Penelope Lemov is a GOVERNING correspondent. She was GOVERNING's health columnist and was senior editor for several award-winning features.E-mail: email@example.com
Some state pension plans are doing so well that the private sector could use their advice.
CalPERS is a very big fish. When California's $250 billion employee pension plan flexes its muscle in boardrooms, corporate CEOs sit up and take notice. When it dumps stocks from countries with morally offensive policies, leaders of those nations hear about it.
None of the other public employee pension plans in this country has quite that much clout. But quite a few are starting to gain some. "Public pension plans were for decades sleepy things that nobody paid attention to," says Beth Almeida, executive director of the National Institute of Retirement Security. But in recent years, these funds have grown to some $3 trillion in value. "Obviously, with an investment that large," Almeida says, "they become a focus."
They are a focus because most of them -- although not all -- have done well for their civil-servant customers. Some, like CalPERS, have "developed brand-name equity," says Brad Barber, professor of finance at the University of California-Davis. "They've earned solid rates of return for money they have invested."
This has led to a surprising development: A growing number of states are looking at pension plans as a partial solution to the problem that afflicts private-sector employees.
Fifty percent of the private workforce has no pension plan -- no 401(k) or any other retirement savings program. So, officials in several states think the pension plans could do some good by helping to design work-based retirement savings programs for small businesses or even manage private retirement programs. Under some scenarios, public pension plans would, in effect, become agents for private employers -- to administer and invest money placed in, say, an individual retirement account or a 401(k)-style plan.
So far, the legislatures in only a few states are actively looking into the idea -- notably California, Connecticut and Washington. But the notion is gathering steam.
It is, of course, in any state's interest to have its private citizens, as well as its public employees, financially prepared for retirement. Those who aren't prepared are likely to be dependent on the state for assistance. "When you look across the economy and at how Americans are preparing for retirement," Almeida says, "you see clouds on the horizon and stormy weather moving in." The ominous signs include the likelihood that Social Security payouts will be lower for future retirees, the reality that private employers are turning away from defined-benefit pension plans, and the fact that the personal savings rate hovers at or below zero. Meanwhile, the store of wealth that many households relied on -- their homes -- is dwindling in value or being lost.
Although Congress has passed many laws in the past 30 years aimed at improving income security for retirement, those attempts haven't reached people with limited access to retirement plans at work. "We haven't been able to move the needle on that 50 percent coverage rate," Almeida says. That is what the proposals to link public pension expertise with private-employer needs seek to do.
Most workers who lack pension coverage are employed by small businesses that are not in a position to provide a retirement plan -- they have neither the time nor expertise to create or manage them. The employees can, of course, open IRAs -- individual retirement accounts -- at a local bank or financial institution, but few do. Only about 10 percent of those eligible actually open IRAs, and those who open them tend to be at the upper end of the income scale. It takes some effort and knowledge to go to a financial institution, open an account, decide on an investment strategy and make regular payments. "If it's not automatic," says David John, of the Heritage Foundation, "it doesn't get done."
In some states, public pension managers are being asked to help design employer-based IRA programs that would be easy for workers to use, or to advise on contracting out investment responsibilities for the work-based IRA programs.
In California, where legislators are considering a bill that would put CalPERS in charge of small-business-based IRAs, UC-Davis' Barber believes the link to CalPERS is likely to make the plan more marketable. "There are many small businesses," he says, "that would welcome the chance to participate in CalPERS' investment performance."
A Simple Solution
Turning private pension plans over to state managers would mean that employers need not have any role other than to deduct money from the wages of employees who sign up. It would be the state's job to attract private institutions to the market -- or to designate its pension plan to act as administrator and provider of investment services.
A bill debated in Connecticut this spring looked at several options, including an active role for the state pension plan in running the accounts. Although there was support in both houses, it was tabled, but is likely to be refined and reintroduced next year. The state of Washington has asked its Department of Retirement Systems to look into options for setting up IRA-style plans for small businesses. In Maryland, there is interest among business people and state officials in a public-private partnership that would establish IRA-type accounts for small businesses.
The bill before the California legislature this summer is the most ambitious. It would allow private-sector workers whose employers do not offer retirement plans to open employer-based IRAs that would be administered by CalPERS. Contributions could be deducted automatically from paychecks, and the employee would pay management fees. The account would remain intact when an employee switched jobs. Employers would not be required to make a contribution or even deal with any paperwork.
The bill, proposed by Assemblyman Kevin de Le--n, a Democrat from Los Angeles, has the support of Republican Governor Arnold Schwarzenegger. When he endorsed the bill a few months ago, the governor noted that he saw the idea as one that "will help make businesses more competitive, without costing them anything, and will help employees save for their retirement, without costing taxpayers anything, either."
The Securities Industry and Financial Markets Association, which represents the financial services industry, opposes the bill on the grounds that "simpler, more cost-effective solutions already exist in the private sector." Such issues were raised in Connecticut and are likely to surface in any state that brings up the idea of having a public entity compete with pension services offered by private companies. But, as Dean Baker, of the Center for Economic and Policy Research, points out, some private providers admit that the small-business market is not one they're interested in. "They tell me they're not going to go door to door to meet with employers who have only four employees," he says. "Their target is big companies. If the private sector were interested in the small-business market, they'd be in it. There wouldn't be an issue."
If the California proposal becomes law, it will likely have to run the gamut of review by the Internal Revenue Service, the U.S. Department of Labor and, possibly, the Securities and Exchange Commission. Moreover, there will be substantial startup costs. "I suspect these plans won't take off until and unless these critical legal and cost issues are resolved," says Olivia S. Mitchell, executive director of the Pension Research Council. Mitchell also points out that there is a question of whether CalPERS or any other activist public pension plan is the right investment agent for private-employee plans. "Their assets tend to optimize around long-term liability projections," she says, noting that CalPERS' investment approach includes illiquid holdings, such as hedge funds, venture capital and structured financial products. Private employees with smaller accounts frequently need more liquidity.
There also is a question of whether state pension plans would face new liabilities if they take on these new responsibilities. If, for instance, the stock market continues its slide or individual stocks underperform, would participants sue their public-sector money managers -- as they now sometimes sue their private money managers?
"You have to be careful in how you set up the plans," says David John. "You have to make sure that the overall program is structured in such a way that it doesn't damage the safety of the public employees pension system, that there aren't any unintended consequences, that it doesn't end up costing the public systems money."
Mark Iwry, who specializes in retirement issues at the Brookings Institution, believes state governments should be facilitators that turn to their public pension plans for advice and help in contracting out services, but that, as a general rule, the management of private-sector savings arrangements should still reside in the private sector. "The ideal role for government here," he says, "is to serve as a catalyst: Get things going, and then get out of the way."
But there is one other argument for keeping the pension plans involved, and that's the issue of pension envy. With the private sector continuing to shutter its defined-benefit plans and otherwise rein in retirement benefits, taxpayers are growing jealous of, and sometimes hostile to, the public-employee plans whose expenses they pay but whose juicy returns they do not share. Opening the system to private workers might add a new lobby to defend public pensions.