I have a number of concerns about the Cleveland Fed’s Drawing Board video pertaining to the issue of public pensions.
I believe the video’s portrayal of the condition of state and local pension plans is sometimes misleading. Among my major concerns:
The video states that, “By some estimates, more than half of the country’s state and local plans could see their pension funds dry up by as soon as the year 2034.”
The Center for Retirement Research (CRR), which has prepared its own estimates of projected insolvency, has referred to these findings as a “pessimistic portrayal of plan finances.” An excerpt from its study reports that “Most plans have enough for at least 30 years. And these estimates are conservative. They are based on 2009 data and therefore do not reflect the run-up in the stock market in the last year.”
“Most state and local governments are supposed to adjust contributions every year.”
I infer this statement to mean that contribution rates should be adjusted annually. Although adjusting rates annually might be considered by some a best practice, there is no compelling actuarial principle or strong reason that contribution rates should be or need to be adjusted each year. Indeed, the vast majority of public pension plans use actuarial methods designed to keep contribution rates stable, and some plans that are well funded maintain rates that change little over time. Contribution rates for some public pension plans are fixed in statute and change rarely; others change annually, and some are adjusted occasionally.
“Most state and local governments have put themselves in a position where they don’t have any money left over to pay their pension contributions.”
This statement seems to imply that pension costs are the final funding priority of sponsors of state and local government pensions, and that these plan sponsors fund their pensions with whatever funds are available after all other spending priorities have been addressed. Although this scenario may occur in isolated instances, for the vast majority of states and local governments, this is not the case. For example, in fiscal year 2010, the latest year for which full data is available, a majority of public pension plans received their full annual required contribution (or ARC). Many states statutorily require full payment of the ARC.
The observation that many state and local governments don’t have any money left over to pay their pension contributions is not supported by the facts. Without question, many states and cities face difficult challenges and choices due largely to a combination of factors, including lower or stagnant revenues and higher spending demands, of which greater pension costs are one. Many public employees have been furloughed; salary growth for the sector has been weak and, in some cases, negative; pension contributions have been increased in many states; and reductions in public services are widespread. But singling out pension costs in attributing state and local fiscal problems, to the exclusion of other factors, is unfair.
“Many plans could find themselves in a self-reinforcing spiral if they have to dip into their principal to pay their retirees. That means that each year, they have a smaller base from which to pay retirees.”
Unlike some trust funds, the purpose of a pension fund is not to preserve principal, but to pay promised benefits. During the earlier years of the life of a typical pension plan, the fund receives contributions from employees and employers, and pays out less than it receives in these contributions. This condition is known as being cash-flow positive. Eventually, as the plan matures (defined as a diminished ratio of active, contributing members to annuitants), the plan will pay out in benefits more than it receives in contributions. This is known being cash-flow negative, and is a normal part of a pension plan’s life cycle.
Eventually, a pension fund’s principal is going to be used. Whether or not the use of a pension fund’s principal is problematic is a matter of degree and circumstance: it is the size of the required payout, relative to other factors, such as the plan’s long-term obligations and the ability of the plan sponsor to fund the plan, that is more important than whether or not the fund is paying out more than it receives in contributions.
In general, the video does not acknowledge or discuss any of the manifold changes that have been made to pension plans in a number of states. In some cases, these changes actually reduced unfunded pension liabilities, such as in Colorado, Maine, Minnesota, New Jersey, Oklahoma, Rhode Island, South Dakota, and Texas. Lawsuits remain outstanding in some cases, but in others, lawsuits either have not been filed, or have been resolved. Many states have increased required employee contributions on existing plan participants. Yet, both by what it says and by omission, the video leaves viewers to believe that reforms are not taking place and have little hope of enactment or legal success, scenarios that are not, in fact, correct.
There is no question that funding pension obligations poses significant challenges to some states and cities. But the extent of these challenges varies widely from one entity to another, and states and cities are working to resolve the problem.
Although the video presents a dire picture of state and local government fiscal conditions, due especially to pension challenges, a more realistic assessment would, in my view, be more optimistic. If municipal bond markets are any indication, they appear to be optimistic about the future of state and municipal fiscal conditions: current yields on municipal bonds are now at their lowest level in decades, a sign of confidence.
Keith Brainard, Research Director
National Association of State Retirement Administrators