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State retirement funds

This page is about pension and other retirement benefit plans managed by US states. The main question is the financial condition of the plans.

Summary

23 Oct 2010.

Unfunded obligations of state retirement funds, including both pensions and retiree health care, are in the neighborhood of $3 trillion. This is something like two years' worth of aggregate state income. On average, then, this is a heavy, but not crushing, debt load. Because politicians have delayed facing the issue, annual expenditures will rise. One reasonable projection puts pension plan contributions needing to increase by about 5% of aggregate budgets. Health plan expenditures are less well characterized, but might add another 2%, bringing the total adjustment to 7% of state budgets. The difficulties in both pension and retiree health plans are spread very unevenly. Some states face minor adjustment, and some will likely face adjustments of perhaps twice the average. For comparison, the drop in state tax revenues due to the recent crisis averaged about 10%.

Graph

22 Oct 2010. Data through 2008.

Data are from the Census of Governments, covering only defined benefit pension plans.

Highlights

Clippings below covered through Oct 2010.

Cash flow (23 Oct 2010)

  • Pension: Boston College CRR estimate that if state and local governments were to calculate their unfunded liabilities using a 5% discount rate, and then make the full Annual Required Contribution (ARC), pension expenditures would rise from an aggregate 3.8% of budgets to 9.1%, i.e. an increase of 5.3% of budget. For comparison, in CA, the budget of the entire judicial system is 2.9% of the state budget, state support for the University of California is 2.4%, and environmental protection receives 1.2%. So an increase of 5.3% would in fact cause considerable pain. In addition, states will not, in fact, be so sensible, and many are in a much worse than average position. For example, if Illinois continues to spend down capital until it is gone, and then switches to pay-as-you-go, pension expenditures would rise to 16% of the state budget.
  • Health Plan: The health plan problem is somewhat smaller than the pension problem. States paid $15 billion on retirement health plans in 2008 (Pew), compared to $36 billion on pension plans (Census). And, since most retirement health plans are pay-as-you-go, that $15 billion is approximately the benefits paid, while benefits paid in pension plans were $175 billion (Census). However health plan costs are lower partly because there has been almost no effort so far to fund the long-term costs. If states had made the health plan ARC, contributions would have been $43 billion, according to Pew. Other data are anecdotal, but worrying. For example, according to a study from the Empire Center, New York's health plan costs are projected to triple by 2026.

Legal (22 Oct 2010)

  • Pension plan accounting is governed by GASB 5 (1986), which required uniform accounting of future obligations and current funding; and 25 and 27 (1994), which introduced the Annual Required Contribution (ARC), covering the obligations accruing in the current year plus a payment to amortize the unfunded obligation over 30 (originally 40) years.
  • Health plans are covered by GASB 43 and 45, from 2004 (though 45 was not fully phased in until 2009). This requires state and local plans to report the total obligation, the unfunded portion, and the ARC.
  • State pension plans, but not health plans, are protected by law from change for current employees.

Pension bonds are a small problem, in aggregate (22 Oct 2010) Pension bonds, issued to cover required contributions to pension plans, are a terrible idea, and may be a significant problem for some states. But for state pension plans in aggregate, they are almost certainly a small issue. While unfunded liabilities were in the trillions, a total of $50 billion in pension bonds was issued in the 25 years ending with 2008.

Public and private (20 Oct 2010)

  • As of 2009, 20% of private sector employees, and 90% of public sector employess, had access to a DB plan.
  • Benefit levels have risen more for public employees. From 2004-Q2 to 2010-Q2, the rise in an index of employer benefit costs rose 17.6% for private industry and 31.1% for state and local government. Over that period the CPI rose 14.9%.
  • According to the BLS, 19.4% of employee costs go to health benefits and retirement and savings in state and local government, compared to 11.0% in private industry.
  • According to Bloomberg, “State and local governments paid $3.04 per hour toward each employee’s retirement as of 2007, according to U.S. Labor Department data. Private employers paid 92 cents per hour.”
  • There are scattered changes to reduce benefits for new employees


Retirement fund discount rate (17 Oct 2010) The discount rate of a retirement plan is the rate of return on investments that is assumed, when measuring whether current savings are adequate to meet future obligations. Discount rates are highly controversial, and there are good reasons to think they are often set too high.

Few taxpayers or shareholders think carefully about discount rates, but they make a major difference. For example, a $1000 obligation due in 30 years requires setting aside $309 now with a 4% discount rate, but only $99 now with an 8% discount rate.

Naturally, politicians (for public plans) and CEOs (for corporate plans) tend to gravitate towards high discount rates, as it frees money for other purposes today. If actual returns fail to live up to expectations, however, the plan may have to make up the lack by placing excessive burdens on future payers, or may even become insolvent. Further, plan administrators may be tempted to take excessive risks to meet high expected returns.

Corporate plans often use the AA corporate bond rate as their discount rate, in keeping with international accounting standards. But the AA bond rate is higher than the risk-free rate for a reason – to account for the risk of default. So many argue that the risk-free (say, Treasury) rate should be used instead.

State pension plans (and many other public plans) use discount rates that cluster around 8%. Plan administrators argue that this is not far from historic average returns. There are two arguments that, even so, such a rate is too high.

The simple argument is that history may not repeat; the Financial Times comments, on California's largest plan, “Calpers actually has earned its target rate in the past 20 years, but this was a decent period for equities and a great one for bonds.” The more complex but also more telling argument is about volatility. Higher returns tend to be associated with higher volatility. Even if average returns come out on target, volatility may mean a high probability that in some years the plan will be seriously underfunded. Funds do not provide any risk analysis of temporary insolvency due to volatility. The conservative course would be to use low risk investments and a corresponding lower discount rate.

State pension plans have the bulk of members and assets (19 Oct 2010) As of 2008, state-administered pension plans accounted for 8 percent of total plans, but 88 percent of the active members and 82 percent of assets.

Variation between states, pension (19 Oct 2010) Some states are conscientious about making required contributions and some are not. State pension funded ratios had the following distribution as of 2008:

State pension funded ratios:

<65%     5 states
65-74%  11 states
75-84%  11 states
85-95%  12 states
>95%    11 states

Variation between state, medical (22 Oct 2010) States vary greatly both in the generosity of their promises and in the state of their funding (though most are pay-as-you-go). The end result may be seen in the variation of the ARC (annual required contribution, see above): The highest ARCs per capita, as of 2009, were in Alaska $553, Hawaii $556, and New Jersey $675. The lowest were Iowa $8, Indiana $7, and North Dakota $6.

Underfunding, aggregate (22 Oct 2010)

  • Pension and health: As of 2008, Pew looked at 231 pension plans and 159 health plans, and found that they were about $1 trillion underfunded. This is based on states' estimates, and so included an unrealistic discount rate and had not taken 2008 losses into account. To give some sense of scale, the unfunded obligation exceeded annual payroll in 22 states.
  • Pension: As of 2009, the 116 largest state and local pension plans were, using Treasury rates to discount, $3.1 trillion underfunded. Using corporate accounting rules, they were about $2 trillion underfunded.
  • Health (in all cases, what was actually evaluated was the “other post-employment benefits” category, but this is mostly health benefits; also note that all evaluations based on state calculations thereby include unrealistic discount rates and unrealistically low healthcare cost inflation, and fail to reflect 2008 losses):
  • In the Pew study, as of 2008, $555 billion ($587 billion liability and $32 billion in funding). This is using the states' calculations.
  • According to Orin Kramer, chairman of the council for NJ state pension funds, health obligations are about $1 trillion underfunded (this assumes a AA corporate bond discount rate)
  • E.J. McMahon of the Empire Center, a research and lobbying group in NY, quotes several other sources as supporting a figure of $1 - $1.5 trillion
  • The GAO, using state data, found an underfunding of $405 billion, but they note that some of the plans are covered in documents other than the CAFRs they reviewed

Sources

  • BLS Employee Benefits Survey gives the availability and take-up of various benefit plans in various sectors.
  • BLS Employment Cost Trends gives data on the breakdown of different employer costs, including retirement plans, and the growth of these over time.
  • Boston College Center for Retirement Research provides a number of useful overview briefs.
  • Census of governments. Annual survey with partial quarterly updates. The only survey that attempts regular and fairly comprehensive coverage of both state and local pension (not health benefit) plans. The comprehensive data is always far behind (data through summer of 2008 was released in Mar 2010), but there is coverage of a few of the larger plans that is nearly current. Provides cash flow, membership, and investment information, but not obligations.
  • GAO, in the study cited below, gives URLs for obtaining each state's Comprehensive Annual Financial Report.
  • Joshua Rauh's papers are helpful.

