Funding deterioration, higher risk profiles, unreasonably high rate-of-return assumptions and even social activism have contributed to a $1 trillion shortfall in public pension plans that is rooted in poor governance, the Manhattan Institute for Policy Research said in a
The shortfall – “even under such plans’ own overly rosy growth assumptions” – jeopardizes retirement security, according to free-market leaning think tank Manhattan Institute. “In the alternative, [it] threatens the broader public with draconian tax increases and-or reduced funding for vital services,” said the report, co-authored by institute senior fellows James Copland and Steven Malanga and titled “Safeguarding Public-Pension Systems: A Governance-Based Approach.”
Since 2000, the report said, public-pension plans in the aggregate have gone from fully funded to 74% while in 2014, 63% of such plans were less than 80% funded, a level deemed at-risk for private-employer pension plans under the Pension Protection Act. Additionally, 20% were funded at less than 40%, according to the report.
“To date, little attention has been paid to how board composition and governance might increase the likelihood of such mismanagement,” the report said.
The report comes amid heightened scrutiny of teetering pension plans nationwide, with red flags cited in Puerto Rico, New Jersey, Illinois and Pennsylvania, among other state and municipal issuers.
“Rating agencies have taken note with downgrades – citing pensions’ growing budget burden as well as deferred infrastructure investment,” Wells Fargo Securities senior analyst Natalie Cohen said in a commentary.
Cohen also cited increased awareness of outdated mortality tables among public pension plans. She referenced Detroit, which just reported a $491 million pension shortfall beyond agreements resolved in bankruptcy court.
The city’s Financial Review Commission is estimating the additional cost to the city. While Cohen praised the commission as ahead of the curve, “few public plans have made the transition,” she said.
Pennsylvania is home to an estimated $63 billion unfunded pension liability that has triggered multiple rating agency downgrades the past three years. Pension overhaul debate in the commonwealth has ranged from plan-redesign proposals to reducing Wall Street fees.
Gov. Tom Wolf said this week that in the past year, the Public School Employees’ Retirement System has reduced management fees by $103 million and that the commonwealth’s other pension fund, the State Employees’ Retirement System, has reduced the fees it pays by $16 million.
“I will continue to work with both pension systems to reduce fees even more,” Wolf said in a statement.
Copland and Malanga also said the percentage of assets in cash and fixed income for state and local pension plans have plummeted from 96% in 1952 to less than 19% in 2015. Also, they said, the implied risk premium in state and local pension plans’ rate-of-return assumptions has risen from 30 basis points over 30-year Treasurys to 480 basis points today, up 1,500%.
“If public pension plans assumed a ‘riskless’ rate of return, state and municipal pension plans would be only 50% funded,” Copland and Malanga wrote.
Citing research by University of Tennessee finance professor Tracie Woidtke, Copland and Malanga said social activism harms share value.
“Empirical research suggests that such social-issue focus, at least in the form of shareholder-proposal activism, is associated with lower firm value in funds’ portfolio companies,” they wrote.
“Some of the largest public pension funds, including those for California employees and teachers and those for New York city and state employees, have placed substantial emphasis on social, political and environmental concerns in managing their portfolio investments.”
To improve board governance, said Copland and Malanga, boards should reflect both taxpayer advocacy and financial expertise; enact ethics and conflict-of-interest standards; prohibit lobbying for workers’ benefit enhancements and standardize the choices of discount rates and investment assumptions based on independently determined formulas.
