Wednesday, December 8, 2010

Passing the Pension Time Bomb?

Reuters reports, NYS public pension costs will double in 5 years:

New York State taxpayer-funded contributions to public pensions will "explode" in the next five years, forcing the state to divert resources from other services to meet the obligation, the Empire Center for New York State Policy said in a report on Tuesday.

Taxpayer contributions to the New York State and Local Retirement Systems could double over the next five years, adding nearly $4 billion to annual taxpayer costs, according to the report by the nonpartisan think tank.

Taxpayer contributions to the New York State Teachers' Retirement System, which totaled $900 million this year, could reach $4.5 billion by 2016, the report said.

"The run-up in pension costs threatens to divert scarce resources from essential public services during a time of extreme fiscal and economic stress for every level of government," the report said.

"This is not just a matter of financial necessity but of basic fairness to current and future taxpayers -- the vast majority of whom will never receive anything approaching the costly, guaranteed benefits available to public employees," it said.

Using private-sector accounting rules, the Empire Center estimates the New York State and Local Retirement Systems are $71 billion short of what is needed to fund pension obligations, while the state retirement system for teachers has a funding shortfall of $49 billion.

Based on the same standard, New York City's pension funds had unfunded liabilities of $76 billion as of mid-2008, before their net asset values plunged in the wake of the financial crisis, the report said.

You can download the complete report by clicking here. I quote the executive summary below:

Public pension costs in New York are mushrooming—just when taxpayers can least afford it. Over the next five years, tax-funded annual contributions to the New York State Teachers’ Retirement System (NYSTRS) will more than quadruple, while contributions to the New York State and Local Retirement System (NYSLRS) will more than double, according to estimates presented in this report. New York City’s budgeted pension costs, which already have increased tenfold in the past decade, will rise by at least 20 percent more in the next three years, according to the city’s financial plan projections.

NYSTRS and NYSLRS are “fully funded” by government actuarial standards, but we estimate they have combined funding shortfalls of $120 billion when their liabilities are measured using private-sector accounting rules. Based on a similar alternative standard, New York City’s pension funds had unfunded liabilities of $76 billion as of mid-2008—before their net asset values plunged in the wake of the financial crisis.

The run-up in pension costs threatens to divert scarce resources from essential public services during a time of extreme fiscal and economic stress for every level of government. New York needs to enact fundamental pension reform to permanently eliminate the risks and unpredictability inherent in the traditional pension system.

While I agree that using a discount rate based on rosy expected investment returns is a recipe for disaster, the report irked me when it went as far as recommending closing defined-benefit plans to new members:

The lesson is clear: the traditional pension system exposes taxpayers to intolerable levels of financial risk and volatility. New York’s existing defined-benefit (DB) public pension plans need to be closed to new members, once and for all. They should be replaced either by defined-contribution (DC) plans modeled on the 401(k) accounts that most private workers rely for their own retirement, or by “hybrid” plans, combining elements of DB and DC plans, that cap benefits and require employees to share in some of the financial risks of retirement planning.

This is not just a matter of financial necessity but of basic fairness to current and future taxpayers—the vast majority of whom will never receive anything approaching the costly, guaranteed benefits available to public employees.

So let me get this right, it's fair to close defined-benefit plans to new teachers, police officers, firemen, and civil servants?!? Why not just use a proper discount rate, increase contributions and bolster the governance of these plans so that pension fund managers are properly compensated based on risk-adjusted returns over the long-term? In other words, don't condemn defined-benefit plans, but look into other structural weaknesses of the US pension model and try to incorporate Canadian-style pension governance.

And if you think there aren't governance issues at New York's pension funds, just look at Attorney General (now governor) Cuomo's probe into misconduct and fraud at NY State's pension fund. Sure, it could happen in Canada too, but I bet you it's much more prevalent in the US where pension fund officers are poorly compensated and politics permeate pension funds.

Of course, New York isn't the only state that has to deal with rising pension costs. Bloomberg reports that trustees of the $24 billion retirement system for state employees in Pennsylvania, the sixth most-populous U.S. state, approved plans to shift assets from hedge funds to stocks and fixed-income securities:

The move will raise the share of the fund’s holdings to 39 percent stocks from 27 percent, and to 26 percent fixed income from 15 percent, according to a news release from the State Employees’ Retirement System. The transition will help cover rising benefit payments and is a long-term target, the release said.

Benefits and expenses are expected to cost $2.6 billion in 2011, rising to $4 billion in 2020, the news release says.

The plan adopted today “continues the planned gradual shift, introduced last year (and subject to annual review), toward a greater allocation to fixed-income investments in order to meet the liquidity needs arising from a projected increase in benefit payouts as the fund matures,” the release says.

The fund, which has about 226,000 members, gained 5.2 percent, or $1.2 billion, during the quarter that ended Sept. 30, according to the news release.

Finally, Chicago Business reports, Bond sale not enough to help Illinois plans, Moody's says:

The combined funded level of Illinois’ five state retirement systems would weaken further, even if the state issues some $4 billion in pension obligation bonds to finance its required annual contributions, according to a Moody’s Investors Services report on Monday.

An anticipated issue of eight-year general obligation bonds to pay the state’s pension contributions for the current fiscal year to the state systems “would at least limit deterioration in the funded status of the state’s pensions, which are the lowest-funded among states,” the one-page report said. “Nonetheless, we expect the state’s pension funded ratios to weaken further before improving, given that statutory contributions are below the actuarially determined amounts needed to amortize the plans’ unfunded liabilities.”

The state Senate last month in a special session failed to pass a bill to authorize the state to issue up to $4.1 billion in pension obligation bonds, even though the House passed the legislation 71-44, with two voting present, on May 25.

The bill calls for borrowing between $3.7 billion and $4.1 billion, depending on whether the systems certify their actuarially required state contributions, taking into account a reduction in funding costs stemming from a measure enacted last spring that cut pension benefits for new state employees.

Senate approval for the bond sale “may be forthcoming during lame-duck legislative sessions” scheduled for January, the report said.

Illinois already has about $13 billion in pension obligations bonds still outstanding from $10 billion sold in 2003 and $3.4 billion in January.

Earlier this year, Gov. Pat Quinn proposed a state budget provision that wasn’t approved by the General Assembly that called for contributing $3.74 billion to the five state retirement systems, taking into account state saving from restructured pension benefits. Under it, the $33.7 billion Illinois Teachers’ Retirement System, Springfield, would receive $2.16 billion; the $12.9 billion Illinois State Universities Retirement System, Champaign, $777 million; and the $10 billion Illinois State Board of Investment, Chicago, a combined $801 million for the three systems it oversees — Illinois State Employees’ Retirement System, the Illinois Judges’ Retirement System and the Illinois General Assembly Retirement System.

These are just a few examples of state pension woes. There are plenty of other states suffering similar problems and no matter how many state pension obligations bonds they emit, all they're doing is buying time and not dealing with the underlying structural issues. At one point, the pension time bomb will explode, and taxpayers will be stuck footing the bill.

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