See also

Recent commentary:

  • State and local retirement shortfalls will trouble us for many years Pew released a report today on the funding shortfall for state retirement benefits. The shortfall is a trillion dollars, even before recent stock market losses are fully factored in. Municipalities are not covered by the report, and many also have serious pension and healthcare funding issues. This is a bigger problem than the much-publicized current budget deficits of the states. It is certainly possible that some of the obligations will never be paid, so choose municipal bonds with great care and, if you are expecting state benefits, consider backup options in case they could be reduced.
  • Pension funds: rate of return is not the main issue Since state retirement funds are generally in bad shape, there is considerable controversy about their expected investment returns, which some say are too optimistic. However historical returns suggest expectations are not too far off. Probably the main issues to watch are around (1) promised benefits and (2) fund contributions.
  • Another point of view on the pension obligation discount rate Rauh and Novy-Marx show that if state pension funds were to use the return on Treasury bonds as their discount rate, rather than the 8% in common use now, the underfunding would be closer to $3 trillion than the $1 trillion commonly reported.
  • Retirement savings, projected investment returns, and volatility Sales pitches for retirement savings plans often include dazzling projections of modest savings magically grown by 7-9% compound returns over decades. State pension plans likewise project optimistic views of their solvency by assuming 8% annual returns forever. A major problem with both views is volatility – if the market is down when the money is needed, one has a problem. For state pension plans, if one projects the value of current savings forward using the risk-free rate, the underfunding is $3 trillion rather than $1 trillion.
  • A cash flow perspective on public retirement funds Cash flows of public pension funds were, in aggregate and on average, healthy over the period 1993-2008. However (1) some funds are less well funded than others and are now dipping heavily into capital, and (2) payments from funds grew at a 9% compound annual rate over 1993-2008, reinforcing worries about long-term solvency.
  • A pragmatic assessment of the state retirement fund crisis Unfunded obligations of state retirement funds, including both pensions and retiree health care, are in the neighborhood of $3 trillion. This is something like two years' worth of aggregate state income. On average, then, this is a heavy, but not crushing, debt load. Because politicians have delayed facing the issue, annual expenditures will rise. One reasonable projection puts pension plan contributions needing to increase by about 5% of aggregate budgets. Health plan expenditures are less well characterized, but might add another 2%, bringing the total adjustment to 7% of state budgets. The difficulties in both pension and retiree health plans are spread very unevenly. Some states face minor adjustment, and some will likely face adjustments of perhaps twice the average. For comparison, the drop in state tax revenues due to the recent crisis was about 10%.

On Census coverage of state and local plans

Mar 2008. Center for Retirement Research Boston College.

http://crr.bc.edu/briefs/what_do_we_know_about_the_universe_of_state_and_local_plans.html

“WHAT DO WE KNOW ABOUT THE UNIVERSE OF STATE AND LOCAL PLANS? By Alicia H. Munnell, Kelly Haverstick, Mauricio Soto, and Jean-Pierre Aubry*”

“The Census of Governments is the only source that reports on the entire universe of state administered plans, in addition to more than 2,000 locally administered plans. …

A Census of Governments is undertaken at five-year intervals. The Census includes a volume on Employ- ee-Retirement Systems of State and Local Governments, which provides data on revenues, benefit payments, assets, holdings and membership of the employee retirement systems. The strength of this publication is that it identifies 2,670 retirement systems that are sponsored by a government entity. This information on a vast universe of plans is the only way to assess the extent to which surveys are representative and to calculate the proportion of assets and membership covered by the surveys. Because the Census contains no data on pension liabilities, it is not possible to determine the funding status of plans. Nevertheless, the Census data provide a useful overview of the retirement landscape in the public sector. …

The state systems usually cover general state government employees and teachers; locally-administered systems often cover police and fire as well as general municipal employees. But the structure varies enormously. Some states (Maine and Hawaii) have a single system covering all types of employees, while other states (Florida, Illinois, Michigan, Minnesota and Pennsylvania) have over a hundred systems.

The stylized fact that emerges from the data is that state-administered plans account for a tiny fraction of the plans but almost all the participants and assets. Specifically, state-administered plans account for only 8 percent of total plans, but 88 percent of the active members and 82 percent of assets. …

While local plans on average tend to be small, they hold substantially more assets per active employee than state-administered plans. The most likely explanation is that these plans often cover police and firefighters, who have physically demanding jobs and are allowed to retire at earlier ages and require more extensive disability protection. …

With respect to plan type, the Census data almost exclusively cover defined benefit plans. Prior to fiscal year 2005, the data also included the income and assets of some defined contribution plans and some health care plans.”

Condition of state pension funds

12 Nov 2008. Moody's via ResearchRecap.

http://www.researchrecap.com/index.php/2008/11/12/no-immediate-impact-on-public-issuer-credit-ratings-from-pension-losses/

“State and Local Governments Facing Mounting Pension Losses”

“State and local government pension fund losses upwards of 35 percent so far in 2008 will likely trigger increased funding requirements in the next few years, said Moody’s Investors Service in a special comment this week. But the ratings agency sees little near-term impact on the credit ratings of public issuers as a result of pension losses. … Moody’s emphasizes that long-term “smoothing” of pension fund losses, which are phased in over a period of time, usually five to seven years, means that municipal and state government budgets won’t be affected until at least fiscal 2011.”

[Reading off of the included chart by eye:]

State pension funded ratios:

<65%     5 states
65-74%  11 states
75-84%  11 states
85-95%  12 states
>95%    11 states

Pension bonds are a small part of the problem

3 Mar 2009. Bloomberg.com.

http://www.bloomberg.com/apps/news?pid=20601109&sid=alwTE0Z5.1EA

“Hidden Pension Fiasco May Foment Another $1 Trillion Bailout. By David Evans”

“Public pensions in the U.S. had total liabilities of $2.9 trillion as of Dec. 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30 percent less than that, at $2 trillion. With stock market losses this year, public pensions in the U.S. are now underfunded by more than $1 trillion.

That lack of funds explains why dozens of retirement plans in the U.S. have issued more than $50 billion in pension obligation bonds during the past 25 years – more than half of them since 1997 – public records show.”

Public-sector pensions still defined benefit

11 Jul 2009. Economist p15

http://www.economist.com/opinion/displaystory.cfm?story_id=E1_TPJRRGDG

“Dodging the bill”

“most new public-sector employees in Britain and America continue to benefit from pensions linked to their salaries.”

Public-sector pensions underfunded by $3 tn, partly due to excessive benefits

11 Jul 2009. Economist p77.

http://www.economist.com/displaystory.cfm?story_id=E1_TPJRPGRR

“Unsatisfactory state”

“Mr Novy-Marx and Mr Rauh (who is now at the Kellogg School of Management at Northwestern University) estimated the accrued liabilities of the 116 largest state and local-government pension plans using the risk-free rate. They found the plans were underfunded by $3.12 trillion, more than three times the states’ estimate. This figure dwarfs the states’ combined municipal debt of $940 billion. …

The gap [between pension value in private and public sectors] is hard to measure because some public-sector schemes are unfunded. But the BNAC estimates that the implied gap in benefit rates is as much as 30% of salary. The Pensions Policy Institute (PPI), a think-tank, using a different discount rate, calculates a gap of between 10% and 30% (see chart 2).

This should be allowed for when private- and public-sector pay rates are compared. In Britain the mean private-sector salary in 2008 was £27,408, against £23,943 in public service. But the mean is inflated by the high wages of investment bankers and so forth. The median public-sector employee is better paid. Once you allow for pension rights, he is even further ahead.

A further disparity is that public-sector workers tend to retire young. The average retirement age for state workers in Ohio is just 57. The normal retirement age for many plans is less than 62, and workers become eligible for retirement at 50. Fire-fighters and police officers often are able to retire with full benefits, sometimes on as much as 90% of their final salaries, before reaching middle age.”

