The nation’s public pension underfunding crisis isn't the overwhelming issue for the municipal finance industry that it’s often made out to be.
“We find that in the aggregate pensions can be stabilized with moderate fiscal adjustments,” Louise Sheiner of the Brookings Institution’s Hutchins Center on Fiscal & Monetary Policy, said at the annual Brookings Municipal Finance Conference in Washington.
Sheiner and co-authors Jamie Lenney of the Bank of England and Byron Lutz of Federal Reserve Board reached that conclusion in a new
Many pension plans have, in fact, already taken significant steps to assure their long-term viability such as reducing benefits for new hires, delaying the full retirement age, reducing cost-of-living adjustments for retirees and increasing contribution rates.
“Plans have actually made a lot of changes,” Sheiner said in a
Seventeen of the 40 plans they studied have reduced COLAs since 2007. The study found that if COLAs equaled inflation, benefits would rise about 25% over next two decades. If plans eliminated COLAs, and many could do so legally, benefits would eventually fall an additional 9%.
The authors contend that focusing on the long-term sustainability of public pension plans rather than their underfunding as required by the Governmental Accounting Standards Board standards allows communities to focus on immediate pressing priorities such as reducing the lead in their drinking water.
The sustainability approach is rooted in the history of public pension plans, which were not required to be fully funded several decades ago.
Most plans were created before the creation of GASB and were not targeting full funding before the 1980s. In 1978 17% of the defined benefit plans were funded through pay-as-you-go, Sheiner said.
No matter how you look at the plans they are not fully funded and have never been fully funded, she said.
Credit rating agencies have put pressure on state and local governments to focus on pension underfunding but communities can achieve high credit ratings even if their plans aren’t fully funded.
However, the nation previously has not had unfunded public pension liabilities this economically significant, said Tom Aaron, vice president and senior analyst at Moody’s Investors Service.
“We look at pensions as a must pay obligation,” Aaron said.
That said, Aaron said Moody’s gives a high credit rating to many cities and communities. The public pension obligation is only one of the factors that go into a community’s rating for general obligation bonds.
The authors, who say their paper does not reflect the views of their employers, studied a sampling of 40 plans. These included some well-known underfunded plans and some highly funded ones in an effort to achieve the mean levels for the nation.
They did what they described as “reverse engineering” of the cash flows to determine how long the plans could survive under their current funding levels.
They then looked at what amounts of additional funding could sustain them longer term using three stabilization approaches. One used a 1.5% real rate of return on pension assets. Another used a 5.5% real return and the third used a 3.5% real return which is about what the plans have realized since 2000.
“In aggregate, plans don’t exhaust (hit zero assets) for 30 years under a 1.5% rate of return, and not until after 50 years under 3.5%,” the paper found. “At 5.5% real return, plans are overfunded on average.”
