Economics

The Coming Public-Sector Pension Crisis

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From the Cincinnati Enquirer, a report on the Queen City's criminally negligent funding of its workers' pension plan:

Although reforms that council adopted in June have shaved tens of millions of dollars off the city's long-term retirement costs, the revised projections make it clear that City Hall still faces daunting challenges over the next decade in funding pension and health benefits for nearly 7,800 workers and retirees.

To keep pace with projected expenses, the city's $26.4 million contribution to the pension fund this year would need to rise to $84 million in 2010—a scenario that council members and other city leaders concede is unrealistic.

With the city facing a 2010 budget deficit estimated at $51.5 million, a shortfall that City Manager Milton Dohoney Jr. has warned is all but certain to force layoffs and worker furloughs, council likely will find it difficult to allocate much more to the pension fund than it did this year.

More here. Exactly this sort of scenario is playing out in a locality near you.

The causes of such shortfalls include bad stock market returns and a lackadaisical approach more generally to fully funding future commitments (why rob from today's funds to pay for tomorrow's bills, if tomorrow may never come or if a stock market boom will make it easier to fund it? and a governmental unit can always raise future taxes, right?). Read Jon Entine's February 2009 Reason cover story on public-sector pensions to get a sense of how off things are.

But a huge part is in the nature of the retirement and health plans, especially in the public sector. Retiring Cincinnati workers get up to 90 percent of the average of their last few years' of work and have generally small co-pay portions on benefits. More to the point, the defined benefit plan is yesterday's model, and one that was predicated upon many more workers per beneficiary than is likely to be seen ever again. Which is one reason why virtually all new retirement plans are based on a defined-contribution model, where companies and workers fully fund (or, same thing, are fully responsible for) their retirement benefits via a 401(k) or similar system. 

The only real question left is who gets stuck with most or all of the bill for the sort of old-school program in Cincinnati and most other governmental units around the country: The people in it or the rest of us.

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  1. The causes of such shortfalls include bad stock market returns

    And more generally the problem of raising benefits or lowering employee contributions any time there’s a run of good returns, but only raising taxes when there’s a run of bad returns. The union pressure helps, of course, as does the desire of politicians to avoid strife now, and pass the buck onto a time when they’ll be out of office.

  2. If we’re already are on the hook for “private” sector union pensions, of course we’ll have to pay for the public sector’s. I think there is going to be money to be made building poor houses pretty soon.

    1. You won’t have to build anything. There will be, as there are in leading public decay cities like Detroit, Toledo, and hundreds of other Democrat cities, millions of free houses that have, or will be, abandoned from the raiding, pillaging of tax assessors and the products of the LBJ poverty factories.

      1. The average price of a home in Detroit ten years ago was $73,000.

        Today in 2009 it’s $7,300.

        That’s not a mistake: 1/10th.

        You’re right. Plenty of homes to go around, if you want to freeze to death in Detroit.

  3. It isn’t them having pensions I object to so much as the absolutely ridiculous salaries some of these state and municipal government employees make.

    1. So, do you not object to these people continuing to get 90% of their bloated salaries when they no longer “work”!

  4. If you work for the government, money *does* grow on trees.

  5. “More to the point, the defined benefit plan is yesterday’s model, and one that was predicated upon many more workers per beneficiary than is likely to be seen ever again.”

    This statement is only true in the case of unfunded (e.g., Social Security) or severely underfunded (e.g., most state and local pensions) pension plans. If a defined benefit plan is properly funded during an employee’s working years, and the investment manager for the trust understands pension liabilities (i.e., recognizes that pension liabilities move very similarly to investments in bonds – not stocks), then the plan will function just fine regardless of changes in the size of the workforce.

    1. However, that’s a lot of “ifs,” and history has shown that, particularly with public-sector unions, those promises get violated.

      It’s a lot harder to retroactively change a defined contribution plan.

  6. Wait- you mean not *every* “retirement plan” is a Ponzi Scheme? Are you sure?

    1. No. They bank on you dying soon after retiring and not collecting.

      That’s what’s really insidious about the “Cadillac” systems for Government employees that allows relatives to the fourth or fifth generation (I exaggerate, but only a bit) to continue collecting long after the two-term congressman has kicked the bucket.

