imagines that all medical (and ancillary) care can be provided by the federal government with no limits, copays, or waits, it is also the case countries simply don’t fund their systems by means of “taxing the rich” but expect the same citizenry that benefits from the system, to pay for it, either as a part of an income tax system in which everyone pays at rates higher than in the United States, or through a payroll tax similar to our FICA tax, or both.

Of Bernie Sanders’ favorite countries, that is, Scandinavia: Denmark funds its system mainly through a national health tax of 8% of taxable income, and Norway and Sweden fund their systems through national and local taxes, according to the Commonwealth Fund’s International Health Care System Profiles.

The United Kingdom funds its system through both general tax revenues and a employee tax of 2.05% of pay up to GBP 45,032 in annual earnings, and 1% thereafter, plus an employer tax of 1.9% of earnings.

German employees and employers pay 7.3% of pay up to a EUR 53,100 per year cap, plus 1.275% each up to the cap for long-term care (which, incidentally, covers only a portion of those costs).

In France, employees pay between 0% and 6.5%, employers pay 13.5%, and the national government pays an additional amount from general tax revenues.

And to our north, again, Canada funds its system through general tax revenues, as well as up to a 4.3% employer payroll tax, varying by province, and, in Ontario, a premium of about 1% of pay, capped at $900 for income of $200,000.

(In each of these cases, this excludes the additional costs to individuals for out-of-pocket costs and private insurance.)

The fundamental premise of social insurance is one of “we’re all in this together.” These are programs in which everyone pays (with certain exceptions for the poor) and everyone benefits.

And consequently, to truly implement a system such as what Warren promises, in which it is the wealthy and corporations who bear the burden of providing health benefits for Americans, would not be placing us within the norm for healthcare-providing countries, but far outside it.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “What Does It Take To Build The World’s Best Pension Systems? Ask The Netherlands And Denmark”

Originally published at Forbes.com on October 22, 2019.

 

The Melbourne Mercer Global Pension Index 2019 edition has been published (full report here), and the United States has been given a rank of C+ in this comparison of pension systems of 37 rich and middle-income countries, with a score of 60.6, slightly above the average of 59.3. Also in the C+ category were the UK and France; among the C countries were Spain, Austria and Italy; B countires included Canada, Ireland, and Germany.

Which countries were at the top of the rankings?

Why the Netherlands and Denmark, of course.

Regular readers will recall that I profiled Denmark’s retirement system back in September, in “Bernie Sanders Wants A Scandinavian-Model Social Insurance System. Sure, Why Not? (For Retirement Anyway).” It’s a three-part system, with a flat “basic retirement income” benefit for all residents and prorated for short residency in the country, a modest statutory flat-contribution benefit (literally flat contributions – everyone pays the same amount – not merely a level percentage of income), and high prevalence (90%) of employer provision of Defined Contribution retirement savings accounts, which protect plan participants from investment risk not by means of employers providing guarantees but through conservative investments.

The system is much the same in the Netherlands: a basic retirement benefit prorated for residency (see “Let’s Talk ‘Basic Retirement Income’ Social Security Reform: What Would It Look Like?”) combined with widespread prevalence of employer retirement benefit provision, traditionally in the form of traditional defined benefit plans sponsored by individual employers or industry-wide but now more commonly through defined contribution or “collective defined contribution,” which are characterized by risk-sharing among participants and potential benefit cuts if fund assets don’t meet investment return targets. Again, these plans are commonly invested in low-risk products such as deferred annuities.

So how is it that this type of system – a flat state-provided benefit paired with near-universal DC (or at any rate, employer-guarantee-less) benefits – finds its way to the top of Mercer’s ranking?

