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More steps must be taken to reduce risks in Minnesota’s public pension system

Kurt Winkelmann

A $16 billion hole in the pension plans for Minnesota public employees got a timely patch in May when recently enacted legislation cut the deficit in half. The Legislature (especially the Legislative Commission on Pensions and Retirement), the governor and other important constituents should be applauded for taking an important first step. However, further steps should be taken to reduce the risks to pension beneficiaries and taxpayers of significantly reduced benefits or significantly increased contributions. I am skeptical, however, that such steps will be taken. And, without a commitment to further action, future generations could be left to foot a large bill.

I am doubtful that steps will be taken because despite over a decade of warning about public pension funding, nothing fundamental has changed. Pension industry experts and financial economists have persistently warned about the perils of using investment returns to value pension obligations and the importance of automatic stabilizers. These warnings have just as persistently been ignored, even as other pension and insurance systems have heeded the warnings.

The role of fear

Why have public pensions resisted the entreaties and advice from experts? A perhaps overly simplistic one-word explanation is fear. Pension beneficiaries are understandably afraid of either reduced benefits or increased contributions. Legislators are understandably afraid of increasing taxes. So, instead of dynamically and transparently managing contributions and benefits, pension investments have been left to shoulder the responsibility of funding benefits. In a period when investment returns are generally expected to be lower than in the past, pension investment managers have had to respond by taking on more investment risk.

Fear also helps us explain the use of language that obscures the underlying issues. Here are some examples of half-truths that I have heard or read that prevent serious discussion of pension reform:

  • “Taxpayers aren’t on the hook for changes to the pension system — it is employers and employees.” Ultimately, taxpayers are the employers of public employees. If contributions go up, some taxpayers will pay, one way or another.
  • “If we pay pensions, we’ll have nothing left to pay teachers.” Pensions are, of course, a form of compensation for public employees. So funding pensions is essentially ensuring that this compensation gets paid. 
  • “Pensions are paid out of investment returns.” The implication of this statement is that contributions (savings) don’t matter. It should be self-evident that a pool of assets exists because somebody contributed (saved) at some point in time.
  • “It doesn’t make sense to have a fully funded pension plan.” This statement means that taxpayers are always on the hook for an unfunded liability. How can this make sense? For the most part, shareholders don’t tolerate companies that are persistently in the red (with tech firms being a puzzling counterexample).
  • “Who is contributing to the pension— the employer or the employee?” The real question is whether employees are getting an increase in compensation (taxpayer contributions increase) or whether they are shifting compensation to the future.

These kinds of half-truths impede any serious conversation around pension funding and pension solvency. Note that this is an issue of how pensions are funded, not whether they are guaranteed retirement benefits (DB) or guaranteed contributions (DC). There are plenty of good examples of solvent pension systems where benefits are guaranteed.

How would a serious pensions conversation start?

A serious conversation on funding public pensions would start with a statement of the magnitude of the problem. It would go on to discuss the tradeoffs and risks of alternative solutions. And, it would identify the groups most at risk under different policies.

Here’s a crack at starting such a conversation. The recent pension bill reduces the pension deficit to $8 billion, or $3,745 per Minnesota household. However, using the valuation standards of virtually ANY other pension system in the world or the Minnesota commissioner of insurance, that number increases significantly. Here is a discussion question: Why do public pensions value pension benefits differently than state insurance commissioners value annuities?

Even if the cost to Minnesota households is “only” $3,745, there are still risks. One risk is low investment returns, brought about by subpar economic growth. If investment returns are low, then either Minnesota households are on the hook for more than $3,745 or public employees will need to consider more permanent reductions in benefits. Here’s another discussion question: How do public employees and taxpayers want to manage this risk?

Demographic groups will be affected in different ways

A prolonged period of low investment returns will only be revealed after the fact. Thus, not every demographic group will be affected the same way. One obvious scenario is that future taxpayers and future beneficiaries will face some combination of lower benefits and higher taxes. So, here’s a final discussion question: How much of the investment risk should be shifted to future generations? And, a bonus discussion question: Should the impact of demographic change influence how intergenerational risk is considered?

I said at the outset that I am skeptical that any next steps will be taken. I am skeptical because the questions to be addressed are hard, and conflict avoidance is easy. I am certain, however, that someone will write a rebuttal to my points here. They will argue that (a) everything is fine and (b) my interest is in privatizing the public pension system. I am willing to engage in fact- and evidence-based discussions with anyone; just name the time and place. These issues can only be resolved through open and honest debate.

Ordinarily op-eds such as this one close with a call to action. This is mine: I would encourage today’s young workers, public and private, to get educated about pension issues. I would encourage them to ask hard questions; if the answers don’t make sense, then ask again. Ultimately, they are the ones most at risk.

