In light of the recent GAO report, one question I have received is how public pension solvency dates would change if one assumes an “Ongoing” model instead of a “Termination” model. The Termination approach asks how long existing assets would last to cover liabilities that have already been promised. It assumes that future contributions will cover the cost of future benefit promises and will not be wiped out to fund legacy promises. This is the approach I took in a paper from 2010 that examined exhaustion dates. An Ongoing approach instead assumes that future contributions are available to make payments at the time and could be completely wiped out if necessary to pay legacy liabilities. Note that in many systems departing employees can ask for contribution refunds, so that it is not clear that all future employee contributions are fully available for legacy promises.
Fortunately, Alicia Munnell and coauthors have already analyzed and answered this question in the 2011 paper “Public Pension Funding In Practice,” Journal of Pension Economics and Finance 10: 247-268. The main table from Professor Munnell’s paper is as follows. It shows that under the Termination framework public pension plans nationwide have assets through 2025 assuming 8% returns and 2022 assuming 6% returns. Allowing future contributions to be wiped out to pay for legacy liabilities extends the solvency horizon on average by 4-5 years.
Another interesting graph from the paper is the following, constructed under the 8% return scenario.
It is interesting that even under the Ongoing framework, assets of more than half the plans (7%+29%+33%) are exhausted by 2029, 36% (7%+29%) are exhausted by 2024, and 7% are exhausted before 2020.
At the time of the Munnell study, assets in the sample plans were $2.7 trillion as of 2009, according to the study. As of the last high-water mark for the stock market (June 2011), total state and local government retirement assets stood at $3.0 trillion according to the Fed Flow of Funds, which also corroborates the 2009 figure. It is telling that even a very strong market in which stocks have returned approximately 10% annually since 2009 have had such a relatively small effect on the situation.
Thank you! Actually, your clarifying analysis and Alicia Munnell’s could be considered overly optimistic. They assume: There never will be another market downturn; that chief investment officers chasing riskier investments always will pick winners; that “placement agents” and other politically connected insiders will not scrape off too much for themselves; that boosted benefits and double dippers never included in actuarial calculations will give back the unfunded portion of undeserved benefits; that strapped state legislatures will make full ARCs and catch-up contributions; that young public employees will be willing to pay thousands of dollars for benefits they never will receive, and that taxpayers who never will be able to retire _ who got set up, sucker punched and mugged, then taxed to bail out the people who did it _ will docilely pay increased taxes forever so state and municipal workers can retire early. Perhaps some actuary could calculate the probability of all those phenomena occurring constantly for the next 50 years. What that GAO clearly says is despite “reforms,” the current system is not sustainable indefinitely without higher taxes, service cuts and risk that some dedicated public employees could end up with nothing. Wake up!
http://www.statebudgetsolutions.org/blog/detail/gao-report-buries-ugly-truth-about-doomed-public-pension-plans
Thanks for your comment. It is interesting that if returns are even 6% instead of the 8% used in my study and in the baseline in the BC study the runout dates move forward by 3-4 years. It is hardly an unlikely scenario.
THE COLORADO WE LIVE IN. Fact #1: Governor Hickenlooper signs bill this week to give a raise to state legislators. Fact #2: State legislators steal contracted, earned, fully-vested, and accrued retirement benefits from elderly in our state (SB 10-001, COLA theft bill.) Our values are warped.
Thank God the courts are beginning to correct the outright, unabashed theft of public pension benefits that has occurred in a number of states across the U.S. Read below the clarity that this Florida judge brings to the matter, it is truly breathtaking.
COLA LAWSUIT VICTORY IN FLORIDA! – FLORIDA JUDGE: IT’S ILLEGAL TO TAKE EVEN FUTURE COLA ACCRUALS FROM EMPLOYEES, LET ALONE COLA BENEFITS THAT HAVE ALREADY BEEN EARNED AND ACCRUED (SEE: COLORADO GENERAL ASSEMBLY, SB1.)
The Florida Legislature attempted pension reforms that were not nearly as aggressive, in terms of risk of unconstitutionality, as those adopted by the Colorado General Assembly. Nevertheless, the Florida Legislature has been smacked down by the courts.
