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Watching out for disability abuse

A Night in the Doghouse?

Putting a Leash on Underperforming Pension Funds

If a public pension fund is underperforming, should taxpayers or legislators "freeze" the plan and require additional funding to set it straight? That's what the Illinois Civic Federation proposed recently in a new report highlighting the $16 billion actuarial deficits of Chicago-area public pension plans. The federation recommends that the state's General Assembly:

· Prohibit benefit enhancements unless a pension plan is at least 90 percent funded.

· Require increased employer, and possibly employee, contributions to a pension fund if its funded ratio is below 90 percent.

This report contains the germ of an idea that may garner support in other states, especially among taxpayer associations and business lobbyists: Put underperforming funds in the doghouse. Although a growing number of public pension plans are returning to acceptable levels of actuarial funding as the economy improves, some plans suffer chronic underfunding.

Like sour investments, they are the "dogs" of the pension world. Their doghouse status often reflects historical decisions to award benefits without paying for them, actuarial hubris at market peaks, or lackluster investment management. The federation's proposal would prohibit such doghouse plans from awarding new benefit increases until their funding ratio improves.

One can quibble about whether 90 percent is the right number and whether the funding ratio alone is the right measure, but let's set those technicalities aside for now.

What's intriguing about the Chicago proposal is that there could be other doghouse pension plan rules that taxpayer advocates might present in the coming legislative and ballot-petition season. For example:

· Prohibit a doghouse plan from awarding future benefits that are more generous than those paid to nongovernmental employees, unless approved by the voters. This addresses the so-called "pension envy" issue attracting media attention, with taxpayers reportedly becoming resentful of public employees receiving pensions more generous than their own.

· Gradually raise the doghouse plan's normal retirement age (e.g., to 62 or 65, over a decade or more) while allowing an actuarially reduced early retirement pension. New Jersey unions just accepted an age increase.

· Prohibit new employees from entering a doghouse plan — which would force employers to establish new plans with proper funding or lower benefits or alternatively to establish a defined-contribution plan. This kind of back-door defined-contribution legislation might be just the opening that the mutual fund industry has been looking for. However, it would do nothing to solve the underfunding problem of the crippled pension fund unless the employer donates its savings to the doghouse.

· Move underperforming investment funds from local management to the state pension system if the state demonstrates superior investment performance. Small local pension plans have an inherent disadvantage in today's sophisticated markets. Lacking scale, they typically incur higher fees and miss opportunities — alternative investments ranging from timberland to Hollywood to private equity and hedge funds — that now go first to the Big Dogs. Massachusetts has proposed to do just that.

· Apply a doghouse rule to retiree medical benefits, which are grossly underfunded nationwide. Here, a 90 percent funding threshold would be completely impractical; it would trigger a national scramble for funding solutions far beyond that caused by the Government Accounting Standards Board's new rules on "other post-employment benefits" accounting. That could spark a wildfire of OPEB bond sales, which might not be timely or prudent. A lower, realistic doghouse ratio for OPEB plans would be necessary for at least a decade.

Whether any of these doghouse proposals would help solve underfunding is open to technical debate. But they may achieve their purpose if they force trustees, management, politicians, labor leaders and participants in these doghouse plans to focus on fixing the funding problem — instead of ratcheting up benefits when the market hits new highs or underfunding when politicians can't get their budgets to balance.

Such proposals could have a chilling effect on the public-sector pension community and governmental labor relations. Without corrective local or legislative action soon, however, the smoldering political environment could kindle a nationwide "Pension Prop. 13" movement, with an impact on public agencies echoing California's Proposition 13-inspired tax-cut crunch.

Last month: Set the stage for downshifting

Index of recent columns

Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net.
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