CalPERS actuary admits pension benefits unrealistic

10 Aug 2009. Calpensions.

http://calpensions.com/2009/08/10/calpers-actuary-pension-costs-unsustainable/

“CalPERS actuary: pension costs unsustainable. By Ed Mendel”

“Ron Seeling, the CalPERS chief actuary …

“I don’t want to sugarcoat anything,” Seeling said as he neared the end of his comments. “We are facing decades without significant turnarounds in assets, decades of — what I, my personal words, nobody else’s — unsustainable pension costs of between 25 percent of pay for a miscellaneous plan and 40 to 50 percent of pay for a safety plan (police and firefighters) … unsustainable pension costs. We’ve got to find some other solutions.”

Anne Stausboll, the CalPERS chief executive officer, told the seminar that the CalPERS board talked about the “cost and sustainability of pension benefits” the previous week and decided that the system should take a “proactive role” on the issue.

“They asked us to formulate a way to convene our stakeholders — employers, labor, legislators and other stakeholders in our system — to convene everybody and start having a constructive dialogue on sustainability of pension benefits,” Stausboll said.

Dwight Stenbakken of the League of California Cities told the seminar that pension benefits are “just unsustainable” in their current form and difficult to defend politically.

“I think it’s incumbent upon labor and management to get together and solve this problem before it gets on the ballot,” he said.”

Report on state retirement health plans

Nov 2009. Center for state and local government excellence brief.

link

“The Crisis in State and Local Government Retiree Health Benefit Plans: Myths and Realities. Robert L. Clark (North Carolina State University)”

“GASB 45 and Accounting for Retiree Health

On June 21, 2004, the Government Accounting Stan- dards Board approved Statement No. 45 (GASB 45). This statement requires public employers to produce an actuarial statement for retiree health benefit plans using generally accepted accounting standards as set forth by GASB.2 In general, GASB 45 requires states and local governments to report the present discounted value for the future liability of health care promises to current workers as these benefits are accrued along with the present value of these promises to current retirees.3 In addition, the actuarial report must indicate the annual required contribution that is needed to pay the normal cost of the plan plus the amount needed to amortize current unfunded liabilities.

A common belief is that GASB 45 requires pub- lic sector employers to establish trust funds for their retiree health plans and to move toward full fund- ing. This is a myth. GASB 45 does not require public employers to establish irrevocable trusts or to begin moving toward full funding of their liabilities. The goal of GASB 45 is to provide a transparent assessment of the liabilities associated with health care promises to public employees. However, establishing a trust fund and contributing sufficient monies to cover current costs and accrued liabilities may be prudent public policies as it requires today’s taxpayers to bear the full cost of today’s public services.

This issue brief focuses on the current financial status of state retiree health plans and reports unfunded actuarial accrued liabilities (UAAL), annual required contributions (ARC), and the current method of financ- ing these plans. The UAAL is the difference between all actuarial accrued liabilities (AAL) and any assets that the employer has set aside in an irrevocable trust. Obviously, if the plan is completely pay-as-you-go, the UAAL is equal to the AAL because there are no assets held by the employer with which to pay for the future health insurance of today’s employees. …

Annual required contributions are how much the employer would need to contribute to cover this year’s normal cost of the plan plus the amount needed to amortize the existing unfunded liability over a 30-year period. Thus, if a government were to establish a trust fund for its retiree health benefit plan and contribute monies each year equivalent to the ARC, the state or locality would be on pace to fully fund the plan. …

In addition to the demographic projections, key assumptions used by the actuarial consulting firm or the in-house actuaries to calculate the UAAL and the ARC are the rate of medical inflation and the discount rate used to determine the present value of future retiree health benefits. Assumptions made by the actu- ary have a large impact on the projected discounted lia- bilities of retiree health plans. All actuarial statements project a rapid decline in the rate of medical inflation. Such declines are more likely to be wishful thinking or a myth. …

GASB requires that the actuarial statements assume that the current provisions of the retiree health plan will remain in effect. There is a common belief that retiree benefits are protected by law and cannot be altered. This is a myth. …

The highest reported values for UAAL as a percent of payroll are found in Hawaii (359.6 percent), Maryland (351.1 percent), and Rhode Island (292.5 per- cent). The highest values for the ARC as a percent of payroll are Maryland (26.9 percent), Hawaii (26.2 per- cent), and Rhode Island (24.9 percent).”

[Highest ARC per capita, from table 2. Alaska $553, Hawaii $556, New Jersey $675. The lowest were Iowa $8, Indiana $7, and North Dakota $6. One could get aggregate numbers by summing the tables given, but no totals are already provided.]

GAO on condition of state OPEBs

Nov 2009. GAO report.

http://www.gao.gov/products/GAO-10-61

“STATE AND LOCAL GOVERNMENT RETIREE HEALTH BENEFITS: Liabilities Are Largely Unfunded, but Some Governments Are Taking Action”

“GAO described (1) what has been reported in state and local governments’ comprehensive annual financial reports (CAFR) regarding OPEB liabilities, (2) actions state and local governments have taken to address retiree health liabilities, and (3) the overall fiscal pressures these governments face. GAO reviewed the CAFRs for 50 states and the 39 local governments with at least $2 billion in total revenue. GAO also reviewed the actions taken to address retiree health liabilities by 10 state and local governments, selected based on geography and variation in approaches to address their liability. Finally, GAO simulated the fiscal outlook for the state and local sector and projected health care costs for state and local retirees. …

The total unfunded OPEB liability reported in state and the largest local governments’ CAFRs exceeds $530 billion. However, as variations between studies’ totals show, totaling unfunded OPEB liabilities across governments is challenging for a number of reasons, including the way that governments disclose such data. The unfunded OPEB liabilities for states and local governments GAO reviewed varied widely in size. Most of these governments do not have any assets set aside to fund them. The total for unfunded OPEB liabilities is higher than $530 billion because GAO reviewed OPEB data in CAFRs for the 50 states and 39 large local governments but not data for all local governments or additional data reported in separate financial reports. Also, the CAFRs we reviewed report data that predate the market downturn. Finally, OPEB valuations are based on assumptions about the health care cost inflation rate and discount rates for assets, which also affect the size of the unfunded liability. …

Governments have typically accounted for the cost of their retiree health benefits on a pay-as-you-go basis, reporting just the amount paid each year for employees who have already retired. Recently adopted accounting standards, however, require governments to change the way they account for the cost of retiree health benefits, specifying that governments should account for these costs on an accrual basis. Under an accrual basis, the cost of retiree health benefits is recognized when an individual earns the benefits, not when the benefits are paid or provided. As such, a government would periodically estimate and report the value of benefits that are earned for both past and current employees as a liability in its financial statements. Specifically, in 2004, the Governmental Accounting Standards Board (GASB)—an independent, private sector organization that maintains standards for accounting and financial reporting for state and local governments—issued Statement 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, which requires state and local governments to measure, recognize, and report future obligations for providing OPEB, the largest of which is generally retiree health benefits. Under Statement 45, governments should periodically have an actuarial valuation performed, through which an actuary estimates the amount that will be needed to pay for future benefits, assuming that the current provision for benefits remainsineffect.13 More specifically, the actuary estimates the following values, which governments are to report in their financial statements and related notes.

