Robert L. Clark and Melinda S. Morrill, North Carolina State University
Retiree Health Plans in the Public Sector
While no longer common in the private sector, most public sector employers offer retiree health insurance (RHI) as a retirement benefit to their employees. While these plans are thought to be an important tool for employers to attract, retain, motivate, and ultimately retire workers, they represent a large and growing cost. Clark and Morrill review what is currently known about RHI in the public sector, while highlighting many important unanswered research questions. Their analysis is informed by detailed data from states on their liabilities associated with RHI, which were produced in accordance with the 2004 Government Accounting Standards Board Rule 45 (GASB 45). They consider the extent of the unfunded liabilities states face and explore what factors may explain the variation in liabilities across states. The importance and sustainability of RHI plans in the public sector ultimately depends on how workers view and value this post-retirement benefit, yet little is known about how RHI directly impacts the public sector labor market.
Leora Friedberg, University of Virginia
Labor Market Aspects of State and Local Retirement Plans: A Review of Evidence and a Blueprint for Future Research
Alicia Munnell, Jean-Pierre Aubry, and Laura Quinby, Boston College
Public Pension Funding Standards in Practice
Public pension funding has recently become a front-burner policy issue in the wake of the financial crisis and given the pending retirement of large numbers of baby boomers. Munnell, Aubry, and Quinby examine the current funding of state and local pensions using a sample of 126 plans, estimating an aggregate funded ratio in 2009 of 78 percent. Projections for 2010-13 suggest that some continued deterioration is likely. Funded status can vary significantly among plans, so they explore the influence of four types of factors: funding discipline, plan governance, plan characteristics, and the fiscal situation of the state. Judging the adequacy of funding requires more than just a snapshot of assets and liabilities, so the authors ask how well plans are meeting their Annual Required Contribution and what factors influence whether they make them. They also address the controversy over what discount rate to use for valuing liabilities, concluding that using a riskless rate of return could help improve funding discipline, but would have to be implemented in a manageable way. Finally, the researchers assess whether plans face a near-term liquidity crisis and find that most have assets on hand to cover benefits over the next 15-20 years. The bottom line is that, like private investors, public plans have been hit hard by the financial crisis and their full recovery is dependent on the rebound of the economy and the stock market.
Henning Bohn, University of California, Santa Barbara
Should Public Retirement Plans be Fully Funded
Most state and local pension plans strive for full funding, at least by actuarial standards. Funding measured at market values fluctuates and often falls short. A common argument for full funding is that pensions are a form of deferred compensation that does not justify a debt. Bohn examines public finance, political economy, and financial market issues that bear on optimal funding, broadly and in a series of models. He finds full funding difficult to justify except under extreme assumptions. Importantly, most taxpayers hold debt and face borrowing costs, and this makes pension funding costly.
Robert Novy-Marx, University of Chicago and NBER, and Joshua D. Rauh, Northwestern University and NBER
Policy Options for State Pensions Systems and Their Impact on Plan Liabilities
Novy-Marx and Rauh calculate the present value of state pension liabilities under existing policies, and separately under policy changes that would affect pension payouts including cost of living adjustments (COLAs), retirement ages, and buyout schedules for early retirement. If plans were frozen as of June 2009, liabilities would be $3.2 trillion if capitalized using taxable municipal curves, which credit states for a possibility of default in the same states of the world as general obligation debt, and $4.4 trillion using the Treasury curve. Under the typical actuarial method of recognizing future service and wage increases, liabilities are $3.6 trillion and $5.2 trillion using municipal curves and Treasury curves respectively. Compared to $1.8 trillion in pension fund assets, the baseline level of unfunded liabilities is therefore around $3 trillion under Treasury rates. A single percentage point reduction in COLAs would reduce total liabilities by 9-11 percent;, implementing actuarially fair early retirement would reduce them by 2-5 percent; and raising the retirement age by one year would reduce them by 2-4 percent. Even relatively dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets under Treasury discounting. This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state DB pension plans.
