Jeff Kempker, CEBS, CRC
The May 2, 2016 article on Forbes.com, A Solution To Our Public Pension Problem, left me scratching my head. The overall theme of the article is, that because ALL public pensions are doing poorly, we should completely abandon pensions so all Americans are covered under 401(k)-type plans. I will admit that some public pensions have great challenges and may be in need of reform, but these are the minority and many plans across the nation have already made adjustments so they are more sustainable. I will also fully admit that I am not an economist, and would never claim to be. I’m just a guy that believes retirement security is for everyone and it can be achieved without an all-or-none solution. With that being said, let’s discuss the article’s main points.
There is a public pension crisis.
The authors of this article talk about a public pension crisis in America and make the reader believe that there is a wide-spread problem. This is not true. The truth is there is a retirement crisis in America, not a public pension crisis. In fact, most public pension plans in the U.S. are working well to promote retirement security while at the same time, many Americans do not have enough money saved to support themselves during retirement. If public pension plans are abolished in favor of defined contribution accounts, e.g. 401(k)s, this will only hurt retirement security and further exasperate the retirement savings crisis.
The authors of the Forbes article talk in length about the unfunded liabilities of public pensions but fail to mention the underfunding of individual retirement savings accounts. Bottom line, people with only a 401(k) are not saving enough. According to a report by Monique Morrissey of the Economic Policy Institute, the average retirement savings for working age Americans is $95,776 and for those on the cusp of retirement, ages 56-61, the average account balance is $163,577. These amounts are hardly enough for someone to sustain an adequate standard of living during retirement. And, these amounts only include workers that have retirement savings, which is only around 50% of the workforce, the other half has nothing. So, if you include ALL families, the average retirement savings for Americans age 56-61 is $17,000.
Unfunded Liabilities
The authors mention the unfunded liabilities of public pensions as an enormous problem. The truth is that most states and localities are doing a good job in funding their pensions for sustainability. For example, Missouri LAGERS has 682 participating employers who diligently make their required contributions each and every month and move toward being fully funded over decades of time. While each LAGERS employer has their own funded level, LAGERS as a whole is 94% funded (80% is considered good).
Think about the purchase of a home. The belief is that buying a home is a long-term investment. No one would say that taking out a 30-year mortgage is irresponsible so long as you diligently make your required monthly payment and you are living within your means. That is how we should view public pensions, as a long-term investment in our communities to attract and retain the best public servants possible. Then, after those workers have helped make their communities better over a career, pensions provide a dignified means for exit from the workforce at an appropriate age. Often when we look at unfunded liabilities all we can see is the dollars. But those dollars represent time worked protecting, maintaining, and building strong communities.
A Fundamentally Flawed System
The authors of the Forbes article say that defined benefit plans are a flawed system pointing to “generational accounting and excessive expected rates of return.” First, the authors describe a pay-as-you-go pension funding model, like Social Security. This is a model where the people who are working now are paying for the benefits being paid now. So, over time, costs have to increase because there are more retirees.
What the authors fail to mention is that most public pensions don’t use a pay-as-you-go funding model. Pensions, including LAGERS, typically use a pre-funding method of payment so benefits are funded before an individual retires. This method requires a higher contribution in the beginning so that the funds can be invested and contributions don’t need to increase as the retiree pool grows. Contribution rates are designed to remain level over decades of time.
Expected Rates of Return
This is referring to the return that pension plans assume they will make on their investments. The Forbes article authors infer that all public pensions use unrealistic investment projections to calculate their liabilities. This, again, is not true.
Investment income matters, as investment earnings account for a majority of pension funding. A shortfall in long-term expected investment earnings must be made up by higher contributions or reduced benefits.
Funding a pension benefit requires the use of projections, known as actuarial assumptions, about future events. One actuarial assumption is the investment experience. This must be a realistic figure to ensure that members and taxpayers (the other sources of funding) are not being undercharged or overcharged. If the assumption is too low, member and employer contributions must increase, if the assumption is too high, shortfalls in the investment performance would have to be made up by higher contributions or reduced benefits.
LAGERS investment return assumption is 7.25% and the average investment return assumption for public pensions is 7.85%. LAGERS’ assumption is based on historical returns as well as a recent asset liability study projecting returns 20 years into the future. LAGERS’ 20-year return is 8.70% and its return since inception is 8.92%. We believe our assumption is realistic, prudent and sustainable. We are in this for the long haul.
Take a cue from the private sector.
I could write a series of responses on the flaws of this section of the Forbes article. Here the authors contend that all people, public and private, should be placed into 401(k) type plans. They say that this puts “the power of an individual’s future in their own hands instead of depending on the good fortune of government-directed DB-style plans” and “retirees will finally have the opportunity to determine how much risk they are willing to take.” While these are great soundbites, here are the facts.
The retirement system in the private sector is in shambles and the 401(k) experiment has failed. People are not saving enough, don’t understand the investment landscape, are being forced to work longer, and have no security because their nest eggs are subject to the whims of volatile markets. While the 401(k) may be a great vehicle for higher paid workers to generate wealth, it has not been a sufficient vehicle for all workers to generate secure, dependable retirement income, especially those with lower or more modest wages.
The authors also say that private sector employers moved to the 401(k) system because of the plan’s “efficiency, simplicity and fully funded nature.” This is also not true. Private sector employers moved to 401(k) plans for two reasons, to reduce costs, and therefore, reduce retirement benefits and because of the over-regulation of private pension plans. You see, the 401(k) was intended to be a supplement to pensions for those who could afford to save more and as a way for companies to pad executive compensation. They were never intended to be THE retirement plan. However, over the years, companies realized they could save money by reducing retirement security and doing away with pensions. Further, the Federal government, in an effort to save pensions, actually has done more harm by enacting complex and expensive regulations that have forced private sector employers away from defined benefit plans.
Investing money is complicated. Knowing how much to save, which products to purchase, when to re-allocate, and how to draw out an account so you don’t run out of money during retirement can be completely overwhelming. The 401(k) system requires the individual to navigate the murky waters of the investment seas completely on their own. Sure, there are financial advisors willing to help (for a fee), but many people are hesitant to trust the advice of a stranger and don’t know how to find a qualified advisor. For these reasons, the move to 401(k)s has further widened the gap between the haves and have-nots. Those with higher incomes can afford to save more, have more access to financial help, and have increased capacity to make investment decisions. For the rest of us, good luck.
Retirement security should be for all Americans who work hard and play by rules. Defined benefit pension plans are worth fighting for because they are the most efficient way to promote retirement security, provide a dignified exit from the workforce and help middle-class workers transition into being middle-class retirees.
Jeff Kempker, Manager of Member Services