  • The “actuarial accrued liability” or “liability” reflects the value of benefits that are attributable to employees’ past service, assuming the current provision of benefits.
  • The “actuarial value of assets” represents the actuarial value of cash, investments, and other assets that are set aside to fund OPEB.14
  • The “unfunded actuarial accrued liability” or “unfunded liability” equals the excess, if any, of the liability over the assets. Thus, unfunded liabilities indicate the amount of benefits earned for which no assets have been set aside.
  • The “funded ratio” is assets expressed as a percentage of the liability. The funded ratio indicates the extent to which a government has set aside enough assets to pay its liability. For example, a funded ratio of 80 percent indicates that there are enough assets to pay for 80 percent of the liability.
  • The “annual required contribution” (ARC) is an estimate of the amount that if paid in full each year would be expected to fund currently accruing costs as well as a portion of any unfunded liability. Although referred to as a “required” contribution, accounting standards do not establish funding requirements—governments can choose to pay more or less than this amount. …

We found that the total reported unfunded liabilities for OPEB (which are primarily retiree health benefits) for state and select local governments exceed $530 billion.19 The $530 billion includes about $405 billion for states and about $129 billion for the 39 local governments we reviewed. We reported in 2008 that various studies available at that time estimated the total unfunded OPEB liability for the states and all local governments to be between $600 billion and $1.6 trillion, although the studies’ estimates were based on limited government data.20 It is not surprising that our total is on the low end of that range because we did not review data for all local governments, though we did review reported liability data for the largest local governments and all 50 states. Five-hundred and thirty billion dollars is still a large unfunded liability for governments. As variation between studies’ totals shows, totaling unfunded OPEB liabilities across states and local governments can be challenging. This may be attributable, in part, to some OPEB data being reported in plans’ separate financial reports that are not included as part of the government’s CAFR. In addition, over time valuations of OPEB reflect more up-to-date assumptions, policy decisions, and data. For example, the variety of actuarial approaches used can result in variations among the OPEB data reported in the CAFRs, such that two valuations of the same underlying OPEB can differ.21 …

we reviewed governmentwide CAFRs and not information for component entities or cost-sharing multiple-employer plans that is reported in separate financial statements and not in the CAFRs.27 For example, in fiscal year 2008, $2 billion in unfunded OPEB liabilities for one state’s public employees’ retiree health and life insurance plans was reported in the plans’ own financial statements and not in the state’s CAFR. Consequently, the $2 billion is not included in our total for states’ unfunded OPEB liability. …

Two significant assumptions used in OPEB liability calculations are the discount rate and the health care inflation rate. When governments value their OPEB liabilities, a decrease in the discount rate or increase in the health care inflation rate used results in higher unfunded OPEB liabilities, holding other factors, like the benefit plan and employee population, constant. A July 2009 study prepared for SLGE reported that one state’s unfunded OPEB liability increased by almost 20 percent based on a 1 percent increase in the health care inflation rate assumed. As the July 2009 SLGE study showed, actuarial valuations for state OPEB assumed discount rates rangingfrom3percentto8.5percent.30 Ourreviewof10states’most recently issued CAFRs found that 5 states used discount rates on the high end of that range.31 Further, in accordance with GASB guidance,when governments value OPEB liabilities, governments apply a health care inflation rate based on expected long-term future trends. According to the July 2009 SLGE study, virtually all state governments assume their expected long-term future rate to be about 5 percent, although actual health care inflation rates from 2002 to 2005 ranged from 16 percent to 10.3 percent, respectively.32”

Pew says state retirement funds are $1tn in the red

18 Feb 2010. Pew Center on the States research report.

http://www.pewcenteronthestates.org/report_detail.aspx?id=56695

“The trillion dollar gap”

“Of all of the bills coming due to states, perhaps the most daunting is the cost of pensions, health care and other retirement benefits promised to their public sector employees. An analysis by the Pew Center on the States found that at the end of fiscal year 2008, there was a $1 trillion gap between the $2.35 trillion states and participating localities had set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of those promises.

To a significant degree, the $1 trillion gap reflects states’ own policy choices and lack of discipline: failing to make annual payments for pension systems at the levels recommended by their own actuaries; expanding benefits and offering cost- of-living increases without fully considering their long-term price tag or determining how to pay for them; and providing retiree health care without adequately funding it. …

most states’ retirement systems allow for the “smoothing” of gains and losses over time, meaning that the pain of investment declines is felt over the course of several years. The funding gap will likely increase when the more than 25 percent loss states took in calendar year 2008 is factored in. …

Pew researchers analyzed these data to assess the funding performance of 231 state-administered pension plans and 159 state-administered retiree health care and other benefit plans, including some plans covering teachers and local employees. …

Health Care and other Non-pension Benefits

Retiree health care and other non-pension benefits create another huge bill coming due: a $587 billion total liability to pay for current and future benefits, with only $32 billion—or just over 5 percent of the total cost—funded as of fiscal year 2008. Half of the states account for 95 percent of the liabilities.

In general, states continue to fund retiree health care and other non-pension benefits on a pay-as-you-go basis—paying medical costs or premiums as they are incurred by current retirees.

only two states had more than 50 percent of the assets needed to meet their liabilities for retiree health care or other non-pension benefits: Alaska and Arizona (see Exhibit 2). only four states contributed their entire actuarially required contribution for non-pension benefits in 2008: Alaska, Arizona, maine and North Dakota.

Both health care costs and the number of retirees are growing substantially each year, so the price tag escalates far more quickly than average expenditures. States paid $15 billion for non- pension benefits in 2008. If they had started to set aside funding to pay for these long-term benefits on an actuarially sound basis, the total payments would have been $43 billion. …

Because there are legal restrictions on reducing pensions for current employees in most states, the majority of changes in the past two years were made to new employee benefits. Ten states increased the contributions that current and future employees make to their own benefit systems, while ten states lowered benefits for new employees or set in place higher retirement ages or longer service requirements. …

Although the median investment return for pension plans over the past 20 years averaged over 8 percent, some experts in the field, including renowned financier and investor Warren Buffett, believe even those assumptions are too high. By comparison, the Financial Accounting Standards Board requires that private sector defined benefit plans use investment return assumptions based on the rates on corporate bonds. As of December 2008 the top 100 private pensions had an average assumed return of 6.36 percent. …

Because unions and other employee representatives often have vigorously opposed defined contribution plans, it is unclear whether any state will find such a switch viable …

Health Care and other Non-pension Benefits … states have an average funding rate of 7.1 percent—and 20 states have funded none of their liability. …

The “actuarially required contribution” is the amount of money that the state needs to pay to the plan during the current year for benefits to be fully funded in the long run, typically 30 years. Although it is called a “required” contribution, in many states funding is at the discretion of the legislature. In fiscal year 2008, states should have committed $64.4 billion to their pension plans. They ended up paying just $57.7 billion, or 89.6 percent, of that amount. …

one way to understand the magnitude of the unfunded liability is to compare it to the current annual payroll that is covered by the plan. States with a higher degree of excess are considered to have a higher burden. For fiscal year 2008, the unfunded liability exceeded covered payroll in 22 states. In four of these states, the excess was less than 10 percent. In seven states, the unfunded liability was more than twice the covered payroll. …

The state in the worst shape in fiscal year 2008 was Illinois. With a combined funding level of 54 percent, the five pension systems of Illinois had accumulated a total liability of $119 billion, $54 billion of which was unfunded. To start closing that gap and covering future expenses, the state should have made an actuarially required payment of $3.7 billion in 2008. Instead, it contributed a little less than $2.2 billion, meaning that the state will face a bigger gap in 2009 even apart from investment losses. For Illinois, the unfunded liability is more than three times annual payroll costs. …

For many years, states offered their retirees health care benefits without ever identifying the long-term costs. That changed in 2004 when the Governmental Accounting Standards Board created statements 43 and 45 that required governments to report on their long-term liabilities for retiree health care and other non- pension benefits. …

Illinois has a nearly $40 billion [health benefit] liability with only $75 million in funding set aside. …

States paid $15 billion for non-pension benefits in 2008. If they had funded these benefits on an actuarially sound basis by putting away adequate money to pay for future benefits, the total payments should have been $43 billion. …

Unfunded liabilities develop when governments fail to provide funding as benefits are earned and also when inaccurate assumptions are used to calculate payment amounts. For states with underfunded pension systems, those annual costs become more expensive. That is because a second payment is added to the actuarially required contribution that is intended to eliminate the unfunded liability over a period of no more than 30 years, according to rules set by the Governmental Accounting Standards Board. …

For a long time, New mexico periodically granted benefit increases in lieu of salary increases, creating a benefit structure that became one of the most generous in the country. one notable aspect of New mexico’s pension systems has been its early retirement age: general employees can retire with full pensions after 25 years of service at any age, and law enforcement personnel can retire at any age with only 20 years of service. … In addition, a significant lobbying push by the state’s municipalities led to the removal of the cap on what individuals could earn if they retired and returned to government work. Without the cap, workers could earn both a full salary and a full pension simultaneously. The case to permit retirees to return to work was strengthened by shortages in police departments. But the legislation was not limited to public safety—the income caps for retirees who returned to work were removed for everyone. …

In Vermont … In 1991, the state began to allow employees to retire at age 62 with no vesting requirement. This meant an employee could work for the state a few months, and as long as he or she retired directly from state employment, Vermont would pay 80 percent of medical premiums for the employee and spouse for the rest of their lives and for other dependents until they reach an age at which they are no longer covered …

Pension benefits are supposed to reflect the employee’s salary level and are thus based on the worker’s wages in the final years of his or her employment. Workers have found ways to boost their salaries in those final years, greatly increasing the level of benefits to which they are entitled. Common ways to boost salaries include ensuring that overtime goes to the most senior workers, saving sick leave and getting temporary promotions or last-minute raises. …

According to the Bureau of Labor Statistics, 86 percent of state and local government employees participate in a retirement plan compared with 51 percent of private sector workers. Defined benefit plans also are far more prevalent in the public sector. While only 20 percent of private sector employees have access to defined benefit plans, 90 percent of public sector employees do. …

the fact that taxpayers are asked to fund benefits that they often lack themselves, has created a politically potent push to alter the status quo. …

The main data source used for this project was the Comprehensive Annual Financial Report (CAFR) produced by each state for fiscal year 2008. …

many states allow local governments to participate in the same plans set up for their own government agencies. As a result, this study includes plans for municipal workers or teachers when those plans are run by the state and the state maintains a financial interest. Locally run pension plans were excluded.”