Here are some noteworthy portions of the Florida ruling:
“This court cannot set aside its constitutional obligations because a budget crisis exists in the state of Florida. To do so would be in direct contravention of this court’s oath to follow the law.” “To find otherwise would mean that a contract with our state government has no meaning.” “There was certainly a lawful means by which they could have achieved the same result.” “Florida law is clear that a legislature can, as part of its power to contract, authorize a contract that grants vested rights which a future legislature cannot impair.” “The elimination of the future COLA adjustment alone will result in a 4 to 24% reduction in the plaintiffs total retirement income. These costs are substantial as a matter of law.” “Where the state violates its own contract, complete deference to a legislative assessment of reasonableness and necessity is not appropriate because the state’s self-interest is at stake.” “All indications are that the Florida Legislature chose to effectuate the challenged provisions of SB 2100 in order to make funds available for other purposes.” “If a state could reduce its financial obligations whenever it wanted to spend the money for what it regarded as an important public purpose, the Contract Clause would provide no protection at all.” “The Takings Clause is intended to prevent the government from forcing some people alone to bear public burdens, which in all fairness and justice should be borne by the public as a whole.” “Defendants are further ordered to reimburse with interest the funds deducted or withheld . . . from the compensation or cost-of-living adjustments of employees who were members of the FRS prior to July 1, 2011.”
Here’s a link to the decision in Florida:
http://judicial.clerk.leon.fl.us/image_orders.asp?caseid=49809133&jiscaseid=&defseq=&chargeseq=&dktid=87117441&dktsource=CRTV
Here’s hoping that one day Justus will prevail in Colorado. Read all about it and support the lawsuit at saveperacola.com.
Mr. Al has a simple philosophy: I want what you promised, and you pay for it. Don’t tell me you can’t afford it, because you promised.
I stopped believing that in the third grade.
I’m beginning to wish there were 49 States …. w/o Colorado ….so we would STOP have ALcut & paste this garbage every day on multiple websites.
Josh, Nice summary. Of particular interest is the 4-5 extra years that a rundown of future contributions adds to the failure duration.
TL, the US Constitution and its Contract Clause are not garbage. All of my conservative buddies support capitalism and the sanctity of contracts. In Colorado, it was the public unions that championed the breach of retiree contracts (tossed their retired brothers under the bus, out of fear that their pension contributions would haave to be increased.) The conservatives fought the breach of contract in SB1. The pension administrator, Colorado PERA, hired a troop of lobbyists (I have read from 12 to 20) to ram the pension bill through the process. They hired these lobbyists with money from our pension trust funds to take our contracted pension benefits.
Robert, the simple philosopy is actually “I want what was contracted for, rather than promised, now you pay for it. I understand that states and locaal governments intend to honor their corporate contracts. Tell me why one class of contract is inviolate, the other may be trampled. I understand that pension obligations are a fraction of state and local government expenditures and that they have 30 years to pay the off (like my mortgage).” I continued to believe all of this right through grad school. Sort of makes sense.
TL, there are ploicy areas where I am more of a conservative than you are. It is unnatural for conservatives to support the breach of contracts. In Colorado, it was the Republicans who fought the breach of retiree contracts, they wanted real reform, not immoral, prima facie unconstitutional reforms. All of this “reform” will have to be repeated with prospective provisions. The conservatives of Utah reformed their public pensions a couple of years ago LEGALLY, and PROSPECTIVELY. They are ridding themselves of pension obligations without selling their souls. There is no reason why conservatives across the country cannot support LEGAL pension reform. Take the high ground like our Colorado consservaatives did.
Al, you reinforce the concept that many public employees have: ratchet up but never down. The contract only works while you are still employed, and while the maker of the contract can still meet its terms. You leave the govt with little choice, make the system a two-tier, then fire the expensive older group.
In private industry, those contracts can be amended going forward, and the responsible parties must make contracts that can be sustained.
But in public employee contracts, you have an entire branch of the govt (judges) who won’t allow contracts to be amended down, even though they are way beyond the original intent of the makers. Judges can’t make the funds happen to pay for these promises, because that is the job of the legislature.
