Friday, September 6, 2013

Derailing U.S. Pension Reforms?

Suzanne Bishopric, Director of the United Nations Joint Staff Pension Fund, sent me an op-ed published in Pensions & Investments earlier this week, Derailing pension reforms:
The Obama administration is using the federal government's financial clout to attempt to weaken public employee pension reforms passed last year by the state of California. In particular, it is holding up transit project funding for California to try to force state officials to dilute those reforms.

This is unacceptable. States must to be able to decide their own terms and scope of their collective bargaining agreements, just as they determine the terms and funding for their pension programs.

They are on the hook for funding their public employee pension obligations, for drawing on taxpayers and retirement plan participants to contribute to the pension plans. The federal government is not on the hook, and should never be on the hook.

States are supposed to be sovereign entities, not administrative units of the federal government. Last year, California sought to control its pension costs by enacting the Public Employees' Pension Reform Act. It raised contributions and the retirement age of public employees.

Gov. Edmund G. Brown Jr. was correct to stand his ground against the attempt to use the Federal Transit Act to undo the pension reform for state, local and transit district employees.

The leaders of the unions representing the employees protested the reforms under a provision in the act that allows the Department of Labor to hold up transit funding if it finds collective bargaining rights are impeded, according to an Aug. 19 Pensions & Investments story.

Labor Secretary Thomas Perez expressed concern that the California reform statute weakens collective bargaining over pensions. Both the DOL and state officials were negotiating over the dispute, according to the story.

But Mr. Brown shouldn't support a state legislative compromise to exempt public transit employees from the pension reform law in an attempt to satisfy concerns of the Department of Labor. A successful appeal by public transit employees in the state could lead other public employees to seek similar accommodations, and wind up unraveling the financial reforms.

Mr. Perez endorses a level of collective bargaining that federal employees generally don't enjoy. At the federal level, employees are generally prohibited from negotiating on pay and pensions, said Chelsea Bland, communications specialist, American Federation of Government Employees, an AFL-CIO affiliate.

Pension reform is spreading across the states. Wisconsin and Florida, among others, have passed pension reforms in the last two years in an effort to shore up the defined benefit plans for public employees. However, President Barack Obama, having sought unsuccessfully to derail Wisconsin's reform by endorsing union member protests of changes in collective bargaining proposed by Gov. Scott Walker, and now pressuring California over its reforms, seems to oppose these efforts.

Many public employee retirement plans are unsustainable, often because politicians have over promised on benefits and failed to make the actuarially required contributions. Because the bulk of their obligations aren't due for many years, plan sponsors were able to defer proper funding, relying on the growth of current assets to push back the reckoning. But now the day of reckoning is near.

The funded status of 134 state defined benefit plans fell to 73% in fiscal year 2012, from 77% the previous year, according to a study by Wilshire Associates Inc. earlier this year. The rise in interest rates this year should improve funding levels but won't put to rest concerns about sustainability.

California took a major step to protect future pension benefits by seeking to reduce costs and better secure their long-term financing, and it should be supported for that step.

Instead of trying to challenge reform, Mr. Perez ought to encourage steps designed to keep defined benefit plans affordable and promote their viability. He should know what a challenge it has been to maintain those plans for public employees. But Mr. Perez appears to lack a grasp of the costly consequences of the fragility of pension reform.

Many private-sector pension sponsors have given up, deciding they don't want to continue to pay the bills, while other corporations have declined to start such plans.

Mr. Perez should appreciate the challenges of defined benefit systems because he oversees the private-sector pension system as well as being one of the three members of the board of directors of the Pension Benefit Guaranty Corp. The private sector is abandoning defined benefit plans because of costs and regulation. Mr. Perez should appreciate how reforms would contribute to shoring up the system.

As Warren Buffett noted in a 1975 memo about pension financing, virtually all elected officials — and he might well have included appointed administrators — “simply never fully grasp the magnitude of liabilities they are incurring by relatively painless current promises. In many cases in the public area the bill in large part will be handed to the next generation, to be paid by increased taxes or by accelerated use of the printing press.”

California can't print money and the governor, in embracing reform, recognizes that taxpayers have reached their limit. Joshua Rauh, professor of finance, Stanford Graduate School of Business, has shown in his research the desperate funding condition of some public plans.

If benefits are kept reasonable and contributions affordable, defined benefit plans can serve as efficient vehicles for meeting retirement income needs.

But federal government efforts to weaken reform risks pushing costs higher and compelling sponsors, even public ones, to move to defined contribution plans, exposing participants to financial market volatility, leaving them without the protection of defined benefit plans.
Last Friday, I discussed common myths about public pensions, explaining why defined benefit plans are much better than defined contribution plans.

But in order to sustain defined benefit plans, U.S. states have to enact common sense reforms, which is exactly what California did by raising contributions and the retirement age. I agree with this opinion piece, the federal government shouldn't use its clout to weaken public employee pension reforms passed by states. In doing so, it will only weaken defined benefit plans.

There are other pension reforms U.S. states need to enact. As I read about  how money from Detroit's pension fund was misspent, I keep thinking how the U.S. pension governance model is all wrong:
A report by a consulting company helping to restructure Detroit's operations says pension trustees weakened the city's retirement funds with misspending.