Conservative accounting suggests a $3tn public retirement fund deficit

22 Feb 2010. FTUSA p14.

http://www.ft.com/cms/s/0/5302b9da-1f52-11df-9584-00144feab49a.html

“View from the top: Orin Kramer, New Jersey pension fund. Telis Demos, Chrystia Freeland”

“For more than a decade, Orin Kramer has sounded warnings about the mounting funding crisis facing nearly every US state's pension fund. Mr Kramer is chairman of the council that oversees New Jersey's state pension fund, one of the largest in the US, and also a highly influential behind-the-scenes figure in the Democratic party. He is deeply worried that the growth of obligations to teachers and other workers in many states has outstripped their investment returns.

Edited highlights of a video interview with Mr Kramer - who discusses his account of the scale of the crisis - on FT.com appear below.

In a recent report, it was estimated that the funding gap in state pensions and other obligations is $1,000bn. Your estimate is even higher than that. What is your estimate and why is it higher?

In simple terms, if you use the accounting standards that are applied to corporations, the shortfall for the states, what they ought to have today and don't have, is $2,000bn-plus for the public pension funds and probably another $1,000bn-plus for the health [obligations] side.

So $3,000bn in total?

If you use government accounting constructs, pension funds are probably about 88 per cent funded. If you just tweaked one variable and said, you know what, instead of using the average assets for the last five years, and assuming that's what we have, let's actually take market values year-end 2009. That brings you down from 88 to 75 per cent funding. And then if you say, let's use corporate accounting that doesn't allow you to assume double-digit returns from equities and so forth, that would make those funds 60 per cent funded, which translates into a $2,000bn-plus shortfall on the public fund side, before you get to the health piece.

What kind of solutions would work?

If you assume 8 per cent annualised returns, which is what they assume, which is more aggressive than I'd want to be, but if you assume 8 per cent returns, and you assume . . . the levels of contributions you've had in recent years, the average state fund actually runs out of cash in 2025, so my guess is before 2025 you sit people down in a room, like they did in New York City in the late 1970s.

For people managing public pots of money, is it going to be more difficult to invest in alternative assets in the wake of the crisis?

I have seen one thing that's been coming up more among public funds, which is wanting to lever Treasuries and lever Tips [Treasury inflation- protected securities] in order to generate higher yields. And that to me is reminiscent of when pension funds went out and began leveraging themselves and borrowing against themselves. The trade is working but, to me, “carry trade” and “pension fund” shouldn't be in the same sentence.

What is your economic outlook?

I want to bring household debt [relative to people's disposable incomes] levels back to the ratio not of 1982 but what we had in 2000 relative to gross domestic product. That is a 25 per cent reduction [in the US], one-third off in the UK and about a 50 per cent reduction in Spain. So those kinds of long-term challenges, exiting this extraordinary fiscal and monetary stimulus, these are going to be difficult processes to negotiate. I think we haven't had any deleveraging yet. We've just substituted government borrowing for less activity in the private sector. That's not a sustainable model.”

State and local retirement benefits grew through the crisis

23 Mar 2010. Mandel on Innovation and Growth.

http://innovationandgrowth.wordpress.com/2010/03/23/the-growing-gap-between-govt-and-private-sector-benefits/

“The Growing Gap between Govt and Private Sector Benefits”

“Yowza! Somewhere in 2004, the world changed, and we didn’t realize it. Employers in the private sector put a lid on the cost of benefits (which includes healthcare, retirement, vacation, and supplemental pay of all sorts). Meanwhile the cost of benefits in state and local govt jobs just kept rising, with barely any break, both before and after the financial bust. This is not good.”

[Goes on to show wages did not diverge, and health spending did not diverge. The big one was retirement benefits.

The data are from BLS; see databases and tables, pay & benfits, employment cost index, one-screen data search. The data are as follows:

Series Id:     CIS2030000000000I
Seasonally Adjusted
compensation:  Total benefits
sector:        Private industry
periodicity:   Index number
Industryocc:   All workers

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
2001	78.8	79.5	80.6	81.5	 
2002	82.3	83.3	84.1	85.0	 
2003	87.0	88.1	89.4	90.5	 
2004	92.9	94.4	95.4	96.5	 
2005	98.0	98.8	99.7	100.3	 
2006	100.8	101.6	102.5	103.3	 
2007	103.1	104.2	105.0	105.8	 
2008	106.5	107.0	107.5	107.9	 
2009	108.1	108.3	108.6	108.9	 
2010	110.4	111.0
Series Id:     CIS3030000000000I
Seasonally Adjusted
compensation:  Total benefits
sector:        State and local government
periodicity:   Index number
Industryocc:   All workers

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
2001	75.2	76.3	77.4	78.0	 
2002	78.8	79.9	81.4	82.9	 
2003	84.1	85.4	86.9	88.0	 
2004	89.5	91.1	92.5	93.9	 
2005	95.6	96.8	98.4	99.9	 
2006	100.8	102.0	103.6	105.1	 
2007	107.1	108.7	109.8	110.9	 
2008	111.4	112.4	113.3	114.1	 
2009	115.2	116.4	116.9	117.9	 
2010	118.3	119.4

So, the gain from 2004-Q2 to 2010-Q2 was 17.6% in private industry and 31.1% in state and local government. The CPI, over that period, rose 14.9%.

See also http://www.bls.gov/ncs/ect/home.htm for more background, historical data, press releases, etc.]

Realistic estimate of CA pension gap

6 Apr 2010. NYTimes

http://www.nytimes.com/2010/04/07/business/07pension.html

“Analysis of California Pensions Finds Half-Trillion-Dollar Gap. By MARY WILLIAMS WALSH”

“An independent analysis of California’s three big pension funds has found a hidden shortfall of more than half a trillion dollars, several times the amount reported by the funds and more than six times the value of the state’s outstanding bonds. Justin Sullivan/Getty Images

The analysis was commissioned by Gov. Arnold Schwarzenegger, who has been pressing the State Legislature to focus on the rising cost of public pensions.

Graduate students at Stanford applied fair-value accounting principles to California’s pension funds, using a method recently devised by two economists working in Illinois, Joshua D. Rauh of Northwestern University and Robert Novy-Marx of the University of Chicago. …

The Stanford project focused on California’s big state-run employees’ pension fund, known as Calpers; a second large fund for teachers, known as Calstrs, and the University of California Retirement System. The three funds serve more than 2.6 million public employees and retirees.

Smaller public pension funds in California, run by cities and some counties, were not included in the analysis. …

After the researchers applied a risk-free rate of 4.14 percent, equivalent to the yield on a 10-year Treasury note, the present value of the promised benefits ballooned. The researchers came up with a $425 billion shortfall for the three funds.

As of July 1, 2008, the funds officially reported they were $55 billion short. They have not issued financial statements since then, but have said informally that they lost a total of $110 billion.

The researchers concluded that their estimate of the gap would also have grown by roughly $110 billion, to more than half a trillion, today. Their full report is expected to be released this week on the Stanford Institute for Economic Policy Research Web site.

