Retirement & Health Benefits in the Public Sector

April 10 and 11, 2015
Robert L. Clark of North Carolina State University and Joseph P. Newhouse of Harvard University, Organizers

Jeffrey R. Brown, University of Illinois, Urbana-Champaign and NBER, and George Pennacchi, University of Illinois, Urbana-Champaign

Discounting Pension Liabilities: Funding versus Value

Brown and Pennacchi argue that the appropriate discount rate for pension liabilities depends on the objective. In particular, if the objective is to measure pension under- or over- funding, a default-free discount rate should always be used, even if the liabilities are themselves not risk-free. If, instead, the objective is to determine the market value of pension benefits, then it is appropriate that discount rates incorporate default risk. The researchers also discuss the choice of a default-free discount rate. Finally, they show how cost-of-living adjustments (COLAs) that are common in public pensions can be accounted for and valued in this framework.

Jeffrey Clemens, University of California, San Diego and NBER, and David M. Cutler, Harvard University and NBER

Impact of ACA on State and Local Health Plans

The landscape of retiree health coverage has changed dramatically since the Great Recession. Between 2008 and 2013, recent retirees between ages 50 and 65 became 8 percentage points less likely to report having coverage through an employer. Clemens and Cutler find that declines were substantial in both the public and private sectors. In the public sector context, substantial changes in retiree coverage have been associated with instances of acute, short-run fiscal stress. While coverage alternatives made available through the Affordable Care Act may facilitate this cost-cutting strategy, the data do not, as of yet, allow the researchers to systematically link these phenomena.

Jeremy D. Goldhaber-Fiebert, David M. Studdert, and Monica Farid, Stanford University, and Jay Bhattacharya, Stanford University and NBER

Will Divestment from Employment-Based Health Insurance Save Employers Money? The Case of State and Local Governments

Reforms introduced by the Affordable Care and Patient Protection Act (ACA) build new sources of coverage around employment-based health insurance. But what if firms find it cheaper to have their employees obtain insurance from these sources, even after accounting for penalties (for non-provision of insurance) and employee bonuses (to ensure the shift is cost neutral for them)? State and local governments (SLGs) have strong incentives to consider the economics of such "divestment"; many have large unfunded benefits liabilities. We investigated whether SLGs would save under two scenarios: (1) shifting all employees and under-65-retirees to alternative sources of coverage; (2) shifting only employees whose household incomes indicate they would be eligible for federally subsidized coverage and all under-65-retirees. Full divestment would cost SLGs more than they currently pay, due primarily to penalty costs. Selective divestment could save SLGs nearly $129 billion over 10 years at the expense of the federal government.

Robert L. Clark; Emma Hanson, North Carolina State University; and Olivia S. Mitchell, University of Pennsylvania and NBER

Lessons for Public Pensions from Utah's Move to pension Choice

This paper explores what happened when the state of Utah moved away from its traditional defined benefit pension. Instead, it offered new hires a choice between a conventional defined contribution plan, versus a hybrid plan option having both a guaranteed benefit component and a defined contribution plan shifting investment risk to employees. Clark, Hanson, and Mitchell show that some 60 percent of new hires failed to make any active choice and, as a result, they were automatically defaulted into the hybrid plan. Slightly more than half of those who made an active choice elected the hybrid plan. Interestingly, post-reform, employees who failed to actively elect a primary retirement plan were also far less likely to enroll in a supplemental retirement plan, compared to new hires who made an active plan choice. The researchers also find that employees hired following the reforms were more likely to leave public employment, resulting in higher turnover rates than previously. This could reflect a reduction in the desirability of public employment under the new pension design. The results imply that public pension reformers must consider employee responses, in addition to potential cost savings, when developing and enacting major pension plan changes.

Alan R. Weil, Project Hope

State Health Plans and Their Impact on State Budgets

Alicia Munnell, Jean-Pierre Aubry, and Mark Cafarelli, Boston College

COLA Cuts in State-Local Pensions

In this paper, Munnell, Aubry, and Cafarelli find that one surprising response of public plan sponsors to the financial crisis and recession was their reduction of cost-of-living adjustments (COLA) for current workers and retirees. The response was surprising because it has often been assumed that public workers have greater benefit protections than their private sector counterparts. The Employees Retirement Income Security Act of 1974, which governs private pensions, protects accrued benefits, but allows changes to benefits going forward. In contrast, most states have legal provisions that limit changes to future benefits for current workers. Yet they were able to change COLAs for current workers and, often, for retirees.

Robert L. Clark, and Emma Hanson, Melinda S. Morrill, and Aditi Pathak, North Carolina State University

Supplemental Plan Offerings and Retirement Saving Choices: An Analysis of North Carolina School Districts

Unlike private sector employers, public school districts generally offer more than one type of supplemental retirement savings plan and allow multiple vendors to offer products. Using an employer survey coupled with individual-level payroll data from over half of the public school districts in North Carolina, this study examines the impact of inter-district differences in supplemental plan management and offerings on participation in these savings vehicles. Clark, Hanson, Morrill, and Pathak find wide variation in total participation rates and in 403(b) plan participation rates in particular, even among this population of public-sector workers with consistent defined benefit plan, health, and retiree health coverage. Individual and district characteristics explain some, but not all, of the variation observed.

Jeffrey R. Brown, University of Illinois, Urbana-Champaign and NBER, and Richard Dye, University of Illinois, Chicago

Illinois Pensions in a Fiscal Context: A (Basket) Case Study

Public pensions for Illinois state workers are among the worst funded in the nation. Benefit generosity is not the primary culprit: Illinois is around the middle of the distribution of state plans based on initial retirement benefits. Although the annually compounded three percent post-retirement benefit increase makes Illinois' pensions one of the more expensive systems on a lifetime basis, this only partially offsets the fact that most Illinois workers do not participate in Social Security. Brown and Dye present evidence that the main reason for Illinois' underfunding is a history of making inadequate contributions, dating back to the very origins of the state's public pensions. The researchers discuss the recent history and current uncertain legal status of pension reform efforts in the state. Using a fiscal model of the state's finances, they project how Illinois' fiscal situation may evolve in the future, both with and without pension reform being upheld by the courts. A key finding is that with or without pension reform, Illinois will continue to face significant structural deficits that will require revenue increases or additional spending cuts to address.

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