The Detroit News reports Friday that the review by Conway MacKenzie found that trustees used hundreds of millions of dollars on savings plans for active workers and gave out annual bonus checks. The practice was used since the mid-1980s.

The report says spending was "effectively robbing" pension funds and contributed to a "significant underfunding" of the funds.

Pension officials deny waste or abuse of pension funds.

The report is expected to factor into pension fund audits ordered by Detroit's state-appointed emergency manager Kevyn Orr.

Detroit filed for bankruptcy in July. Orr says the city has underfunded obligations of $3.5 billion for pensions and $5.7 billion for retiree health.
If serious reforms aren't passed, including reforms on governance, Detroit's cries of betrayal will be heard all over the United States, exacerbating America's new pension poverty.

When it comes to pensions, the U.S. can learn a lot from other countries. The National Institute of Retirement Security  recently put out a press release stating Australia, Canada and the Netherlands Retirement Programs Outshine the U.S.:
While the U.S. faces a retirement crisis, other countries have implemented programs that provide a better level of economic security in retirement. As compared to the U.S., Australia, Canada and the Netherlands provide higher retirement income for more of their citizens through their social security and universal/quasi-universal employer retirement plans.

These findings are contained in a new research brief entitled, Lessons for Private Sector Retirement Security from Australia, Canada, and the Netherlands. The paper is authored by John A. Turner, PhD, director of the Pension Policy Center and Nari Rhee, PhD, manager of research for the National Institute on Retirement Security.

"Americans are struggling to save for retirement. The typical family has only a few thousand dollars saved and the U.S. retirement savings deficit is somewhere between $6 and $14 trillion. Yet, other advanced countries are doing a far better job of enabling older populations to have economic security in retirement," said Nari Rhee, NIRS manager of research and report co-author.

"Our research suggests that U.S. policymakers are wise to look at successes in Canada, Australia and the Netherlands to help get our retirement system back on track. While each country is unique, it's clear that universal coverage and risk sharing are essential success factors in the three countries we studied. In sharp contrast, the U.S. system for private sector employees has low rates of retirement plan coverage. Furthermore, the large-scale shift from pensions to 401(k) accounts has shifted almost all of the funding, investment, and longevity risks to employees. So it's not surprising that the U.S. lags behind other advanced nations, and that we have pronounced retirement insecurity for a majority of the U.S. workforce," Rhee said.

The paper finds that while the level of risk borne by employees varies across the three countries' retirement income systems, risks are pooled among workers or offset by employers and government to a greater extent than in the U.S. In none of these three countries does the average worker individually bear all of the risks related to saving and investing to produce a level of retirement plan income that, combined with social security, provides a basic standard of living. The research also finds that:
  • All three countries provide relatively higher retirement income for low- and middle-wage workers through their social security and universal/quasi-universal employer plans combined than does the U.S. In Australia and the Netherlands, universal or quasi-universal employer-sponsored programs provide a substantial supplement to social security income.
  • Australia's universal workplace retirement system, the Superannuation Guarantee, is a DC system in which workers bear investment risk individually. However, the success of the system is based largely on nearly universal coverage and high mandatory employer contributions, which are now a gross 9 percent of pay and will rise incrementally to a gross 12 percent of pay in 2019.
  • The Netherlands' pension-centered system, funded primarily by employers, is the centerpiece of a national retirement income system that provides some of the highest income replacement rates among wealthy nations. Employers are shifting market and longevity risks toward employees through the increased use of hybrid plans, but employees bear those risks as a group and intergenerationally, not as individuals.
  • While Canada has a voluntary, pension-centered employer-sponsored retirement benefit system with lower coverage than the Australian and Dutch systems, it has a highly progressive, two-part social security system that replaces over 70 percent of lifetime average wage-indexed earnings for low-income workers and about 50 percent for median-income workers.
The experiences of these countries in designing and adjusting their retirement systems provides potential lessons for U.S. policymakers for improving private sector retirement security:
  • Australia, after reviewing problems with its decentralized Superannuation Guarantee system, is carefully setting standards for default funds, fee disclosure, and financial advice.
  • The Netherlands has developed innovative hybrid workplace retirement plans, called Collective Defined Contribution Plans, which are DC plans from the perspective of employers, but are hybrid DB plans from the perspective of employees.
  • In Canada and the Netherlands, employee contributions to DB plans, not just DC plans, are tax deductible. This may be a factor in the relative strength of DB plans in those countries.
The full report can be downloaded here. You can also download a PowerPoint presentation here and listen to a presentation of the report findings here (also embedded below).

I like this report but will point out one major flaw: there is no discussion on how the success of the pension systems in Australia, the Netherlands and Canada is due to a better governance model which separates government from the entities managing pensions.

In particular, pension fund managers at Canada's top ten are much better compensated than their U.S. counterparts, allowing them to attract talented individuals that can manage assets internally. Their governance model is the primary reason behind their long-term outperformance.

Below, Nari Rhee, manager of research for the National Institute on Retirement Security, goes over the key findings of the report she co-authored with John A. Turner, director of the Pension Policy Center.