Sifting Through Pension Rhetoric In Search of Pension Truth

A new Moody’s report places Minnesota among the top 15 states in the nation in managing its pension liabilities. But does this relative performance compared to other states really mean our situation is under control? Current efforts to market past and present Minnesota pension policy as a model of fiscal responsibility are not lacking exaggeration and dubious statements of fact.

Among public pension advocates, nothing prompts more finger-waving indignation than referencing the dire situations currently faced by Illinois, California, and several other states in a discussion of Minnesota’s public pension situation. Doing so, they argue, is highly misleading rhetoric that fails to acknowledge the considerable reforms Minnesota has put in place while prompting “free floating panic.” We are, according to public pension advocates, “a model for other states.”

There’s a lot of truth to the argument that for whatever problems Minnesota may have, other states have it a lot worse. A new Moody’s report examines adjusted net pension liabilities relative to all governmental fund revenues (which provide a sense of pension liabilities relative to issuer’s resources) and is expected to be used by that firm in their state credit ratings. According to the report Minnesota’s adjusted net pension liabilities relative to all governmental fund revenues is 27.3% or 37th in the nation. That’s below the national median of 45.1% and well below the intensive care unit known as the Land of Lincoln which ranks first in the nation at a mind-boggling 241.1%.

There is also truth to advocates’ claims that Minnesota’s statewide public pension systems feature some fiscally responsible features not found in some states; most notably employee contributions into the system and prohibiting non-public safety retirees from drawing full benefits until age 66. And the contribution increases imposed on both government and employees, cost of living freezes/adjustments, and other tweaks made over the past two legislative sessions were very important and necessary efforts to help stabilize Minnesota’s public pension systems. (For the record, our organization has consistently acknowledged these features and efforts and has not suggested Minnesota’s current condition mirrors high profile state basket cases).

But pension defenders’ own rhetoric also clouds the issues as Minnesotans struggle to ascertain the “real” condition of the state’s public pensions. Current efforts to market past and present Minnesota pension policy as a model of fiscal responsibility are not lacking exaggeration and dubious statements of fact. Let’s take a closer look at the self-proclaimed “long history of handling pension obligations in a responsible manner.”

• For roughly a decade, despite concerns expressed by plan officials and other experts, Minnesota gave away excess investment returns as permanent benefit increases crippling the ability to weather difficult investment periods. Not only did this policy trigger deficits from which the pension plans have never fully recovered, it created gross inequities among pensioners with benefits for recent retirees struggling to keep pace with inflation while others who retired prior to the dot-com boom have seen their pensions grow over 300% faster than inflation.

• According to a study by the Pew Center for the States examining pension management from 2005 to 2010, “Minnesota consistently failed to pay its full annual pension contribution”

• Policymakers continue to ignore the recommendations of the plans’ own actuaries made four years ago to lower the long-term assumed annual rate of return on the plans’ investments from 8.5% to 8.0%. Why? One very practical reason looms large: because the move would increase the gap between expected future liabilities and assets, resulting in a need for even more contribution increases that would be problematic for both employees and governments.

• Policymakers have extended the periods the pension plans have to pay off their unfunded liabilities well beyond the average service lives of the current employee base. It’s like lowering your mortgage payments by restarting the 30 year repayment period whenever you need to. Not only does this make contribution deficiencies look a lot better on paper, it violates principles of intergenerational equity by making future taxpayers pay for services from which they do not benefit. Or to put it more bluntly – “kicking the can to your kids.”

• This year the legislature appropriated millions in direct state aids for struggling pension plans, and for the St. Paul Teachers plan the state’s injection of cash came with a benefit increase for plan members; making the hole wider while at the same time trying to fill it.

These questionable policies have been accompanied by half truths or outright myths in trying to quash legitimate public concerns about public pension issues:

The myth of 80%. Pension advocates have done a remarkable job of selling the idea to unquestioning media that 80% funding actually represents decent health. Unfortunately, the American Academy of Actuaries has declared that notion a “myth”. In fact, pension experts argue 80% “is the bare-minimum funding level at the bottom of a recession — and only then” and that “it is mathematically necessary for a reasonable funding ratio to be higher than 80 percent and rising on a clear path to full funding” -- which ours are most certainly not.

The myth of the free lunch provided by investment returns. Pension advocates represent investment returns as covering two-thirds of the cost of these plans thus making the role of contributions look relatively marginal -- and reasonably affordable -- in the process. The problem, of course, is that investment follows principal – money needs to be there in the first place to earn those returns. Moreover, long term plan costs are profoundly influenced by investment returns, and if returns fail to materialize as expected, contributions backstop investment performance. Fidelity or private equity funds will not cut big checks to Minnesota with a note saying “whoops, sorry we missed your expectations” to cover the cost of these plans.

The half-truth of the modest “average” benefit. To counter any public concerns about the generosity of these benefits, retirement plans frequently report the “average retirement benefit” for their beneficiaries. However this relatively modest “average” benefit includes large numbers of beneficiaries who receive substantially lower benefits because they willingly made government employment only a temporary part of their career path. The fact is, in conjunction with Social Security, Minnesota’s defined benefit plans are designed to replace approximately 90% of a career employee’s peak income. We have calculated that in 2010, newly retired career employees had an average initial pension benefit 64% - 120% higher than these “average” benefits.

The myth of transition costs. Pension advocates frequently cite the unaffordability of true structural reform noting that the state plan’s actuary estimated that if the state closed its defined benefit plans it would incur transition costs of $3 billion over 10 years because a freeze would trigger accounting rules that accelerate pension costs. But experts point out that accounting rules require nothing of the sort – Government Accounting Standards Board rules don’t determine plan funding, they only govern plans’ financial statements. Governments set funding policy and regularly violate GASB rules, sometimes paying more than GASB requires and sometimes paying less. Having new employees participate in a new pension design makes no difference to what the old DB plan owes. Nothing prevents a government from following current amortization schedules even as they shift to an alternative plan design like a hybrid. (Full disclosure: we were duped by this one ourselves.)

The myth of reform. The crux of the sustainability repairs employed in the last two legislative sessions essentially boil down to new cash infusions from higher employer and employee contributions and state aids, and temporary reductions or freezes in cost of living adjustments until fund health improves (but notably resuming before reaching 100% funding). That’s a very generous interpretation of the word “reform.”

So in engaging citizens on this complex and confusing issue there seems to be an opportunity to move forward in a more productive way. Pension critics should refrain from Chicken Little sensationalism which only a handful of states currently deserve and also acknowledge the best practices Minnesota has in place and the substantive efforts to improve fund condition. In return, pension advocates should stop wallpapering over real issues and legitimate concerns that continue to plague Minnesota’s public pensions and pacifying taxpayers with claims of reform that really aren’t.