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Posted November 9, 2007 The full Governing Management Letter | Subscribe to The Governing Management Letter Bonus columns: GIRARD MILLER’S BENEFITS BEAT Hidden Strengths in Public Pension Funds Yet taxpayer costs surge Questions, success stories or anecdotes about benefit issues in government? The National Association of State Retirement Administrators (NASRA) recently released a report summarizing its annual survey of the nation's largest public pension funds. It tells an interesting story of quiet improvements and important trends. In a nutshell, most public pension plans are stronger financially and recovering steadily from the last recession. If financial markets can hold their current levels or better, the funding status of most pension funds should continue to improve in the next year's report as well. What can we learn from this experience? 
First, the funding status of public pension plans improved significantly, but because of "actuarial smoothing," it's almost impossible to tell that. With best intentions, the actuaries try to dampen the volatility of stock market returns in making their projections of required employer contributions. So they smooth (average) the actual market levels of plan assets over time — often three years, sometimes even more. When the stock market is rising in an expanding economy, the asset values used by the actuaries are less than what the portfolio is really worth. (An average always lags the latest number when a trend is underway.) One noteworthy graphic in this year's NASRA report ("Figure E" below) shows the distribution of each system's ratio of actual market assets vs. the actuarial "smoothed" assets used to calculated the unfunded liability ratio. Some plans were below 90 percent and one was actually 140 percent of its smoothed actuarial level. The average plan had a market value of 103.8 percent of its actuarial number. As you can see, most plans enjoy market values at or above their actuarial values. So they are actually in better shape than their actuarial reports would suggest, at least on that measure.
This is healthy. And it's not a result of anything devious by the plan administrators or the actuaries. Over the long run, actuarial smoothing helps avoid highly erratic annual funding contributions by public employers, which would wreak havoc on their budgets and tax rates. Especially when times are good and markets are ebullient, the actuarial data helps deter the "tomb raiders" looking for magical benefits increases (see my previous column on pension overfunding). After all, the next recession will likely take 15 points off those funding ratios before the next upcycle begins. In fact, my experience in working with some of the nation's largest pension plan administrators and trustees is that they learned a lesson from the frothy markets of 2000 — and will be much more reluctant to accept benefits increases if financial markets continue to rally. They have learned that in pension market cycles, what goes up will eventually come down. That's how many plans slipped into their present under-funded positions in 1999-2000, because they caved in to lobbyists pushing for better benefits allegedly "at no cost." Needless to say, there has been a cost. Just look at the bar graphs below ("Figure M") to see how much additional money the taxpayers are forking out or giving up these days to make up for the benefits-enrichment blunders of pension boards and legislators at the peak of the last bubble. The chart shows annual rates for the past five years. For plans with employees eligible for Social Security, the employers' costs have increased by a factor of 42 percent, from 6 percent of payroll to 8.5 percent. A similar but less dramatic cost increase, from 10.3 percent to 11.5 percent of payroll, was required in plans which exempt their employees from Social Security benefits. These percentages represent tens of billions of taxpayer dollars of added pension expenses. Notably, the employee contribution ratios did not increase during this period. The taxpayers have essentially borne the entire expense of the new asset-liability gap, which is what inevitably happens when benefits are increased on the illusory premise of inflated investment returns.
To put these charts into perspective, the increase in major public employer pension plan contribution rates in the past five years was greater than the payroll tax rate increases required to completely eliminate the national Social Security deficit for the next 75 years! Critics would argue that this was all done without a single taxpayer vote, and with no "fair share" employee contribution increases — which pension officials would admit but reply that at least their plans are already addressing their deficits, unlike the Social Security trustees and Congress. So if we are fortunate enough to witness a continued bull market in the next year or two, plan trustees and politicians must be reminded of the lesson that history gave us in the last full market cycle. In fact, if investments ever do produce a widespread public pension surplus, that money should first be recycled for unfunded retiree medical benefit promises, not to fund yet more benefits increases, as I outlined before in my OPEB funding column. On the investment front, the good news is that public pensions clearly got their act together and produced some pretty impressive overall portfolio returns. I'll bet that on average the plans have outperformed their member employees' personal investment portfolios and their 457/401(k)-type accounts by 1 or 2 percent annually over recent years, and more than that when fees are considered. The report includes statistics on that as well, for those interested. Finally, my hat's off to author Keith Brainard at NASRA, who does stellar work in collecting, compiling and intelligently presenting this valuable information for public consumption. He's a true professional and one of the best researchers in public finance if not America. Last month: 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. © 2007, Congressional Quarterly, Inc. Reproduction in any form without the written permission of the publisher is prohibited. Governing, City & State and Governing.com are registered trademarks of Congressional Quarterly, Inc. | |||||||
