Fiscal Challenges of Public Sector Pensions Public Sector Pension Reform: Addressing Pressing Fiscal Realities from a Long-Term Perspective A Forum of the TIAA-CREF Institute and the Rockefeller Institute of Government SUNY Global Center, 116 East 55th Street, New York, New York December 7, 2012 Donald J. Boyd Senior Fellow dboyd@albany.edu
Why focus on contributions? • State & local govt budgets are short run • Liabilities are abstract and long term • Contributions are real and immediate: – Increases lower services or higher taxes – (or gimmicks, for a while) • Current or impending contribution increases spur policy changes • (Sometimes liability fears can be a spur) 2 Rockefeller Institute of Government
We all (sort of) know the underfunding facts • ~$1 Trillion unfunded liabilities in 2011, actuarial methods, ~75% funded [top 100-126 plans ~$850b UAAL, ~85% of universe; depending on source] • $3-4Tr. at low-risk discount rates; ~50-45% funded • Great variation – some systems extremely underfunded, some well-funded • Two schools of “thought”: – Sky is Falling – Don’t Worry, Lots of Time – (And, thankfully, positions in-between) 3 Rockefeller Institute of Government
Best and worst, actuarial estimates 4 Rockefeller Institute of Government
Will unfunded liabilities lead to unaffordable contributions? When? Comparison to bonded debt • SLGs have $2.8Tr. long-term debt (Census, not FOF) • But their path will pay existing debt off: – Interest alone exceeds $100b annually (aggregate DS not easily measured) – Affordable: generally level payments – Predictable : fixed rates, scheduled amounts. Budget-threatening spikes not ordinary or automatic. • Plus: (1) assets are still delivering services!, (2) legal promises are pretty clear, (3) states need those to whom they owe - want to go back to debt markets • Few people are hysterical about debt. 5 Rockefeller Institute of Government
SLG contributions: $96b in 2011, up 11% 6 Rockefeller Institute of Government
Don’t Worry - contributions are “only 3.8% of operating budgets” • That was then. They are rising. SLG contributions increased 11% in 2011. CA +20%, KY +61%, NY +35% • Taxes (available funds) better denominator than spending: 6.6% of taxes in 2010, 7.3% in 2011 • Depends on where you are: 2010 state-local contrib. range: 2.3% of taxes in ND to 12.6% in NV. Local govt contrib 25% of local taxes in NV! • Huge for some specific govts: San Diego 20% of gen fund, San Jose 27% (per press reports) 7 Rockefeller Institute of Government
Contributions “only 3.8%”… • Contributions are below what actuaries request: $17b below ARC in 2011. If full ARC paid, contrib. ~9% of SLG tax. • Actuaries request less than economists estimate. Novy-Marx & Rauh estimated $163b increase in annual ERC for full funding, low- risk rates. Increase ~what SLGs spend on highways; or on police, prisons, jails combined. • In some places, paying promised compensation for past services is crowding out current services. 8 Rockefeller Institute of Government
Which govts pay contributions ? State vs. local • Local govts: 74% of SLG workforce, 72% of wages • Locals pay ~59% of contributions on avg (states often pay some contributions for local workers) • It depends on which state (and on where in state): – ME, NJ, UT – state pays nearly 100%. IL state pays TRS contributions outside of Chicago. – AZ, FL, NV, OR, and a few others – locals pay > 80%. CA, NY – significant local component. • So, it depends: local govts and state govts both can be at risk when plans are in trouble. 9 Rockefeller Institute of Government
Billion Dollar Bad Boys Club • Most govts pretty good about paying ARCs: ~50% of plans rec’d 95+% of 2011 ARC • Govts paid ~80+% of ARCs in 2011 ($17.2b short); 2007-2011 shortfall was $61b • A few states account for essentially all of the shortfall. • Contribution shortfalls are SMALL compared to $1.3Tr. investment income shortfall. That’s a far bigger cause of underfunding. • But they are insidious: system only “works” if ARCs are paid. Otherwise promises are empty.
Even well-funded plans can cause fiscal stress. Example: New York ERS • Conservative aggregate cost method can cause rapid ARC increase after investment shortfalls. (Thanks to CRR for insight.) • Court decision requires funding the ARC ( McDermott v. Regan ). (“Amortization”* law effectively allows some deferral.) • 182% contrib rate increase, 2010-2014, ~+$3.7b • Governments must pay, mostly* (that’s a good thing). But this increases local fiscal stress.
Addressing shortfalls: will they or won’t they? • NY: govts generally must pay • NJ: 7-year ramp; contrib must increase ~$4.5b 2013-2018 (depending upon returns, …). Increase =~40% of annual education aid. Crowd-out. Will they pay? • IL: who can say? 12 Rockefeller Institute of Government
Risk • Novy-Marx/Rauh numbers indicate risk being taken. (Govts could avoid risk by paying $163b more annually, 2010 rates. More now.) • In practice, plans will continue to have risky investments. If return assumptions are met, it could work out for most plans. Or, underfunding could get much worse. • 2007 to 2009: funds fell about $1.3Tr short of assumptions. CalSTRS and CalPERS both went from ~100% to 60% funded in 2 years. Could this happen again? 13 Rockefeller Institute of Government
As retirement systems mature, payments exceed contributions and investment earnings become more important
As investment earnings’ importance has increased, asset riskiness also generally has increased
Who bears this risk? • Ostensibly, the govts (mostly). Pensions have strong legal protections, albeit varying and subject to court interpretations. • But when/if the money’s not there, legal protections may be diluted or hard to enforce. Possible incentive to negotiate reductions in promised benefits, in exchange for more-certain benefits. 16 Rockefeller Institute of Government
Options re: benefits depend upon intersection of law, politics, and need • New tiers are easiest legally and politically because they only affect people not yet hired. But none of the unfunded liability is for people not yet hired! • Benefits still-to-be-earned by current workforce: very gray area. • “Base” benefits of retirees very hard to adjust – legally, politically. • COLAs of retirees: powerful $; possible under some circumstances • Contributions by existing workforce • Lots of litigation ahead 17 Rockefeller Institute of Government
Conclusions • “Bad actors” (AHM) in trouble no matter what. Who will bear the cost? • For others – contributions probably increasing through about 2015, if return assumptions are met. If plans reduce return assumptions will be large subsequent contrib. (ARC) increases. • With current assumptions, lots of risk; low current-returns environment a concern. (Further work on risk and contributions needed.) 18 Rockefeller Institute of Government
Rockefeller Institute The Public Policy Institute of the State University of New York 411 State Street Albany, NY 12203-1003 www.rockinst.org Donald J. Boyd, Senior Fellow dboyd@albany.edu
Appendix 20 Rockefeller Institute of Government
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