Calpers challenged the research, saying it was “out of sync with governmental accounting rules and actuarial standards of practice.” ”

5-year averaging means funding status will worsen for some time

Apr 2010. Center for Retirement Research at Boston College.

http://crr.bc.edu/briefs/the_funding_of_state_and_local_pensions_2009-2013.html

“THE FUNDING OF STATE AND LOCAL PENSIONS: 2009-2013. By Alicia H. Munnell, Jean-Pierre Aubry, and Laura Quinby”

“The financial crisis reduced the value of equities in state and local defined benefit pensions and hurt the funding status of these plans. The impact will become evident only over time, however, because actuaries in the public sector tend to smooth both gains and losses, typically over a five–year period. The first year for which the crisis will have a meaningful impact on reported funding status is fiscal 2009, since in most cases the fiscal 2008 books were closed before the market collapsed. After 2009, the funding picture will continue to deteriorate to the extent that years of low equity values replace earlier years of high values. …

The Governmental Accounting Standards Board (GASB), which came into being in the early 1980s, provided guidance for disclosure of pension information with Statement No. 5 in 1986. One important requirement was that all plans report their benefit obligations and pension fund assets using uniform methods to allow observers to make comparisons across plans. In most cases, this required two sets of books, as the GASB method was very different from the approach most plan actuaries had adopted for establishing funding contributions. What’s more, the uniform methods were not applied retroactively, which made historical comparisons impossible. As a result, when users needed information about a plan’s funded status and funding progress, they generally looked to numbers generated by the plan’s own methodology.

GASB Statements No. 25 and 27, issued in 1994, contained a key innovation: they allowed sponsors that satisfied certain “parameters” to use the numbers that emerge from the actuary’s funding exercise for reporting purposes. Among others, these parameters defined an acceptable amortization period, which was originally up to 40 years and reduced to 30 years in 2006, and an Annual Required Contribution (ARC), which would cover the cost of benefits accruing in the current year and a payment to amortize the plan’s unfunded actuarial liability. …

our sample of 109 state-administered plans and 17 locally administered plans …

The funding ratios are based on actuarial assets and liabilities reported under GASB methods of accounting. [presumably using the states' own discount rate] …

While funding ratios for 2009 were the lowest they have been in 15 years, reported numbers are likely to decline further over 2010-2013 as gains in the years leading up to 2007 are phased out and losses from the market collapse phased in. The precise pattern of future funding will depend, of course, on what happens to the stock market. To address such uncertainty, projections were made using three sets of assumptions for the Dow Jones Wilshire 5000 Index between now and 2013 (see Figure 7). The pessimistic projection assumes negligible economic growth, rising un- employment, profits growing at only 3 percent annually, falling price-earnings ratios, and the stock market remaining at its current level of roughly 12,000. The most likely projection assumes an economic expan- sion sufficient to reduce unemployment slightly, profits growing at 7 percent annually, and stock prices rising about 6 percent annually to produce a Wilshire 5000 of 15,000 by 2013. The optimistic projection assumes a stronger economic expansion that reduces unemployment significantly and allows profits and stock prices to grow nearly 11 percent annually, so the Wilshire 5000 reaches 18,000 by 2013. The opti- mistic projection is designed to exceed the central projection to the same extent the central exceeds the pessimistic.

In order to estimate the actuarial level of assets for 2010-2013, we replicate the smoothing method of each plan in our data set as detailed in the plan’s actuarial valuation, based on each of the assumptions regarding the Wilshire 5000.14 Because, historically, contribution payments hold relatively steady for each plan, we estimate future contributions based on an average of the prior three years plus a 5-percent per- year increase (the average increase between 1990- 2007). Benefit payments, which also show little varia- tion over time, are estimated in the same manner as contributions.

The results are shown in Figure 8 on the next page. Certainly, the more distant the year, the more uncertain is the projection. In all likelihood, assuming any changes to benefits or contributions would have no material effect, 2010 actuarial reports will show assets equal to about 77 percent of promised benefits. What happens thereafter depends increasingly on the future performance of the stock market. Under the most likely scenario, the funding ratio will continue to decline as the strong stock market experienced in 2005, 2006, 2007, and much of 2008 is slowly phased out of the calculation. By 2013, the ratio of assets to liabilities is projected to equal 72 percent. The comparable 2013 ratio for the optimistic scenario is 76 percent and for the pessimistic scenario 66 percent.”

Fraction of pay devoted to benefits in public and private

8 Sep 2010. BLS ECEC release.

http://www.bls.gov/news.release/pdf/ecec.pdf, from the page http://www.bls.gov/ncs/ect/home.htm

“EMPLOYER COSTS FOR EMPLOYEE COMPENSATION – JUNE 2010”

Empire Center on NY public retirement health plans

13 Oct 2010. Empire Center.

http://www.empirecenter.org/Special-Reports/2010/10/icebergahead101310.cfm

“Iceberg ahead: The hidden cost of public sector retiree health benefits in New York. E.J.McMahon”

“Classified by accountants as Other Post-Employment Benefits, or OPEB, retiree health insurance is rarely offered by private sector employers—but it’s among the fastest-growing components of public-sector employee compensation at every level of government. OPEB accounts for nearly 40 percent of annual em- ployee health benefit costs at the state level, and for more than one-third of the an- nual total in New York City. Buffalo, the state’s second largest city, already spends more every year on retiree health insurance than on coverage for active workers. …

Now, thanks to a new government accounting standard, the true cost of this long- term entitlement is finally emerging from the murky depths of state and local fi- nances. The unfunded retiree health care liability for New York’s 89 largest state and local government employers totals at least $165 billion, according to their most re- cent financial reports.2 These estimates suggest the total unfunded liability for all of New York’s state and local employers comes to $205 billion …

[Table shows unfunded OPEB obligation for New York state is $60 billion, and for all state and local governments is $205 billion.]

In other words, New York’s state and local governments have promised more than $205 billion in post-retirement health care coverage that they have set aside no money to pay for. Thanks to its relatively large government payrolls and generous benefits, New York represents an outsized chunk of a nationwide state and local un- funded OPEB liability estimated at between $1 trillion and $1.5 trillion.3 …

The good news for New York taxpayers is that public-sector retiree health benefits, unlike pensions, are not guaranteed by the state Constitution. Elected officials can still change course on retiree health care by restructuring benefits for both current retirees and active employees. …

Pensions are based on length of service, with the biggest benefits flowing to those who have worked the longest. However, as explained below, most of New York’s state and local governments offer the same full employee health coverage to all vested retirees, regardless of years of service. Early retirees, who have not reached the Medicare eligibility age of 65, comprise a disproportionately large share of pub- lic-sector retiree health costs. …

Employees hired before Dec. 28, 2001, can qualify for a lifetime of free health benefits after just five years of working more than 20 hours a week for [New York] city. …

federal employees can qualify for continuing health coverage if they retire after only five years, which is half the vesting period for New York State employees and city workers hired since 2001. …

Combined with guaranteed pensions, health benefits give retired public employees a deferred compensation package that most of their private sector counterparts can only dream of. For example, a $60,000-a-year Tier 3 or 4 retirement system member (hired since 1976 but before 2010) who retires at age 55 after 30 years on the state government payroll is entitled to a $36,000-a-year pension – the equivalent of a job paying nearly $40,000, since pension income is exempt from both payroll taxes and state income tax. On top of that, she can retain NYSHIP health insurance currently priced at roughly $14,000 a year for family coverage, while contributing little or nothing to the premium. In 10 more years, when she becomes a Medicare enrollee at 65, her Part B premium will be fully reimbursed and the NYSHIP plan will cover the holes in Medicare. …

The main elements of public sector financial reports are effectively mandated by an independent rule-making body, the Government Accounting Standards Board (GASB), which determines the Generally Accepted Accounting Principles (GAAP) used in financial statements by state and local governments.13 A newly adopted GASB rule will force government officials to begin reckoning, for the first time ever, with the true costs of the promises they have been making to their workers. …

Like most of their counterparts across the country, New York and its local governments pay for current retiree benefits out of their annual budgets, a practice also known as “pay-as-you-go,” or simply “pay-go.” They also typically lump health insurance premiums for both retirees and active employees into a single category of current expenditures. …

These annual outlays—a continual shift of past liabilities into the present—are steadily rising and are projected to continue rising in the future. … the state’s annual expenditure on health insurance for retirees is expected to nearly double (from $1.4 billion to $2.7 billion) by the end of this decade, and to triple by 2026. While the same detailed data are not readily available for other government employers, the slope of future payments is likely to be similar for entities with plans like the state’s. [based on the state's actuarial projection] …

When it came to obfuscating OPEB, private-sector companies used to be as guilty as most government employers. But this began to change in the early 1990s, when the Financial Accounting Standards Board (also known as FASB, the non-governmental counterpart to GASB) issued a rule requiring corporations to recognize their retiree health insurance promises as a long-term liability with real financial consequences. FASB’s Statement 106, issued in 1990, prompted many private employers to reduce benefits, to share more costs with employees, or to eliminate OPEB altogether rather than promise benefits they could not truly afford to fund as a long-term liability.

