 |
|
Posted November 9, 2007 The full Governing Management Letter | Subscribe to The Governing Management Letter Bonus columns: GIRARD MILLER’S BENEFITS BEAT Retirement Funding Realities Get ready to spend another 3 percent of payroll — forever Questions, success stories or anecdotes about benefit issues in government? The federal Government Accountability Office just produced a timely report on the retirement benefits and funding status of state and local governments. It should be required reading for both elected and appointed officials, especially those running pension plans and benefits programs, setting or recommending policy, or managing public finances. 
The report presents a very realistic view of the current status of retirement benefits plans in the state and local government sector, and presents a cogent array of projections of the proper funding levels that taxpayers will likely face in coming years. Most pension plans are "on track." GAO's "base case" projections show that nationwide, public pension funds on average will need to collect another 0.3 percent of payroll from employers and employees if real investment returns exceed inflation by 5 percent annually (a reasonable and commonly used actuarial assumption for a perpetual pension plan). Although it would be nice to see zero as the required additional contribution, this fractional number appears manageable and should put to rest their critics' "Chicken Little" arguments that public pension plans are falling apart at the seams like Social Security. As explained in my companion column this month on the annual survey of state pension plans, the last five years have seen a dramatic increase in employer contribution rates that have already brought these plans very close to their proper long-term funding rates. Of course, there is wide variation around the national averages. As they say, a person can drown in a river that's only 4 feet deep on average. Likewise, there are still many pension plans with dismal funding ratios and insufficient contribution rates, so it's important to avoid the temptation to declare victory nationwide. In Illinois, for example, the insufficiency of contributions for many plans is staggering, as I reported months ago in my column on pension funds in the doghouse.
The real problem: retiree medical promises. The report is far less sanguine about the financial hurdles facing state and local governments in fulfilling their promises to pay other post-retirement benefits (OPEB) — notably retiree medical benefits promises. Here, the picture is actually frightening. For example, here is a GAO graph of the imminent rise in medical benefits costs facing state and local governments if they continue current funding practices: In contrast to pension expenses included in the top line, which are actually projected to decline over time as a percentage of GDP, the cost of health care expenditures including retiree medical will likely double at least. And worse yet, the percentage of the national economy devoted to providing employee benefits for state and local governments is projected to increase to a combined level near 16 percent! If you consider also federal employees and retirees expecting Social Security and Medicare, the percentage of the U.S. economy devoted to retirement benefits seems unsustainable in this context. The GAO report unfortunately did not present a projection of the costs of OPEB funding if all governments were to establish a pension-like trust fund and begin putting away money to actuarially fund their OPEB liabilities. Apparently that was too difficult to model.* But the report (page 35) does show that in the "base case," a pay-as-you go financing system discounted to present value would require additional contributions of 3 percent of payroll, to raise the long-term cost stream from the current 2 percent to a 5 percent long-term level. However, as with the "average river" cited and illustrated above, that average 5 percent number implies a much higher contribution rate in later years. If there is any glimmer of hope in all this, it would be that the additional costs now projected by GAO can be mitigated if state and local governments act soon to constrain their retiree medical benefits payments and begin to fund their obligations properly so that investment earnings will help defray part of the expenses. Such measures will also help ensure that future generations don't get stuck paying the bills for services provided now for current taxpayers. Intergenerational equity will be served best if governments begin to pre-fund the benefits earned by their employees each year, using either a defined-contribution plan with lower risks and probably lower costs to taxpayers, or a defined-benefit structure with lower risks to employees. And let's not forget that employees should rightfully share a portion of these costs in future years, as they are receiving a benefit that few taxpayers enjoy. My companion column this month on hybrid plans explains how this might best be done. *Industry experts have presented data elsewhere showing that pre-funding can result a long-term cost saving of approximately one-third of the actuarial liability, which in this case would save 1 percent of payroll over the long term. See, for example, the Government Finance Officers Association Web site's 2007 conference link to the "OPEB II" session. 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. | ||||