The index evaluates retirement systems with three criteria:

Adequacy asks, straightforwardly enough, whether the system provides benefits that are adequate both to poor retirees and, as a percentage of pre-retirement income, middle-class workers as well. In terms of private-sector pensions, in addition to the benefit level itself, the study asks whether favorable tax treatment provides incentives to save, whether laws prohibit early withdrawals of retirement accounts, whether benefits vest and are portable upon leaving an employer, whether their are mandates or tax incentives for annuitizing retirement accounts, whether divorced spouses receive protection, and whether there are provisions to continue to accrue retirement benefits while temporarily out of the workforce such as when receiving disability benefits. This criteria also looks at the general household savings rate and the degree to which investments in retirement accounts are held in “growth assets.”

The sustainability metric looks at a number of factors: demographics (the old age dependency ratio and labor force participation rates for older workers), government policy that responds to aging populations such as increases in retirement age and phased retirement, the level of advance funding in public and private pensions, and the level of government debt. It evaluates (funded) private pension plan participation, which contributes to sustainability, as well as the extent to which public pension contributions are invested rather than directly paid out to pensioners.

And the integrity sub-index measures a number of factors related to ensuring “that the community has confidence in the ability of private sector pension providers to deliver retirement benefits over many years into the future” (report p. 16). These include “the role of regulation and governance, the protection provided to plan members from a range of risks and the level of communication provided to individuals,” and asks specifically about private-sector plan funding requirements. The value also incorporates broader metrics of governance through the World Bank’s Worldwide Governance Indicators, and evaluates the administrative and other costs of the systems, to evaluate whether plan participants are getting their money’s worth.

In addition to external data sources, Mercer compiled further data by using their international network of consultants, and the report further observes that they did not try to incorporate other factors impacting the well-being of retirees, financial or otherwise (e.g., cost and provision of healthcare or long-term care).

In the adequacy category, the US score of 58.8 is slightly below the average of 60.6, and places is it at a ranking of 24 out of 37. Its sustainability subscore of 62.9 (vs. an average of 50.4) places it 7th, and its integrity subscore of 60.4 (average 69.7) ranks 29th.

What accounts for these scores?

In the adequacy category, it ranks 21st in its provision of benefits for low-income workers (median would be 19th), 15th in its provision of benefits for a range of middle-income workers, and 18th in its overall savings rate (remember, this is out of 37, so the median score is 19), but last in a measusure based on annuization requirements/incentives. Denmark, in contrast, ranks 1st in overall replacement rate and 2nd in benefit provision for low earners, but dead last in the savings rate metric, which brings it to a rank of 5th overall. The Netherlands is also among a cluster of high-scoring systems with respect to overall benefit provision and does well on the index’s supplementary metrics, for an overall ranking of 3rd.

In the sustainability category, the US ranks 11th in terms of the proportion of workers participating in private sector pension plans, but does well in measures of actual pension assets and demographic sustainability. The Netherlands and Denmark tie for first in these first two measures, and are middle-of-the-pack on the third, for ranks of second and first, respectively, when combined with other components of this sub-index. At the same time, Denmark and the Netherlands tie for first (along with 4 others in the category of level of mandatory contributions (public/Social Security and mandatory employer/employee private-sector contributions); the U.S. is 22nd. The report deems a high spending level good and assumes that participants are getting their money’s worth from it.

And in the integrity subindex, Denmark and the Netherlands (and 26 other countries) have tighter regulations of employer-sponsored plans in a variety of ways: stricter funding requirements for defined benefit plans, greater regulatory oversight of plan reporting, restrictions on assets, independence of pension fund trustees, access to a complaints tribunal, and the like. The index also gives points to systems in which large pension funds hold a relatively larger share of assets, because these have economies of scale.

So the bottom line is this: I’m a big fan of pension systems like those of the Netherlands and Denmark, so it’s always nice to see them do well in the rankings. But this report is equally useful in gaining an understanding of what a leading expert in the study of retirement systems has to say about the question, “what makes for a top retirement system?” and the answer is far more complex than either a generous Social Security system or an equally generous mandatory employer-provided pension system.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.