Hi Robert, you are incorrect. Private pension plans are governed by ERISA. ERISA includes an “anti-cutback” rule applicable to private sector plans. ERISA does not govern public sector pension plans, therefore public sector retirees must defend their contracted benefits in court. Governmental entities should not have the “choice” of abandoning their contractual obligations.
You would allow contracts to be “amended down”, if they are “beyond the original intent of the makers.” Let me know how that works out in your business. Or, perhaps you believe that only certain contracts, public sector contracts, should be excluded from the protection of the US Constitution and its Contract Clause. Bottom line, legislatures may not abandon contractual obligations in order to make discretionary expenditures. Legal, prospective pension reforms are available to the states, they always have been. The “easy” road of retroactive changes to contracts will rightly be rejected in the courts. How is it that our conservative friends in Utah managed legal, prospective pension reform, but so many other states ignore this path?
Al, let’s be clear about this: public plans are protected by judges from making changes in future benefits for work that has not yet been started. ERISA protects private plans from changes to pension benefits for work already completed.
Private plans have a contract for benefits, but that contract can be changed for any future work. Judges have too much self-interest to allow that simple reality to apply against public employees.
This is what Professor Munnell’s Center for Retirement Research has said about so-called public pension “run-out dates:”
“[They are] a pessimistic portrayal of plan finances. We assumed that plans only contribute the normal cost, we based our initial stock of assets on 2009 lows, and we didn’t incorporate any changes for new hires. So it’s fairly safe to assume, that the “ongoing” analysis we performed in March 2011 is a worst-case scenario.”
Studies projecting public pension insolvency dates are largely exercises in theory, because, among other reasons, they do not incorporate the likelihood that public pension plan sponsors will make adjustments necessary to restore their plan’s sustainability. Numerous such changes have been made by states and cities since 2009. Some changes affect new hires only; others affect existing active and, in some cases, even retired plan participants.
As the recent GAO report on public pensions stated: “The projected exhaustion dates are … not realistic estimates of when the funds might actually run out of money.”
Read the CRR’s full perspective here: http://pensiondialog.wordpress.com/2012/01/09/will-public-pensions-run-out-of-money/
And those “adjustments” are costly/painful for someone, which is the point of the exercise. The runout dates are what happens without adjustments that are costly to some party — public employees, beneficiaries, taxpayers, or recipients of public services. If your point is that these runouts won’t happen because benefits will be slashed, then your organization should make that point clear to the beneficiaries themselves.
If you read the GAO footnote, their objection is clearly about dates using the Termination approach, as they prefer projections that allow all future contributions to be wiped out to pay legacy liabilities. The CRR has provided those estimates, and they seem like very good estimates of what will happen without cost/pain extracted from public employees, beneficiaries, taxpayers, or recipients of public services. With increased financial suffering by those groups to ramp up contributions into the pension systems, the runout dates might be delayed.
The sad reality of the public plan arena is that employers are not required to fully fund each participant by the time they start retirement benefits.
The employee retires, provides no more services, and yet the employer has a built-in budget to pay off those legacy liabilities.
I would like to see the analysis of these plans that shows contributions which eliminate the legacy liability, both on the optimistic economic model now in use by most plans and on the more cautious economic model with lower interest.
Actuaries would refer to this as individual level premium costing.
[…] it seems that Dr. Rauh is changing his tune. In a recent post, he writes, Those “adjustments” are costly/painful for someone, which is the point of the […]
There is no message change. It has always been the case that raising taxes or cutting other spending to pay for pensions could delay runout dates. The runout dates are based on current government policies, i.e. what happens if no measures are taken. And of those 43 changes you’re touting as having fixed the problem, how many of them affect benefit payments during, say, the next 20 years, and how many do so by any substantial margin? As for the GAO footnote, I’m sure you’re aware you have quoted that out of all proportion and if you had actually chosen to link to the top of my post (https://kelloggfinance.wordpress.com/2012/03/13/termination-vs-ongoing-approach-for-pension-solvency-dates/) rather than just the bit you wanted to take out of context your readers could have seen the discussion of that point and the minimal effect that using an Ongoing method to address the GAO concern would have on the conclusions.