Kurt Winkelmann is the Pension Policy Senior Fellow for the University of Minnesota’s Heller-Hurwicz Economics Institute, which is developing a comprehensive research-based approach to public pension design. Winkelmann has been leading the initiative for the past year.


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Comments (16)

  1. Submitted by joe smith on 08/21/2018 - 09:23 am.

    Public workers need to get off the

    tax payers money for pensions by individual 401k investing. The ludicrous returns projected by States for pension funds are never accurate. Look at the unfunded liabilities the tax payers are responsible for across our country State by State. I like when the author states that MN residents are only on the hook for $3,745 per household. Doesn’t he understand that we’ve already contributed with taxes every year for the past 4-5 decades. I guess that wasn’t enough.
    There will never be enough money to satisfy the public workers when it comes to pensions. Stop it now or everyone be prepared to pay later!

    • Submitted by Patrick Steele on 08/21/2018 - 09:45 am.

      Many say the 401k system is a solution. Of course, we’re just about to find out how the first generation who used it as their primary retirement vehicle fares. Given that the average working-age family has about $5,000 in retirement savings, you are arguing for most of the elderly in our society to live in abject poverty. That’s fine if that’s your stance, but let’s at least be clear what you’re advocating for.

      • Submitted by Pat Terry on 08/27/2018 - 05:46 pm.


        What you do is replace the pension contibution with an employer contribution to the employee’s 401k. That way, the employer pays as if goes with no future obligation.

  2. Submitted by Patrick Steele on 08/21/2018 - 09:32 am.

    Why not encourage young people to ask why they don’t have a pension? Anything else just serves to stir up inter-generational class conflict. We’ve been hearing doom and gloom about Social Security for decades, yet its trust keeps growing and growing. In spite of that, many young workers I talk to say they don’t think it’s going to be there when they retire. If enough believe that, the sentiment will come true.

    • Submitted by Mark Kulda on 08/21/2018 - 02:41 pm.


      The Social Security trust fund is set to be fully depleted in 2034, so in only 16 years. That doesn’t sound like it keeps growing. It is in need of life support.

      • Submitted by Patrick Steele on 08/21/2018 - 02:52 pm.

        Growing, yes. Went up a little over 41 billion between 2016 and 2017. Of course we’re going to draw that down some in future years, but if there ever were a time to cash that in, the peak years of Boomers in retirement would be it.

        In the mean time the system will continue to not miss a payment and will have administrative costs under 1%.

      • Submitted by Frank Phelan on 08/21/2018 - 02:55 pm.

        First Aid Kit

        All it really needs is a first aid kit. If the cap on income subject to the FICA tax is raised, the system will be solvent for decades. I’m told “That’s a political non-starter,” but they’re the same folks that say the point one percent need more tax cuts, so I consider the source.

        If nothing changes, it is projected to be depleted by 2034. That means that it will be back to pay-as-you-go, and benefits would be covered to 79%, not that payments would disappear.

        When I wore a younger man’s shoes, I worked with guys that scoffed at the notion that they’d be able to collect SS retirement benefits. They’ve all been cashing those checks they scoffed at for several years now.

        • Submitted by joe smith on 08/22/2018 - 07:36 am.

          Frank, if those same folks had invested in

          one of many money market funds they would be making 2 to 3 times their current SS check. The average couple who made an average salary put in around 600k into SS, do the math with them investing with Berkshire Hathaway for that same time. Government has and always will be a poor stuart of your money.

          • Submitted by Patrick Steele on 08/22/2018 - 10:12 am.

            How do you figure? FICA taxes put money into the system, money was invested and administration costs were under 1%, and then benefits are paid out. Short of burning through savings at a breakneck pace, how do you manage to get 2-3 times the returns the Social Security Administration manages to get, and are you willing to share your investment secrets with the rest of us?

            • Submitted by joe smith on 08/22/2018 - 02:04 pm.

              The power of compounding.

              Your money doubles every 6-8 years. If you happen to use Northwestern Mutual, Magellan Fund or any number of investment firms (way more reputable firms than Madoff types, no matter how you look at it) you would get a diversified portfolio and have 2-3 times (minimum) more money than the 600,000k you and your wife put into SS, starting 35 years ago.
              The average SS payment per month for June 2018 is $1,413 with a max monthly payment being $2,788 (if you earned over 128k a year the past 35 years), you do the math. You had better hope you both live to 85-90 to get your money back.
              More bad news for you, that SS lockbox that was going to be invested for you was raided a long time ago by legislators.

              • Submitted by Patrick Steele on 08/23/2018 - 08:55 am.

