An Annotated Rebuttal to State Pension Plan Directors’ Star Tribune Commentary

Minnesota’s public pension plans recently made not-so-pleasant national headlines when Bloomberg News reported that under new government accounting standards Minnesota’s public pension health took the biggest hit in the nation.  In that article the executive director of Minnesota’s Legislative Commission on Pensions and Retirement declared our current situation “a crisis.”  Unsurprisingly, this prompted state pension plan directors to go to DEFCON 1 in a Star Tribune commentary to reassure its members and the general public that the state is on top of things and all is well.  

The arguments presented in the Strib commentary are ones we have heard and commented on for many years, but the stakes surrounding this issue are simply too important to let this message go without a response.  

“Those who seek to privatize Social Security and state retirement plans covering public employees like to characterize these earned retirement programs as “Ponzi schemes” or “pyramid schemes.” This is the kind of hyperbole that substitutes for fact for those who are philosophically or ideologically opposed to defined-benefit pension programs. There’s something about the efficiency of pensions that irritates our detractors."

Many staunch supporters of defined benefit pension plans, including pension actuaries and defined benefit plan experts, are critical of the types of certain policies Minnesota pension systems (and public pension systems generally) employ.  It’s an effective rhetorical gambit to suggest everyone who objects to the status quo is politically and ideologically driven.  However, these critics are not bothered by “efficiency,” but rather by the risk and exposure faulty accounting practices and other pension system policies create.

“Public-pension plans are an ongoing and very long-term proposition. Teachers, public-safety officers, snowplow drivers and road-repair workers pay into their pension plans when they begin their careers, which might span 40 years, and receive retirement benefits until they die. This is why we manage public-pension funds with an indefinite horizon in mind.”

Having an “indefinite time horizon” doesn’t eliminate the risk of running out of money – we can point to a few places in the U.S. where this is currently unfolding.   Nor does it excuse the irresponsible current practice of transferring large current obligations onto future taxpayers.  Should current taxpayers be paying for the retirement benefits of both the snowplow drivers and road workers of today and their predecessors?  Should future generations of taxpayers be on the hook for both the employees of today and the employees that are providing service to them in the future?  Because that is exactly what we are now doing, and based on our current path, we’ll being doing a lot more of in the future.

“We continually monitor projections and regularly propose benefit and contribution changes to the Legislature to keep the plans on sound financial footing well into the future.”

Then why, according the latest valuation reports, are we collectively $20 billion short based on market value of assets?

“In response to an increase in liabilities due to longer member life spans and lower expected future investment returns, the Teachers Retirement Association (TRA) has proposed $1.6 billion in benefit reductions and $92 million in annual contribution increases, and the Minnesota State Retirement System (MSRS) has proposed $1 billion in benefit cuts and $37.5 million in annual contribution increases. The Public Employees Retirement Association (PERA) board is currently considering options to pursue in 2018.”

That may sound like a lot of money but those numbers need to be put in perspective.  Since 2002 (about the last time Minnesota pension plans were fully funded) policymakers’ failure to make the necessary required contributions has created over $6 billion of growth in our unfunded obligations.  The $2.6-plus billion in benefit reductions is swimming against $17.3 billion in unfunded liabilities created by a failure to achieve targeted investment returns.  The phrase “a day late and a dollar short” has never been more apropos.

“Critics of public pensions respond that states and their taxpayers can’t afford these plans. In fact, Minnesota pensions are efficient: Government spending on pensions is only 2.3 percent of total state and local spending here, compared with 4.5 percent nationally.“

There is a mammoth difference in what we DO spend and what we NEED TO spend to fund the current system responsibly.  See those numbers above.  It’s not a badge of honor to chronically underfund the system with help from accounting conveniences.  But this is certainly a new way to define “efficiency.”  It’s like your kids saying, “Mom, I cleaned half my bedroom.  It was more efficient than cleaning the whole room like I was supposed to.”

“In addition, Minnesota’s pensions are prefunded, meaning the systems have more than $64 billion in the bank.”

A not-so-minor problem:  we should have about $20 billion more “in the bank” right now just to pay for (*ahem*) prefunded benefits that have already been earned.

“That money is invested by the State Board of Investment and earns more money.”

Except for the money that goes out the door to actually pay retirement benefits, administrative expenses, and money owed to people who leave public service before retirement.  In the 2016 fiscal year, the state’s public pensions paid out $4.5 billion or about $2.2 billion more than the contributions that went into the system. 

“For the year ending June 30, 2017, we earned 15.1 percent on investments. SBI’s average return is 10.2 percent over 35 years.”

