The Real Story of Public Pensions

An important new book provides insights far beyond the conventional wisdom and the political arguments.
by | November 19, 2012

Alicia H. Munnell's new book, "State and Local Pensions: What Now?", is essential reading for anyone who wants to move beyond the conventional wisdom and gain a real understanding of public-employee pensions. Much of that conventional wisdom, it turns out, is wrong.

Munnell is director of the Center for Retirement Research at Boston College, where she also is the Peter F. Drucker professor of management sciences at the college's Carroll School of Management, so she is one of the foremost experts on the subject. The book not only is a comprehensive consideration of the relevant literature but also provides empirical analysis of an exhaustive Public Plans Database that she and her colleagues at the center have put together. It is this database that makes the book unique and is its great strength. The story of how we got to where we are with public pensions is told in prose that is lively and direct.

Before the two financial crises of the last decade, Munnell writes, most public-pension plans were in pretty good shape. In 2000, the overall funded ratio for state and local pensions was 103 percent. The plans took a hit when the dot-com bubble burst and slid to 86 percent in 2005, then began a slight recovery. But in the financial crisis that began in 2007, the funded ratio began dropping, and hit 76 percent in 2010. For most plans, overall funding is beginning to recover again.

However, as she notes, there is great variation among the plans. Some are 100 percent funded, while a few are funded at less than 50 percent. Delaware, Florida, Georgia and Tennessee are among those that have done a good job of providing reasonable benefits, paying their required contributions and accumulating assets. Other states, including Illinois, Kentucky, Louisiana, New Jersey and Pennsylvania, have failed to make required contributions or used inaccurate assumptions so that their contribution requirements are not meaningful.

Alicia H. Munnell
   Alicia H. Munnell
In the current debate over public pensions, two of the most hotly contested issues are the role of public-employee unions and the appropriate discount rate to use to measure public-plan liabilities. With regard to unions, the contention by many commentators and quite a few politicians is that unions have used their lobbying influence to jack up benefits to unsustainable levels and that breaking union power is the key. On the question of the discount rate, the work of several university economists has been used to make the case that the plans' liabilities essentially have been deliberately understated by using a rate of return that is too high.

Munnell demolishes both of these arguments, writing that "it is impossible to identify a link" between the poorly funded plans and either of those factors. "The poorly funded plans did not come close to surmounting the lower hurdle associated with a high discount rate; raising the hurdle is unlikely to have improved their funding behavior (although it might have curtailed benefit expansions). And union strength simply did not show up as a statistically significant factor in any of the empirical analysis."

Instead, she finds that the differences between states where the plans are in good shape and those where they are not is simply whether or not the state has had a culture of fiscal discipline. Those states with poorly funded plans also have considerable non-pension debt and lack sound fiscal controls. "The shenanigans in Illinois and New Jersey ... have more to do with politicians behaving irresponsibly than with understating liabilities or with union power," she writes. She reports favorably on the experience of Rhode Island, which confronted a massively unsustainable pension system that was going to essentially squeeze out other services but put together a fair and effective solution.

Going forward, there are long-term issues that must be addressed by all public-pension plans. Most governments' revenue systems are outdated and simply do not provide enough revenue. Meanwhile, the great weakening of private-sector pensions has resulted in "pension envy," making it very difficult to increase taxes to support public-employee pensions and easier to cut pension benefits. Finally, Munnell notes, public-pension plans are chasing each other up "the ladder of risk," holding too large a share of their assets in riskier investments.

Overall, Munnell's main message is probably that, in her words, we should "dispense with some of the hysteria" over public pensions. The issues confronting state and local pensions, while not trivial, are manageable. Well, maybe not in every case. In Illinois and possibly Kentucky, she says, "they should be hysterical."

Mark Funkhouser  |  Director, GOVERNING Institute
mfunkhouser@governing.com  | 

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