GASB followed the private-sector accounting precedent with the issuance in 2004 of a rule known as Statement 45, or GASB 45.15 Like the FASB standard, GASB 45 is rooted in the idea that retiree benefits are a form of deferred compensation whose costs should be recorded when earned, not when paid. GASB 45 was phased in start- ing in fiscal 2007 for the largest governments (those with revenues above $100 mil- lion), and became fully effective in 2009 fiscal years for government entities of all sizes that produce GAAP-based financial statements. …

The rule does not require states and local governments to immediately begin spend- ing any more money. It does, however, require them to take these steps:

  • Calculate the present value of future retirement benefits that have been prom- ised to and earned by current employees and retirees. The resulting number is called the “actuarially accrued liability,” or AAL.
  • If any funds have been put aside to support the health plan’s future benefit payment, deduct the value of any fund assets from the AAL to produce a sec- ond figure, the “unfunded actuarially approved liability,” or UAAL. This must be reported in notes to government financial statements.
  • Determine the “annual required contribution,” or ARC, which combines the UAAL with the present value of health benefits earned during the past year, including the “pay-go” amount. Employers can spread (or “amortize) the UAAL amount over 30 years. Even with this adjustment, however, the ARC typically is three times as large as the existing annual payment for retiree health coverage. To the extent an employer fails to meet its ARC target, the shortfall is added to its total liabilities.

Again, GASB 45 does not actually require governments to make their “required” payments to begin paying off OPEB liabilities. However, as GASB’s guide to the is- sue points out, “the more of its annual OPEB cost that a government chooses to de- fer, the higher will be (a) its unfunded actuarial accrued liability and (b) the cash flow demands on the government and its tax or rate payers in future years.”16

Governments that ignore the issue will experience a rapid deterioration in their bal- ance sheets, due to the compounded growth in the liability represented by their an- nual required contribution. Wall Street rating agencies have indicated that they will take OPEB funding into account in evaluating a government’s creditworthiness for the public finance markets—which directly affects borrowing costs. …

These figures are enormous in any context. New York City’s unfunded liability of nearly $62 billion is the second largest of any state or local government employer in the nation. It exceeds the city’s own total bonded indebtedness as of 2008. New York State’s unfunded liability of $60 billion, second only to California among state gov- ernments, is nearly equal to its $63 billion in outstanding debt. The total estimated liability of $205 billion for all public employers in New York equates to roughly three-quarters of New York’s state and local government debt as of 2008.

The liabilities are also growing rapidly. Between the end of fiscal 2008 and the start of fiscal 2010, New York State’s unfunded OPEB liability increased by $10 billion, or 20 percent. Between fiscal 2006 and fiscal 2008, New York City’s OPEB liability in- creased by $9 billion, or 17 percent. OPEB liabilities will increase at a similar rate for all government entities in New York that fail to either rein in retiree health benefits or to begin setting aside more money to pre-fund them. …

Table 4. Combined Municipal and School OPEB Liabilities for Selected Cities …

Syracuse … $11,200 per capita …

Syracuse, Buffalo, Niagara Falls and other fiscal struggling upstate cities are facing the same kind of retiree legacy cost that became a crippling financial drag on General Motors before its bankruptcy and takeover by the federal government last year. …

A December 2009 lawd creating a new “tier” of pension benefits for state and local employees also made permanent a temporary measure, dating back to 1994, that prohibited school dis- tricts from making any change in retiree health coverage that was not first negotiated with un- ions representing active employees. Earlier in 2009, Paterson had become the third consecu- tive governor to veto a union-backed measure extending the same “protection” to other types of employees at every level of government. To placate its supporters, however, he formed a tem- porary Task Force on Retiree Health Insurance, which reported in 2010 that it could not reach a consensus on whether to support legislation that would limit the ability of employers to alter re- tiree benefits. This effectively punted the issue to the next governor. …

Nearly all of the New York state and local governments affected by GASB 45 have chosen to calculate and report how much they would need to pay, with interest, to fully fund their OPEB liability over a 30-year period. The resulting number, known as the annual required contribution, or ARC, typically is much higher than the cur- rent pay-as-you go amount. For example, New York State’s ARC of $3.3 billion is fully three times its current annual expenditure on retiree health care. As explained in Section 2, payment of the ARC is not actually “required.” However, the difference between the ARC and the annual pay-go expenditure must now be counted as a “net liability” on the employer’s balance sheet. Thus, for example, in the two years since GASB 45 took effect, the state of New York has amassed $8 bil- lion of unfunded liabilities for OPEB due to its failure to pay the full ARC. The longer the state fails to pay the ARC, the larger those liabilities will grow. At this rate, within 10 years, the state’s total liabilities will exceed its total assets, a condition accountants call “balance sheet insolvency.” …

As of 2009, however, only 18 states had set aside any assets to pay OPEB liability, according to a U.S. Governmental Accountability Office (GAO) study.20 …

As of 2009, however, only 18 states had set aside any assets to pay OPEB liability, according to a U.S. Governmental Accountability Office (GAO) study.20 A separate report by the Pew Center for the States found that only six states were on track to have fully funded OPEB obligations during the next 30 years, and only three (Wis- consin, Arizona and Alaska) had pre-funded more than 50 percent of the retiree health care liability. At least two states, Ohio and Vermont, were pre-funding a por- tion of their OPEB liability through sub-accounts in their existing pension funds. 21

Most states and local governments, like New York, are still financing retiree health coverage strictly on a pay-as-you basis. …

Private pension plans must discount their liabilities based on a market rate— typically, a AA-rated corporate bond rate—which is often much lower than the plans’ targeted rate of return on investments. Public funds, however, are allowed under GASB standards to discount their long-term liabilities based on the target rate—which, for most public funds, is pegged at an optimistic 8 percent or higher. …

Health and Human Services (HHS) Secretary Kathleen Sibelius recently announced that 2,000 employers throughout the country had applied for a piece of a $5 billion “Early Retirement Re- insurance Program” set up under the new federal health care law to subsidize employer- sponsored health insurance for retirees who haven’t yet reached the Medicare eligibility age of 65.a Specifically, the plan will reimburse 80 percent of claim costs between $15,000 and $90,000 for early retirees. …

Is the Obama administration inviting or expecting states and local governments to dump $1.5 trillion in unfunded retiree health care liabilities into Washington’s lap? Stay tuned. …

On the state level, as noted in Section 1, the Legislature and Governor have broad leeway to craft changes in retiree health benefits outside of collective bargaining. Pursuing the following strategy would allow them to strike a politically appealing balance between the competing interests of employees and taxpayers:

  1. Preserve health benefits for workers who have already retired, but stop reimbursing Medicare Part B premiums for those over 65, and require early retirees to pay a larger share of their own premiums.
  2. Reserve the greatest benefit to those who have worked the longest, along the lines initially proposed by Governor Paterson in his 2009-10 budget.
  3. Clarify existing law to allow trust funds to cover adjusted OPEB liabili- ties, but mandate that required contributions to the fund are based on re- turns from conservative, low-risk investment strategies.
  4. Eliminate retiree health insurance coverage for all new hires and employ- ees on the payroll for less than 10 years, and shift these workers into a “retirement medical trust.” Government workers would make tax-free contributions to accounts managed by their unions, which would pool and invest the money to cover medical expenses after they retire.”

Note 3: “The $1 trillion estimate first reported in a 2005 New York Times article (“The Next Retirement Time Bomb,”Dec. 11, 2005). An October 2006 analysis by the Cato Institute put the figure at $1.4 trillion (Chris Edwards and Jagadeesh Gokhale “Unfunded State and Local Health Costs: $1.4 Trillion,” Cato Tax and Budget Bulletin, No. 40. In a 2007 analysis, Credit Suisse estimated the total at $1.5 trillion (“You Dropped a Bomb on Me, GASB,” Equity Research, Accounting & Tax Note, March 22, 2007).”