Well done.  But since we’ve been assuming pension investments would “only” return 8 - 8.5% per year how in the world can we be $20 billion in the hole with that amazing track record – especially since as stated earlier,  “we continually monitor projections and regularly propose benefit and contribution changes to the Legislature to keep the plans on sound financial footing well into the future.”  

Something else must be going on.  And one of many “somethings” is this:  you only get investment returns on the assets you have to invest.  If a pension plan is significantly underfunded, a 15.1% annual return generates far fewer investment dollars overall than if it was 100% funded.

“This successful investment program keeps taxpayer cost low, since the majority (73 cents of every dollar) of what is needed to pay benefits comes from investment gains. Well-funded plans reduce the reliance on future contributions. In an August paper, the National Conference on Public Employees Retirement Systems said that public pensions are “beneficial to taxpayers in a variety of ways that are both underreported and poorly understood.” Indeed, Minnesota taxpayers pay only about 14 cents on the dollar for public pensions and benefit from millions of dollars in pension fund assets invested in our economy.”

What is the source of capital behind pension plans’ investment gains?  Magic beans?  It’s employer and employee contributions and money from the state general fund.   And if those investment gains don’t materialize as expected, who will make up the shortfall?  Will our investment advisors and private equity firms say, “Sorry, we didn’t meet your expectations.  Here’s the difference”?

“And retirees typically spend their pension checks locally, supporting businesses and job creation.”

And tax dollars that don’t go to increased pension support are put in a pile and incinerated.

“But the complexity of public-pension finance makes it easy to mischaracterize or cherry-pick data. For example, we are required by the Governmental Accounting Standards Board (GASB) to report certain data annually using accounting methodology. Financial results using this method are simply a snapshot in time and do not anticipate any future course corrections or adjustments.”

Exactly how is one ever supposed to “establish proper course corrections and adjustments” without proper accounting?  It’s the foundation for making crucial decisions on how to repair these pension plans.  Imagine a business making the same argument on their financials.  “Just ignore our current balance sheet and income statement, what really matters is what we expect they will look like a few years from now.”

“Long-standing actuarial methods of projecting funding status progress are more useful for plan administrators and policymakers because they are future-focused. The year-to-year GASB numbers will fluctuate wildly due to market swings and do not provide appropriate guidance for oversight of pension funding, which is best viewed through a long-term lens.”

“Long-standing actuarial methods of projecting funding status”  =  using the expected investment return as the discount rate to calculate liabilities – a practice which keeps current contribution requirements low and allows pension liabilities to compound just as fast as investment return expectations.   Or to put it more succinctly:

"The use of the expected return assumption as the discount rate virtually guarantees the eventual failure of any plan using it.” -- Barton Waring, former Chief Investment Officer of Barclays Global Investors and author of Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control, in testimony to the Government Accounting Standards Board

“Public-pension opponents use data selectively to lobby for switching public employees to 401(k)-style retirement accounts.“

The defined benefit versus defined contribution debate is a false choice. There are many reform options to explore.

“In 2011, the retirement systems conducted a study and found that closing the pension plans and switching to a 401(k)-type system would cost the state $3 billion.  Benefits would still be paid to those in the legacy plan even as contributions were diverted to private accounts.”

Closing a pension plan doesn’t create new costs.  That $3 billion “cost” estimates what would be needed upfront to speed up the payoff of unfunded liabilities so the can isn’t kicked to future taxpayers.  It’s a timing issue of when the $3 billion would be needed, not if it would be needed.

But the way our pension plans are currently designed is already transferring billions in current pension obligations to future taxpayers.  It’s tough to square up concerns about pension reform saddling future taxpayers with today’s pension costs when current pension practices are already doing an exceptional job of doing just that.

“Studies have shown that the U.S. has a retirement crisis as workers reach retirement age without adequate savings.  Switching public employees to a wholly private savings system would be bad for Minnesota.”

Failing to fund pension obligations responsibly and properly is a lot worse for Minnesota.

“The state’s pension funds are not in crisis. Minnesota has a long history of taking appropriate corrective action when necessary, and now is one of those times. We urge lawmakers and the governor to act on our proposed reforms. With their help, Minnesota’s public-pension plans will be financially sound for many years to come.”

We urge lawmakers and the governor to cease and desist with the increasingly frequent “half measure” tweaks and repairs that are constrained by political and biennial budget circumstances rather than grounded in economic realities.  It is time for full measure reform – and the extent to which that can or should be done within a traditional defined benefits system structure needs to be carefully examined.   We do not serve the interests of present and future taxpayers or public sector workers, or ensure the continuing provision of high quality public goods and services by failing to acknowledge the seriousness and the magnitude of the challenge before us.