Blog: Funding

San Jose Mayor Chuck Reed is sponsoring a statewide ballot initiative that would change California’s constitution to allow state and city governments to make prospective changes to retiree benefits. To better understand the initiative and why he’s sponsoring it, I spoke with Mayor Reed.
Pensions contribute a large amount of money to local economies, but size shouldn't be the end-all argument. We need to get past discussions of size and start talking about the most effective ways to ensure retirement security for all public sector workers.
Every state except Vermont has a balanced budget amendment, yet states have wracked up large unfunded liabilities for their pension and retiree health plans. How can both of these things be true at the same time?
Illinois recently passed pension reform legislation with a number of complex provisions. To better understand the legislation and the issues around it, I spoke with Illinois State Senator Daniel Biss, a co-chair of a bipartisan working group exploring solutions to the state's pension crisis and a co-sponsor of the recent legislation.
Hyping the difficulty of public employee pension funds is one of the few growth industries in the current economy. The reality is that teacher pensions face a mixed situation.
Placing all workers on a path to a secure retirement regardless of tenure or when they were hired should be the principle aim of any retirement system. Unfortunately the current system falls short of this aim in most jurisdictions today.
In terms of teachers and other public school employees, the real challenge is recruiting and retaining the most accomplished professionals to help ensure the success of all our students and ultimately our nation.
The big news out of the latest Public Education Finances Report is official confirmation that school districts spent less money per student in 2010-11 than they had the year before, the first one-year decline in nearly four decades. It’s worth taking some time to reflect on that fact, but the full report is also a valuable source of data on state and district revenues and expenditures and the entirety of the $600 billion public K-12 education industry. One key takeaway is that employee benefits continue to take on a rising share of district expenditures.

Conventional wisdom says that public sector pensions are far too optimistic in assuming an 8-percent investment return. Indeed, the stock market has far underperformed that goal lately, leaving pension plans in precarious financial shape.

But, if we expand our time frame to a longer horizon of, say, 25 years, it turns out that conventional wisdom is false. Using actual investment return results from state pension plans as of the end of 2012, the National Association of State Retirement Administrators found that median investment returns actually exceeded state targets over longer time periods:

5 years: 2.9 percent

10 years: 7.5 percent

20 years: 7.9 percent

25 years: 8.9 percent

This 25-year period included the bull market of the 1990s, one of the longest economic expansions in modern history, but it also included the subsequent crash, the disappointing 2000s, and the Great Recession of 2007-09. It wasn’t a “typical” 25-year period, but no 25-year period is typical. In fact, if you look at the performance of a balanced investment portfolio over long time horizons, it almost always beats state investment assumptions. As is often repeated, past performance is no guarantee of future results, but we shouldn’t ignore it, either. It’s tempting to focus on how bad the last five years have been, but it would be odd to argue that we should pay attention to only very recent history while disregarding the longer perspective.

So why are state pension plans in such poor financial shape today? There are two main reasons. One is that at the end of the 1990s, when state pension plans looked like they were in great shape, many states adopted benefit enhancements. State legislators looked at well-funded retirement plans, buoyed by an amazing stock market run, and decided they could support higher benefit payments. They couldn’t. Inevitably, short-term thinking put them in trouble today.

Second, the plans suffer from tremendous volatility. Investment returns now contribute about two-thirds of a pension plan’s earnings in a given year. When they turn negative during an economic crash, plan funding falls precipitously. But looking at a state pension plan after a recession and declaring it financially insolvent is no different than spendthrift state legislators expanding benefits at the end of the 1990s. They’re both driven by short-term thinking.

Articles on retirement security, like this one from the NY Times, are good to read and know about. The short version is that few of us are saving enough for retirement, so we’re going to see more “retired” people working part-time, retiring later, or, worst case scenario, looking for a government fix. The situation is even worse for younger Americans.

One thing that’s particularly relevant for this blog is that defined benefit pension plans are more or less a thing of the past for most workers, and in the next five or ten years we’re going to have a whole class of workers becoming eligible for retirement age who’ve never had a DB plan in their entire working career.

To see why this matters, check out the chart below from a recent McKinsey report.  It’s divided by age and income, and it shows how much, or how little, workers have saved for retirement and what form that savings takes. At the bottom right-hand side are workers aged 60-65 who earn $20-50,000 a year. Sixty percent of their retirement income will come from Social Security, 22 percent will come from a defined benefit pension plan, only 1 percent will come from personal savings, and they’re facing a 17 percent shortfall between what they have saved and what they’re likely to need. Looking at the next youngest age bracket, workers aged 40-59 earning the same amount, they can expect 48 percent from Social Security, only 4 percent from a DB plan, an 6 percent from personal savings (including 401k plans and IRAs). They face a 42 percent shortfall.

These figures would be improved, although not erased, through a stock market boom. The awful truth is that Americans just aren’t saving enough for retirement.