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Stop Doomscrolling, Public Pensions Will Be Fine
In the long-run, governments have time to respond to stock market shocks and most public pension systems will be able to adjust.
If you are doomscrolling on how the stock market is performing this year, you likely came across a number of news stories about its affect on public pension plans. In case you missed them, here are a few:
Public Pensions’ Lost Decade City Journal
Public Pensions Face Sharpest Funded Ratio Drop Since Great Recession Chief Investment Officer
Public Pensions Facing Largest Single-Year Decline Since 2009 401K Specialist
Big Picture: Public pension plans are a fiscal pressure point for many state and local governments. While contributions are likely to increase as investment returns fall short of assumptions, it is not a fiscal crisis.
For the year, July 1 to June 30, the S&P 500 declined 15 percent in 2007 and another 28 percent in 2008. Since 2008 governments reformed pension benefits, lowered their investment assumptions, and overall have been reducing the risk of their pension plans. Interestingly, a few months ago the NYC Comptroller asked the state legislature to allow his office to invest a greater share of the city’s pensions into riskier alternative assets for higher returns.
Higher Wages are Good for Public Workers
For the past two years, public sector employment recovery has significantly fallen behind the private sector. Low pay is one factor. In West Virginia, a new public-school teacher can start out making a minimum $34,297 according to state statute. Prior to this, WV schoolteachers went on strike in 2018 for nine days, shutting down all 680 public schools for a 5 percent pay increase. Oklahoma’s schoolteachers also went on strike in 2018 for higher salaries and school funding. According to the National Education Association, Oklahoma teachers made an average salary of $45,276 in 2016.
The Jobs Report that came out on Friday shows the public sector jobs recovery is lagging, and in some cases stalled. While private sector jobs have recovered above their February 2020 peak, employment in local government is below its February 2020 level by 555,000, or 3.8 percent. We have covered this a few times, notably in March of this year—that the state and local government jobs recovery has been noticeably slower than the private sector.
Higher than assumed salary growth can increase liabilities and normal costs. Normal costs are the cost of benefits accrued in the current year, typically noted as some precent of total payroll for a government employer. While this requires governments to revise salary growth trends upward, in some cases governments have not been adding to payrolls like they are already assuming. In 2017, the Kentucky retirement system lowered its payroll growth assumption for its Non-Hazardous and State Police Plan to zero, noting its covered payroll was actually contracting in past years. Assumptions should be revised continually and wages should be going up to attract public workers.
One Tool to Help Governments: “Re-amortization”
Amortization is paying off a debt over time in installments. Public pensions use a variety of methods to either not pay down their unfunded pension liabilities over time or change their funding schedule. The ability to re-amortize long-term obligations can provide considerable budgetary flexibility. Governments are not going anywhere and pensions will be paid, so it is not a big deal if an entity likely to exist in perpetuity decides to re-amortize its debt out a few more years. In some cases, this can occur while undertaking other prudent reforms.
In 2017, the state of Connecticut lowered its assumed rate of return for its state employee retirement system from 8 percent to 6.9 percent and extended out the amortization length – it started paying less annually and smoothed contributions over time to ease strain on its budget. This was a prudent example of how re-amortization can help governments ease pressure off their budgets instead of raising new revenues or reducing services.
Is There Really a Crisis?
After the dramatic shock to equities during the 2008 global financial crisis and in the years it took for the stock market to recovery, governments reformed their pension plans.
As one Center on Budget and Policy Priorities (CBPP) put it in 2011,
Unlike the projected operating deficits for fiscal year 2012, which require near-term solutions to meet states’ and localities’ balanced-budget requirements, longer-term issues related to bond indebtedness, pension obligations, and retiree health insurance … can be addressed over the next several decades.
According to a paper presented at the 2019 Municipal Finance Conference,
Plans can stabilize assets and debt as a share of the economy with only moderate increases in contributions, equal to 5 percent and 12 percent, respectively, of their payrolls. In addition, under low 1.5 percent asset returns, the increase in contributions required to stabilize the pension system is similar whether plans act now or in 10 or 20 years. In contrast, the increases required to achieve full prefunding are substantially larger and would likely spark a fiscal crisis.
Leading up to the March 2020 economic downturn, state governments steadily improved their pension funding while reducing plans’ risks over the past decade. Governments have adopted more conservative actuarial assumptions and methods, while directing resources into pension plans above what was annually required. According to the National Association of State Retirement Administrators (NASRA), the average investment return rate assumption has fallen below 7.0%, its lowest level in more than 40 years.
Public Pensions, a Concern, but Not a Crisis
The public retirement system is not in crisis, nor is it going bankrupt. State and local pension systems are continuing to make progress on reforms, such as adopting more conservative actuarial assumptions, revising various other actuarial inputs, and prefunding liabilities. These reforms have put many systems on a path to long-term sustainability. Will governments pay more when the stock market declines, yes, but they have time and, usually, an ability to respond. Some poorly funded plans, lacking legal flexibility to make changes, are facing more pressing concerns.
Already high fixed costs, in cities like Chicago, are a problem that needed addressing before this year’s stock market downturn.
For decades, there has been talk about the same places with poorly funded public pensions. According to reporting by Axios,
The worst-funded statewide pension plans as of 2021 were Kentucky State Employees (22%), Kentucky State Police (33.8%), Indiana Teachers Pre-96 (35.4%) and New Jersey Teachers (35.5%).
The worst-funded local plans as of 2021 were Providence Employees (26.3%), Chicago Firefighters (31.1%), Chicago Police (34.9%), Chicago Municipal (36.4%) and Chicago Laborers (45.9%)
Many of these plans have already enacted reforms in recent years or improved funding. Kentucky moved to more conservative funding assumptions and has been adding billions more in annual contributions to its plans; New Jersey has been increasing contributions to its pension system and dedicated lottery revenues; and Providence (somewhat as a last resort) is issuing pension obligation bonds.
A recent report by the non-profit Equable noted many plans are fragile, but not yet distressed. Some good news they highlighted:
While a few states did not fully fund their required contributions in 2021, on net states collectively paid closer to the actuarially determined rates (99.8% in the aggregate) than in any year since 2001.
The challenge for the public pension system in totality is not one of solvency, but rather how to pay for the benefits and prudently manage their annual budgets. While investment returns have fallen short of expectations now, they should come back over time. If they do not, governments have years, and in some cases decades, to respond (but it is best not to wait). In the long-run, the best way to ensure the sustainability of the U.S. public pension system is for state and local governments to make the necessary contributions to fund benefits using realistic assumptions that reflect actual plan conditions.
Any opinions expressed herein are those of the author and the author alone.
This will be my last post for a few weeks, but will pick this back up sometime in September.