Thinking about public pension funding usually makes people’s teeth hurt, but like sports stadiums and light rail, it’s an issue that won’t go away.
So it’s not surprising that, in the midst of the Great State Budget Impasse, little notice was paid last week to a Ramsey County District Court ruling upholding the constitutionality of changes the Legislature made to the state’s three major public employee pension systems last year as part of a comprehensive “pension sustainability” reform package.
Several public employee retirees had challenged one aspect of the reforms, temporary reductions the Legislature imposed on cost of living (COLA) adjustments until the pensions hit certain funding ratio targets.
In his ruling, Judge Gregg Johnson noted that the changes the Legislature imposed were a “reasonable response to a fiscal threat that jeopardized the long-term interests of Plan members, the State, and the State’s taxpayers.”
An earlier study by the Retirement Systems of Minnesota released this spring reported “remarkable progress” in the systems’ recovery from the negative impacts of the market meltdown and recession of 2008-2009.
The report credited the pension reform package, as well as a strong stock market rebound, for the improvements and applauded the state’s tradition of a “bi-partisan, long-term, responsible approach that the state’s legislators and governors have modeled to maintain the financial security of Minnesota’s public pension plans.”
In addition, the study compared the pros and cons of keeping the traditional pension structure with its guaranteed payout for retirees, known as a defined benefit (DB) plan, moving to a private savings, or defined contribution (DC) plan similar to the familiar 401(k) plans most private sector employees have, or implementing a hybrid combination plan.
Public employee plans in Minnesota and elsewhere have retained the DB structure for the most part, while private employers over the past three decades have increasingly moved to defined-contribution plans, such as the 401(k), while eliminating traditional pension plans, putting the responsibility for retirement savings on their employees.
In 1975, 88 percent of private-sector workers had DB pension coverage; by 2005, the number had declined to 33 percent, according to the National Institute on Retirement Security (NIRS).
But that shift has not translated into a greater feeling of security. American workers are more pessimistic about achieving a comfortable retirement than at any time in the past two decades. Eighty-four percent of Americans survey by NIRS indicated that those with traditional pensions are more likely to have a secure retirement and 77 percent believe the disappearance of pensions has made it harder to achieve the “American Dream.”
Twenty-seven percent of U.S. workers now say they are “not at all confident,” about their chances of achieving a comfortable retirement, according to a Retirement Confidence Survey conducted by the Employee Benefit Retirement Institute.
That level of pessimism is up 5 percentage points from last year, and is the highest level measured since the survey began 20 years ago. The percentage of workers saying they are “very confident” of a comfortable retirement dropped to 13 percent — tied with 2009 results as the lowest rate ever measured by the survey.
Dr. Norman Ehrentreich, a Twin Cities-based pension consultant, who has been critical of public pensions in Minnesota and elsewhere, predicts that within five to ten years public pensions will follow the method of private employers, moving to DC plans.
Maintaining the traditional DB plans “is simply not sustainable in the system they’re working in,” Ehrentreich argues.
He will make his case more fully this Sunday at the Critical Thinking Club in St. Paul when he will speak on “The Future of Public Pensions – Are they Sustainable?” from 10 a.m. to noon.
Ehrentreich, who soon will join the Royal Bank of Canada as a pension consultant, currently has his own consulting company, Ehrentreich LDI Consulting & Research, LLC. He argues that defined benefit plans should adopt a liability-driven investment (LDI) strategy that matches predictable investment returns with known future expenses. This LDI strategy is beginning to find favor in private investment plans and has been successful in the Netherlands, he argues, but public plans have been reluctant to adopt the approach.
Ehrentreich submitted comments (PDF) to the Minnesota Pension Systems study while it was being drafted. He says he was disappointed the comments were not included in the final report.
His critique of Minnesota’s pension plan hinges on three arguments:
Overly optimistic assumptions: The state “adopted the most aggressive and riskiest return assumption among its peers” by holding that its plans will average 8.5 percent return on their investments over time. This is the highest rate of return, which has been adopted by only 10 percent of public pension plans.
Inadequate funding policies: When the state is under budget pressure and temporarily pulls back on funding, it requires even riskier investments in the future to make up for the lost investment gains, a phenomenon he terms “reverse dollar cost averaging.”
Investment performance linked to expected payouts: When investment returns push plan assets up, retirees, employees and the Legislature are tempted to increase future benefits, but this “feedback loop” is not taken into account in making investment return assumptions.
“A potential failure of our DB pension system is not necessarily a question of solvency or fiscal capability,” he tells the Retirement Systems. “It is as much a question of public acceptance,” he says.
“However, if we continue to deceive ourselves about the costliness of future pension obligations, we will continue to over demand, overpromise, and under deliver,” Ehrentreich says. “In that case, the public acceptance of DB pensions for public employees is likely to vanish.”