Note 20: U.S. Government Accountability Office, “State and Local Government Retiree Health Benefits: Liabilties Are Largely Unfunded, But Some Governments Are Taking Action,” GAO-10-61, November 2009.

One interesting summary of public vs private pensions

14 Oct 2010. Bloomberg.

http://www.bloomberg.com/news/2010-10-14/-how-dare-you-take-my-pension-becomes-refrain-as-voters-consider-cutbacks.html

“`How Dare You Take My Pension' Becomes Refrain as Voters Consider Cutbacks. By Ben Elgin and Chad Terhune”

“State and local governments paid $3.04 per hour toward each employee’s retirement as of 2007, according to U.S. Labor Department data. Private employers paid 92 cents per hour. …

Already this year, lawmakers in 16 states increased individual contributions for government employees or cut benefits for new hires. Nine states raised the number of years that new hires must work to earn full retirement, including Missouri and Illinois, which boosted to 67 the age at which they can draw maximum benefits.

California’s new budget, signed by Governor Arnold Schwarzenegger on Oct. 8, requires current state workers to pay more toward their retirement funds and rolls back pension benefits for new hires to pre-1999 levels. …

Seventy-six percent of Californians polled in June said public pension spending was a big problem or “somewhat of a problem,” according to the Pew Center on the States and the Public Policy Institute of California. In the same poll in Illinois, 83 percent answered that way. In New York, it was 79 percent. …

“Pension envy” among private-sector workers is justifiable in some cases, but it goes too far, said Alicia Munnell, director of the Center for Retirement Research at Boston College. The average annual benefit for public retirees was $22,780 in 2008, according to the center’s study of the 126 largest public retirement plans. …

Almost a quarter of San Francisco’s retired firefighters receive $100,000 or more, according to the civil grand jury report. Firefighters routinely receive pay raises of 10 percent or more in their last year on the job, boosting their benefits over the rest of their lives, said the report, titled “Pension Tsunami.” ”

Future cash flow impact of state and local pension plans

Oct 2010. Center for Retirement Research, Boston College

http://crr.bc.edu/briefs/the_impact_of_public_pensions_on_state_and_local_budgets.html

“THE IMPACT OF PUBLIC PENSIONS ON STATE AND LOCAL BUDGETS. By Alicia H. Munnell, Jean-Pierre Aubry, and Laura Quinby”

“The first section provides an overview of state and local plans and in- troduces our sample of six states: California, Florida, Georgia, Illinois, Massachusetts, and New Jersey. The second section presents data on pension expendi- tures relative to budget totals for states and localities in the aggregate and for our sample of plans. The third section develops baseline budgets for the period 2010-2043 for all states and localities and for the six individual states. It then projects annual required pension contributions beginning in 2014 under three scenarios: 1) amortizing the unfunded liability valued at an 8-percent discount rate over the next 30 years; 2) amortizing the unfunded liability valued at 5 per- cent over the next 30 years; and 3) continuing to pay contributions at current levels until the trust fund is exhausted and then paying benefits on a pay-as-you- go basis.

The final section concludes that whereas public plans are substantially underfunded, in the aggregate they currently account for only 3.8 percent of state and local spending. Assuming 30-year amortization beginning in 2014, this share would rise to only 5.0 percent and, even assuming a 5-percent discount rate, to only 9.1 percent. Aggregate data, however, hide substantial variation. States that have seriously underfunded plans and/or generous benefits, such as California, Illinois, and New Jersey, would see contributions rise to about 8 percent of budgets with an 8-percent discount rate and 12.5 percent with a 5-percent discount rate. …

Legislatures and pension-plan administrators often focus on pension contributions as a percent of pay- roll. Pension contributions as a percent of budgets, however, provides a broader framework for project- ing how public plans will affect other state and local activities. The starting point for our analysis is the share of state and local budgets devoted to pensions to date. Figure 4 shows that in 2008 pensions account- ed for 3.8 percent of state and local direct – that is, non-capital – expenditures for the country as whole.

This share varied somewhat among individual states. However, for more than half of the states, state and local pension contributions represented between 3 and 4 percent of state and local government budgets in 2008 (see Figure 5). The range in our sample of six states was similarly narrow – 3.2 percent in Florida to 5.2 percent in California. …

The first step in estimating pension contributions as a percent of budgets is to project budgets for states and localities. This projection is based on the relation- ship of state and local budgets to GDP.5 While these budgets rose sharply until 1990, since that time they have held relatively steady (see Figure 7). We assume that the 2008 ratio of budgets to GDP will hold into the future, so we derive dollar amounts by applying the 2008 ratio to GDP projections from the Congres- sional Budget Office. The same approach was used to project budgets for the six sample states.

The next step is to project future pension contributions. We assume that states and localities increase their contributions incrementally between 2009 and 2013, and then start to pay the full ARC, amortizing their unfunded liabilities over a 30-year period. Normal cost and unfunded liabilities are cal- culated under two interest rate assumptions – 8 percent and 5 percent. The results are shown in Figure 8. Assuming an 8-percent discount rate, government contributions to pensions will rise from 3.8 percent of state and local budgets today to 5.0 percent in 2014. With a 5-percent discount rate, pension contributions would increase to 9.1 percent in 2014. In both cases, the contribution rate remains constant thereafter for 30 years because contributions are usually set as a fixed percent of payrolls and we have assumed that payrolls are a fixed percent of state and local budgets.

The pattern differs across states. Essentially the states that have been conscientious about funding their pensions would see only a small increase in their contributions as a percent of budget – roughly 1 to 2 percent (see Table 2). This increase reflects primarily the increase in unfunded liabilities as a re- sult of the collapse in equity prices. If liabilities were discounted at 5 percent, the percent of the budget devoted to pension contributions would rise to just over 8 percent. In contrast, those states with expen- sive and/or underfunded plans would see the percent of their budgets going to pensions rise from about 4.5 percent to about 8 percent (assuming an 8-percent discount rate) and to 12.5 percent (assuming a 5-per- cent discount rate).

Exhausting Assets and Reverting to Pay-as-you-go

The projections for the high-cost states suggest a very large increase in the share of the state-local budget that would need to be allocated to pensions. If policy- makers are unable or unwilling to make such a com- mitment, what is the alternative? Promised benefits are legally protected and will be paid. One alternative is to contribute at current levels, run down assets, and then pay promised benefits on a pay-as-you go basis. Take Illinois as an example. Figure 9 on the next page shows the pattern of expenditure as a percent of the budget under a pay-as-you-go scenario.10 The pattern is complicated by the fact that Illinois has four main pension plans, and each runs out of money at a different time. Since the plan financed by localities is relatively well funded and state government currently pays the majority of pension costs for the three poorly funded plans, the burden of covering benefits paid on a pay-as-you-go basis would fall primarily on the state.11 Pay-as-you go costs are projected to exceed 16 percent of the Illinois state government budget in 2027. …

How reliable are our estimates? On the one hand, our assumption that plans fund responsibly in the near-term may be optimistic in light of the current economic conditions. To the extent they do not, our estimates understate the long-term pension costs. On the other hand, we assume no changes in benefits or employee contributions. In fact, states are already raising employee contributions and reducing benefits for new employees, which means that we overstate long-run employer pension costs. These offsetting effects may well cancel out, so that this brief provides a reasonable picture of future pension costs as a share of state and local spending.”

States may succeed in changing COLAs

23 Jun 2012. Economist.

http://www.economist.com/node/21557364

“Burning fast”

“Many states that try to bring in pension reforms are ending up in court. Unions argue that to take what has been promised to them is unfair and illegal. There are three different types of court cases, says Alicia Munnell of the Centre for Retirement Research. The first involves COLAs. Some courts, including a New Jersey superior court last month, have upheld COLA cuts and suspensions. The second sort involves changing the contribution rate for current workers; courts in New Hampshire and Florida have ruled against the states in these cases. The third sort is the kind that might arise in Rhode Island, concerning benefit changes for current workers and current retirees. It is not yet clear which way these last decisions might go.”

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