  7. P Brooks – sarcasm or no?

  8. I am a bit confused at the seeming anti-defined benefit (DB) bias from Reason (and commentors). Public deferred tax schemes, sure, those are despicable. But what is the problem with a private company offering a portion of wages to employees in the form of income in retirement. Again, those who scream for bailouts of their plans are also despicable, but the DB plan in general serves a significant portion of the population quite well in retirement. More importantly, what is the free market objection to a company offering wages in whatever form it thinks will attract and retain the best talent?

    1. I suspect that defined benefit plans only work best in an employment for life culture. My cousin retired a few years ago after thirty(+/-) years with one of the big 8 5 3. I t was the only full time job he’d had in his life.

      Not many American workers today share that kind of history, I venture. They need more flexibility and portability.

      1. OK, the strikeouts work except the struckout 8 looks like a struckout zero but why do the 5 and the 3 look like subscripts?

        1. OK, the strikeouts work except the struckout 8 looks like a struckout zero but why do the 5 and the 3 look like subscripts?

          It’s a font stylistic choice. They’re called old-style numerals or text figures. The 3, 4, 7, 9 have descenders, and the 6 and 8 ascenders.

          1. 0123456789

            1. Oh. Thank you.

    2. It’s not realyl a “free-market” objection. It’s the fact that it’s a very bad idea, and a free market objection to bailing out those companies and/or pension funds that tried it.

      It’s a bad idea for many reasons. First of all, the company may well go out of business before the worker reaches retirement age. The tech revolution of the last 20 years has seen the rise and fall of huge corporations that were expected to last, effectively, forever.
      Secondly, the pension funds tend to get raided from when the company starts to go downhill, either by “borrowing” directly from it, or borrowing against the assets. Sometimes with union approval – they want to see the company survive.

      Moreover, a young company without such liabilities is naturally going to enjoy a competitive advantage over any older company with them. So setting up deferred benefits almost guarentees that they company will be put at a competitive disadvantage in the future, and go bankrupt, and raid the pension money. Any kind of deferred benefits are going to cause this problem.

      You are way, way, better off getting paid more now and putting the money into a savings account or a retirement fund than you are counting on your employer to still be in business in 40 years and to keep it’s hands off the pension money.

  9. Defined-contribution retirement plans are racist.

  10. Sarcasm (mostly).

    There is no reason to be opposed to a fully funded, well managed defined benefit program. I have no problem with annuities.

    My real problem is with government officials who, using other people’s money, agree to contracts which provide them a short term political benefit while imposing long term adverse consequences on (nearly) everybody else.

    1. Amen.

      The proverbial can has been kicked down the road so many times it has fallen apart.

  11. More importantly, what is the free market objection to a company offering wages in whatever form it thinks will attract and retain the best talent?

    My problem with this argument is that it is almost always used in defense of union contracts; “management offers a ‘deferred’ payment to compensate for reduced wages now” is complete bullshit in a situation where management is, in reality, offering above market wages in the present, and piling more above market compensation in the future on top.

  12. California here we come!

  13. The City of Philadelphia, was recently successful at lobbying the State Legislature to allow the city to defer pension contributions. So, what happens in two years? Perhaps, someone (Mayor Michael Nutter) should ask the airline industry.

    The State of NJ, for whatever reason, invested about 80% of the state worker’s pension fund in Enron. Gone baby gone.

    In NJ, elected officials, and many high ranking appointees can collect several pensions (one from each position).

    I have no problem with pensions when it comes to the “grunts”. Ask any mail carrier why he is a mail carrier and most likely he’ll tell it’s because of the pension.

    Traditionally, in NJ, state workers receive a less than average salary for their position, but it gets made up for in benefits and paid time off. However, recently, the unions have been pushing for more competitive wages. So, now state workers receive competitive salaries, and huge benefit packages. Something’s got to give.

  14. It seems to me that if you are going to offer a defined benefit plan, then you must invest in defined outcome investments (such as bonds*). Thus, inputs and outputs will be calculable in advance.

    *yes, I realize bonds have some risk, but if you are investing in federal bonds, the risk is the US government defaulting – I think there are bigger worries at that point.

