Muni leaders mulling new approach to pension funding
3 min read
Muni leaders are digesting new approaches to solving pension fund challenges and monitoring warning signs, with recent evidence suggesting that there may be less cause for alarm than previously believed by many.
Despite concerns about underfunded pension plans, a brief published on Tuesday by Louise Sheiner of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution concludes that “under current contribution rates, baseline projections show no sign of a major crisis in the next two decades even if asset returns are low.”
Municipal bond holders are sometimes second in line behind pension fund members for payback if a municipality goes bankrupt. According to the brief, a fully funded pension fund may be an unrealistic goal.
“Stabilizing pension debt as a share of GDP would change the target,” Sheiner said. “Rather than finding the contribution amount that would get you to full funding you would find the contribution that kept the debt to GDP ratio in 30 years at its current level.”
Applying blanket fixes to underfunded pension plans is complicated by a patchwork of laws and collective bargaining agreements.
Referencing the brief, Bill Glasgall senior director, public finance, The Volker Alliance said, “It’s more of a macro approach. There’s no way that an individual pension can use this as a benchmark, because every plan is different.”
Many states host multiple state-level pension plans. Washington state has eight, Texas, Missouri, and California all have five.
In January, a report from Equable, a bipartisan think tank, labeled most state and municipal pension plans as distressed or fragile. The city of Chicago remains a pension fund problem child and the financial collapse of Detroit in 2013 created long-term repercussions and spawned lawsuits.
Charting the financial health of pension funds is complicated by inflation and demographics.
Sheiner believes accepting a possibly eternal pension liability would make things easier than working aggressively toward full funding in the traditional sense.
“Contributions wouldn’t have to increase nearly so much, and pensions would not have to be cut as much,” she said. “This is also a way of distributing the burden of past unfunded pension obligations equally over generations but no one generation would have to pay off the debt.”
Abandoning the concept of fully funded pensions can be hard to swallow. “Setting contributions as a percentage of GDP indefinitely would be similar to setting the point at which a plan is fully funded to infinity,” said Brian Whitworth SVP, Investment Banker, Hilltop Securities.
“We view governments paying more and sooner toward their pension liabilities as generally positive,” said Tom Aaron, VP, senior credit officer, U.S. Public Finance Group, Moody’s Investment Group.” Deferring contributions to the future reduces governments’ future financial flexibility, making future budgets more dependent on revenue growth to accommodate pension costs.”
According to the National Association of State Retirement Administrators 40 states have increased required employee contribution rates since 2009. The practice of making new pension plan member wait longer for vesting and reaping less has also become accepted.
The brief, which was published by the Center for Retirement Research at Boston College shows the ratio of state and local beneficiaries to active workers rising about 36% from 2017 to 2040 before flattening. The brief indicates that the ratio of state and local pension benefit payments as related to GDP has already peaked and will soon head south.
The brief also considers cost of living adjustments, inflation, and hiring reforms by concluding that pension benefits as a share of payroll are near their highest level.
Pension plan assets under three different scenarios are also investigated. Per the brief, “With the .5% real rate of return current contributions are insufficient to keep the plans solvent. With a 2.5% rate of return, assets are declining, but not as quickly. If plans earn 4.5% on their assets, they are sustainable.”
When comparing contribution rates for GDP stabilization versus full funding the brief reveals “the required percentage-point increase in contribution rates to fully fund these plans would be four or five times larger.”
Fixing underfunded pension plans remains a subject of debate and includes discussions about absurdly high discount rates and actuary tables that will eventually solve the problem once and for all.
“This has to be done on a plan by plan and entity by entity basis,” said Tom Kozlik, Hilltop’s head of public policy & municipal strategy. “I understand it from an academic perspective, but on the ground, it doesn’t move the needle.”