George Pennacchi and Mahdi Rastad, University of Illinois
Portfolio Allocation for Public Pension Funds
Pennacchi and Rastad present a dynamic model of a public pension fund's choice of portfolio risk. Optimal portfolio allocation is derived when the pension fund manager maximizes the utility of wealth of a representative taxpayer. Alternatively, portfolio decisions are derived when the pension fund manager maximizes his own utility of compensation. The model's implications are examined using annual data on the portfolio allocations and plan characteristics of 125 state pension funds over the 2000 to 2009 period. Consistent with agency behavior by public pension fund management, the authors find that funds choose greater overall asset and liability portfolio risk after periods of relatively poor investment performance. In addition, pension plans that select a relatively high rate with which to discount their liabilities tend to choose riskier portfolios. Moreover, consistent with a desire to gamble for higher benefits, pension plans take more risk when they have a greater proportions of plan participants on their Boards of Trustees.
Sylvester J. Schieber, Towers Watson
Political Economy of Public Sector Retirement Plan
Virtually all state and local employers in the United States offer workers some sort of retirement benefits today, but there is significant variation in the characteristics of those plans. There is also a great deal of public angst about the level and timing of commitments made in these plans. The literature on retirement plans suggests that there are important elements of compensation that plan sponsors use in meeting their human resource goals. But public retirement plans are created and operated in a public policy environment, and forces other than local labor market considerations may be brought to bear in the organization and operation of these plans. Schieber explores some of the possible explanations for the variation in state retirement plans. He uses public disclosure data ito develop a model that explains relative generosity of benefits based on the characteristics of participants and the marketplaces in which the plans are offered. He then places the issues explored in a forward-looking context. The public disclosure environment recently put in place for public retirement plans is likely to have a more profound effect on state pension operations than any other development in recent history, he concludes.
Brigitte C. Madrian, Harvard University and NBER
Defined Contribution Plans in the Public Sector: Lessons from Behavioral Economics
In the private sector, defined contribution savings plans have largely displaced traditional defined benefit pensions. In the public sector, in contrast, traditional defined benefit pensions are still the norm, although some jurisdictions have followed the private sector and shifted either in whole, or in part, to a primarily defined contribution system. Going forward, fiscal pressures are likely to generate more movement in this direction, and even in states with a primary defined benefit plan, supplemental defined contribution plans are almost always offered to employees. Madrian applies the lessons we have learned about individual savings behavior in private sector defined contribution savings plans, as well as lessons from behavioral economics, to the unique institutions of the public sector and their savings behavior.
Eduard Ponds, Netspar, and Clara Severinson and Juan Yermo, OECD
Funding in Public Sector Pension Plans -- International Evidence
Most countries have separate pension plans for public sector employees. The future fiscal burden of these plans can be substantial, as the government usually is the largest employer, pension promises in the public sector tend to be relatively generous, and future payments have to be paid directly out of government revenues (pay-as-you-go) or by funded plans (pension funds) which currently tend to be seriously underfunded. The valuation and disclosure of these promises is all too often less than transparent, which may be hiding potentially huge fiscal liabilities that are being passed on to future generations of workers. In order to arrive at a fair comparison between countries regarding the fiscal burden of their DB public sector pension plans. Ponds, Severinson, and Yermo gather more evidence on public sector pension plans, especially the type of pension promise, and they quantify the future tax burden related to these pension promises. For a number of plans from a sample of OECD countries, they have estimated the size of the net unfunded liabilities in fair value terms end of 2008. This fiscal burden also can be interpreted as the implicit pension debt. They find that Finland, UK, France, and Germany rank highest as to the net unfunded liabilities as percentage of GDP. The net unfunded liabilities in the Netherlands (ABP and PfZW together), Canada (only public servants), and Sweden are low because of the relatively high funding levels in their funded plans. The United States (all state and local plans) and Norway show up in an in-between position.