  15. robc – that is exactly the strategy change of which many actuaries are currently trying to convince their clients. As to risk – risk is OK in a pension plan, so long as the risk is correlated with the liability. Pension liabilities are related to interest rates and thus move very generally in tandem with bonds. Stocks, obviously, not so much.

    Unfortunately, many’s the institutional investor who sees the pension trust as the place to exhibit their alpha-generating skills.

    1. That is why defined contribution is better, when it is combined with individual control. That way each person can invest at the risk level they are comfortable with.

  16. I do know about anyone else here, but I’m experiencing a bit of schadenfreude at the thought of public service union employees losing their pension money.

    That is until I realzie it means that they’ll probably just make taxpayers bail them out.

    1. Bail them out? We are the ones who paid them in the first place. Public service union employees don’t pay enough taxes to pay their own salaries.

  17. All the big cities with these ridiculous oligations will die out as productive people leave. People are not going to carry those deadbeats.

    1. bingo. this extends to the states as well. bankruptcies at municiplaities and even states will be common. cant bail them out they have been too reckless and stupid.

  18. This is a great reason to fight tooth and nail any expansion of government, including new taxes, new hires, or new programs. Michigan has already gone to defined contribution – we need to force other governments to do the same.

  19. Yet another reason to Starve the Beast. The bottom 70% of all taxpayers are net recipients of tax money. These government pensions and employees are the main reason.

    It’s probably a good time to take a couple years off and do everything within the law to not pay ANY tax until things change (no, not Obama Change). We voted in the election and it didn’t matter — we’re going to vote with our wallets until these parasites get the message.

  20. The push for healthcare reform is motivated by our current financial disaster, and I don’t mean the recession and housing crisis. Congress has promised Medicare, Medicaid, Prescription Drug, and Social Security services over the next 75 years that are underfunded by $88.6 trillion ($88,600 billion).

    The public discussion is about the burden of $1 trillion ($1,000 billion) in extra taxes over 10 years. The true shortfall is 12 times as much, more than $1 trillion per year.

    The Democratic “solution” to this political and economic problem is to put everyone into one medical care pot. We then all get equal amounts of services at whatever high tax rate the government can levy. The young must be coerced into this system, to extract as much money as possible to serve the old.

    Obamacare Bails Out Medicare

  21. When Illinois held a constitutional convention in 1970, the politicians went to the trouble of adding a clause to the state constitution barring the state from reducing benefits paid to state employees. I wonder if that is enforceable. I was under the impression a legislative body could not bind its successors like that.

  22. The “Vallejo’s” will only get bigger and bigger!

  23. The Illinois constitutional amendment is enforceable against the state. Illinois will have to pay up regardless.

    In general, the defined benefits retirement programs were contractual agreements between the state and the employees, and it is almost certain that the courts will enforce them.

  24. The public pension crisis, when it hits, alongside the social security crisis, medicare/medicaid, and all of the other unfunded mandates our alleged leaders have placed on our heads, wil well-and-truly bankrupt our nation. When vast armies of government workers and retirees of the civil service, law eforcement/public safety, and the military all find the well dry, that’s when the tipping point will be reached – and maybe then we’ll see those millions of people pouring into the streets (peacefully of course) that we need to get Washington to mend its ways.

    The Fed can print money to pay its bills, and monetize its debts, but not so the states.

    It is criminally stupid that we let anyone – including military and public safety/LE – collect a pension before age 68, except in the case of disability. The government retirement age should reflect those of the rest of society.

    Defined benefit pension plans are a relic of the industrial age, and have no place in modern society, except on a pay as you go basis, i.e. all pensions muct be truly self-contained, no bailouts, no rescues, not tricks. If the income of the fund goes down, so does your check.

    To all those with their hands out for a pension check from the government, just remember this: kill the goose that lays the golden egg, namely the private sector, and your pension goes bye-bye.

  25. Indexing for inflation question.

    Are most public pensions indexed for inflation? I know that military pensions are. Point being that there are strong arguments for a policy of a mild inflation for the next few years. It helps people who borrowed too much and if state/local governments in effect borrowed through future promises then it could help them too.

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