Compliance April 15, 2011

States Must Face the Truth about Pensions to Fix Debts

April 15, 2011 (PLANSPONSOR.com) – Witnesses speaking before the U.S. House Committee on Oversight and Government Reform say current pension accounting practices are not giving states a true picture of their debt.
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Andrew G. Biggs, Resident Scholar at the American Enterprise Institute, contended that economist are almost universal in believing that the accounting rules governing state and municipal governments’ pension contribution rates understate plans’ true liabilities. “As bad as the current pension funding situation may look, the reality is likely far worse,” he said.  

Biggs noted that current pension accounting practices allow plan to discount benefit liabilities that are guaranteed by law using the expected interest rate on a portfolio of risky assets.  “Economists are nearly unanimous in believing that this approach is both technically wrong and, from a policy perspective, dangerous,” he contended.  

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“According to economic theory as well as the practice of financial markets, the discount rate used to value a liability should reflect the relative risk of the liability, not of any assets set aside to fund the liability,” Biggs added.  

In addition, Dr. Robert Novy-Marx, Professor of Finance at the University of Rochester Simon Graduate School of Business, noted that under Government Accounting Standard Board (GASB) rules, a plan’s reported financial status improves when it takes on more investment risk. “This logic is clearly flawed… How you invest your assets has no impact on the current value of your liabilities,” he said.  

Biggs contended that if public sector pensions were required to use economically sound accounting rules, the cost of pension funding would rise from around 12% of employee wages to 46%. Novy-Marx contended that properly accounted for, the unfunded portion of pension promises already made to state and local workers is roughly $3 trillion, or three times as large as that recognized under GASB. “This exceeds all recognized state and local debt combined, and represents a debt owed to state and local government workers of roughly $25,000 for each U.S. household,” he noted.  

Both agreed that the Public Employee Pension Transparency Act reintroduced in the House this year (see Public Pension Transparency Bill Reintroduced in the House) would deflect states from taking a “see no evil” approach to pension financing issues.  

Complete testimony can be downloaded from here.
Compliance April 15, 2011

Governors Say Pension Reform an Answer to Government Debt

April 15, 2011 (PLANSPONSOR.com) – In a hearing this week before the U.S. House Committee on Oversight and Government Reform, the governors of Vermont and Wisconsin suggested pension reform is one answer to improving state and municipal debt.
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In his testimony, Vermont Governor Peter Shumlin, noted that the current fiscal crises that most states are experiencing are the result of the greatest economic recession since the Great Depression. While he said the most significant cost driver in Vermont is health care, he said that also on Vermont’s list of long-term fiscal concerns are its state pension and retiree health care obligations for state employees.   

“What we have learned in this area is that there are steps we can take to significantly reduce costs to taxpayers without undermining traditional defined benefit plans, which most objective parties agree provide far better retirement security, serve to retain quality employees, and are more efficient than defined contribution plans,” Shumlin said.  

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According to Shumlin, states can and should ask everyone to sacrifice. Vermont has negotiated a 3% cut in salary for all state employees, and those at higher income levels have taken a 5% pay cut, for two years with no step or other increases. With its public employees, Vermont agreed to higher retirement ages for state employees and teachers, increased contribution rates, and ratcheted down retiree health benefits.  

Shumlin pointed out that the changes to Vermont’s Teacher pension and retiree health plans that went into effect this past July resulted in the state’s annual actuarially required pension contribution decreasing by almost 25% right away. Long-term unfunded liabilities were reduced substantially.

Is Collective Bargaining Reform the Answer?  

In his testimony before the U.S. House Committee on Oversight and Government Reform Wisconsin Governor Scott Walker defended changes to collective bargaining in his state that sparked protests and a government standoff.  

“We are reforming the collective bargaining system so our state and local governments can ask employees to contribute 5.8% for pension and 12.6% for health insurance premiums. These reforms will help them balance their budgets. In total, our collective bargaining reforms save local governments more than $700 million each year,” Walker testified.  

Walker contended that most workers outside of government would love the states proposal, as on tours he made to numerous factories and small businesses across Wisconsin, workers told him that they pay anywhere from 15% to 50% of their health insurance premium costs. The average middle class worker is paying more than 20% of his or her premium.  

Walker pointed out that even federal employees pay more than twice what Wisconsin is asking state and local government workers to pay and most of them don’t have collective bargaining for wages or benefits. “By nearly any measure, our requests are quite reasonable,” Walker said.  

He added: “The choices we are making now in Wisconsin will make sure our children are not left picking up the pieces of the broken state budget others left behind. Our reforms create the lowest structural deficit in recent history ensuring our budget is stable for decades to come. Moody’s called our budget proposal “credit positive” because of our dynamic efforts to reduce the structural deficit.   

“These changes do more than just balance the budget; they give small businesses the confidence they need to grow and invest in our state. Investors want stability and our budget provides long-term fiscal certainty for our state and local governments.”  

The complete testimonies can be downloaded from here.

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