Mention pensions and—until recently—most people pictured a secure income in old age, possibly including happy thoughts of leisurely trips and visits from grandchildren. Assuming they were lucky enough to have a pension, their eyes would glaze over if the conversation steered toward years-of-service formulas, funding ratios, and other aspects of the arcane and obtuse inner workings of pension funds.
No more. The deteriorating condition of many state and local government pension funds has grown into an impassioned topic for cable talk shows. The financial meltdown and economic downturn have made obvious what many experts long knew: Too many state and local governments routinely underfunded their pension plans while the future cost of their retirement payout promises swelled.
Take Illinois, which has funded only 54 percent of its public pension liability, according to the Pew Center on the States. This financing gap translates into a $54.4 billion bill that is more than three times as large as the payroll for current workers participating in the state's pension program. The generosity of many public pensions is an incendiary topic, with taxpayers potentially on the hook for billions and billions in unfunded promises. "These are structural issues and not just a reflection of where we are at in the economic cycle," says Joshua Rauh, economist at the Kellogg School of Management at Northwestern University. Adds Robert Clark, economist at the Poole College of Management at North Carolina State University: "The next decade will be one of fundamental reform in public sector pensions."
Reforming won't be easy. The harsh fiscal reality is that in most cases, public pension obligations in states and cities can't be changed for existing workers. Those workers will continue to earn their promised pension benefits throughout their government career, although a number of state governments are trying to tinker at the margin, such as by changing cost-of-living payments. Municipalities in Chapter 9 bankruptcy can renegotiate pensions. (In sharp contrast, companies can freeze promised benefits to-date for their workforce, then modify the plan's future returns). As a consequence, public pension reform will mostly affect new hires. In the current political discussion, it is said that if the 401(k) is good enough for private sector workers, it must be fine for the public sector.
Yet three decades after the 401(k) was launched, its own drawbacks are becoming increasingly apparent. "There is certainly 'pension envy' and the answer is, 'let's go to the lowest common denominator,'" says Alicia Munnell, director of the Center for Retirement Research at Boston College. "That doesn't make sense."
Indeed, the heated rhetoric is obscuring the fact that pressure for change offers a real chance at designing a better 401(k)-type pension. Pension experts agree that unlike the current generation of private-sector 401(k)s, public-sector plans should feature a very limited menu of broad, low-fee investment options; mandatory worker participation; a required employer match; and low-cost inflation-hedged annuity options to guarantee a fixed income in retirement. It's an approach the private sector may eventually want to emulate.
"I have grown increasingly frustrated that this is boiling down to a debate of taxpayers versus government workers," says Jeffrey Brown, professor of finance at the College of Business at the University of Illinois at Urbana-Champaign. "The public pensions are ripe for reform and it's a real opportunity for everyone."
A majority of government employees are covered by "defined-benefit" pension plans. To most of us, these are the blue-chip pensions from days past, by which the employer bears all the investment risk and commits to a fixed payout of money based on a salary-and-years-of-service formula. Many more private-sector employers used to offer defined-benefit plans, but they are costly to run and carry onerous obligations toward retirees.
Post a comment about this story in Reader Discussion…
RSS Feed: Most Read Stories
RSS Feed: Most E-mailed Stories
RSS Feed: Most Discussed Stories
Buy a link now!
About Advertising EDGE Programs Reprints Terms of Use Disclaimer Privacy Notice Ethics Code Contact Us Site Map
©2011 Bloomberg L.P. All Rights Reserved.
Read Full Article »