                To put $600k in the system over the past 35 years the couple would have made an average of ~$138k over that time span. For what you’re saying to be true, a young couple in the 1980s would, regardless of income, start investing just over $17k/year and follow through on that for the next three and a half decades. If they get a late jump, they have less time for the returns to compound. They also need to average 9-12% returns (11-14% in nominal terms).

                Over in the real world, the median household makes about $60k and has $5k saves for retirement. Younger households with plenty of time for compounding returns make even less and are often saddled with student loans which make investing even more difficult. All the while, Social Security keeps millions out of poverty and its trust keeps growing.

          • Submitted by RB Holbrook on 08/22/2018 - 10:47 am.

            Blithe Assumptions

            You’re assumption only holds true for a few “average couples.” At some point, there will be an effect on the market of thousands/millions of average couples each putting 600K into money market funds.

            Would that effect be good? Or bad? Would investment and productivity increase, or would the values of existing assets become artificially inflated and, ultimately, collapse?

            You’re also assuming everyone is going to put their money into well-run, profitable funds like Berkshire-Hathaway. There are more Bernie Madoffs in this world than there are Warren Buffetts, and before you tell me that the average couple should be scrupulous about their investments, let me remind you that a lot of sophisticated investors lost a bundle to Madoff.

          • Submitted by Matt Haas on 08/23/2018 - 01:11 am.

            Unless of course

            They came due to retire around 2008 or so, but hey what’s ten years give or take?

  3. Submitted by Bob Petersen on 08/21/2018 - 10:30 am.

    I wish that I had taxpayers to foot the bill of my retirement. But as many people seem to never understand is that the government knows nothing about money. Overinflated investment speculation and the continued ask of taxpayers to foot ever more and more money for others. When the government keeps asking more and more of the taxpayers, there is less for them.

    At least we are not places like Illinois and New York with their bankrupt pension systems. Then again, it shows that these systems do not work and need to be done away with. But we leave that back to the elected who do nothing but pander for votes.

    • Submitted by Frank Phelan on 08/21/2018 - 01:29 pm.

      Who’s Zoomin’ Who?

      What is this non-sense about “tax payers footing the bill for retirement”? What sophistry!

      Mr. Peterson, do tax payers “foot the bill” for the snow plow driver’s groceries? Cable TV? Does a county attorney live in public housing? Do rec center employees buy their own vehicles, or do “tax payers foot that bill too?

      Can a 3M stockholder tell 3M employees, “Hey, I bought that house you live in! I paid for your car, take care of it!”

      Are you suggesting that police should work for free, volunteering their time?

      When you suggest that government keeps asking for more and more, can you back that up with data, or is all you have empty but emotionally satisfying rhetoric?

      Emotional rhetoric is for those snowflakes, the rest of us like data.

  4. Submitted by Frank Phelan on 08/21/2018 - 10:53 am.


    For a long time I’ve wondered if public pension plan would be better with the building trades’ Taft-Hartley funds. First, I am not a industry insider, so my knowledge is at a basic level.

    My understanding is the public employers agree to allow the employees to forgo some of their cash salary in favor of retirement income. The employees contribute a set percentage of their wage to the pension, taken off the top of their wage each payday. (How many people know public employees do that? Not many I’d guess.)

    But as I understand it, there is no contractual obligation for the public employers to contribute their full share to keep the pension fully funded. Who knew politicians would promise something and let someone else figure out the details later?

    In the construction industry, union contractors pay a set amount per hour into an industry trust fund, per the collective bargaining agreement. The pension fund has an equal number of trustees from the union and the contractor’s association. The trustees set the value of a pension credit. If the trustees’ actuary determines that benefits can be raised due to a flush fund, the trustees can do so, but are not obligated to. The trustees may also ask the actuary how much the hourly contribution would need to be increased to fund a given increase in the pension benefit. For example, the actuary may say the pension credit may be increased by $1 with an increase of 15 cents/hour.

    When an individual’s pension benefit is calculated, it’s based on the number of credits (generally one per year) times the value of the credits. In some Taft-Hartley plans, the credits have all the same dollar value, and some can have varying dollar values based on what the trustees set them at when they were earned. Contrast that with the more loosey-goosey formula the public employee plans use, such as the average of the employees’ five highest years’ incomes. That method encourages gaming the system by working scads of overtime in the final years of working. In union Taft-Hartley funds, one can work 3,000 in one year, but it still only earns one credit. As I understand it, the Taft-Hartley system makes actuarial calculations more sound.

    The employer trustees are liable for any unfunded liabilities, so they are conservative about increasing the benefit amount.

    So my question is, had public employee plans been set up this way, would they be so underfunded today? Can they be converted to this today?

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