Shed more light on pension problems

$altText Photo Credit: Illustration by Paul Corio

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Josh Barro, a fellow of the Manhattan Institute for Policy Research, is the co-author of the Empire Center for New York State Policy's report "New York's Exploding Pension Costs."

 

In state capitals all across the country, pension reform is near the top of the legislative agenda. When considering reform, lawmakers need to be asking certain basic questions. How much more does our state owe to government workers and retirees for pension benefits? And over the next several years, how much money will we need to meet those obligations?

Believe it or not, you can't answer these questions by reading the typical annual report of a pension fund.

The New York State and Local Employees' Retirement System (ERS) and the New York State Teachers' Retirement System (TRS) are the two main pension funds covering public employees outside New York City. According to these funds' most recent financial statements, they were both just over 100 percent funded. But those calculations are overly rosy in two ways.

First, they use optimistic estimates of liabilities. That allows public pension funds to understate the cost of making payments that fall far in the future. And they use "smoothed" asset values that don't fully reflect recent weak performance in the stock market. Using a practice consistent with private-sector pension funds - which is what is recommended by many financial economists - my colleague E.J. McMahon and I estimate that ERS was just 65 percent funded, and TRS was 61 percent funded, as of the middle of last year.

More alarmingly, when we estimated the payments that state and local governments will need to make into these systems over the next few years, we found a coming cost explosion.

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When a pension fund loses money in the stock market, governments have to make up the difference. And the bills that ERS and TRS will send to New York governments over the next several years are huge.

In the current fiscal year, school districts around the state had to pay $900 million in contributions to TRS. By the 2015-2016 school year, that payment will rise to an estimated $4.5 billion - an increase that would require an average 3.5 percent rise in school property taxes in each of the next five years, before paying for any other rising costs in school budgets.

Payments to ERS - which are paid out of the state budget and town, county and village budgets - will rise nearly as sharply. And that all assumes that the funds hit their investment targets over the next five years. If they fall short, payments will go up even more.

The fact is that New York is deep in pension debt, and we're going to need to make billions in extra payments over the next several years. That's important information for lawmakers deciding how to reform the state's pensions - so it's bizarre that it's fallen to a couple of policy analysts at a think tank to tell lawmakers about it. Our pension funds could, and should, answer these questions on their own.

 

The lack of pension transparency isn't just a problem in New York; in fact, New York's pension fund disclosures, as inadequate as they are, are actually better than those in the typical state. New York City's pension funds even disclose their liabilities on a market-value basis, similar to private-sector practice - though they do not project future-year contributions.

So while pension transparency should be on the agenda in Albany, it should also be on the agenda in Washington.

Earlier this month, a number of prominent House and Senate Republicans gathered to announce their support for the Public Employee Pension Transparency Act, a proposed federal law that would offer incentives for state pension funds to answer these questions. States not complying with the disclosure requirements would be prohibited from issuing tax-exempt bonds.

If enacted, this law would hand an important tool to state lawmakers looking to get a grip on pension costs. But even if the federal government doesn't mandate better transparency, state lawmakers should demand it on their own.

 

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An instructive example comes out of Utah, which enacted the boldest pension reform among the 18 states enacting changes in 2010.

Starting in July, all new government employees in Utah will be moved out of the state's traditional pension fund. They will instead receive either a 401(k) plan with an employer contribution, or a sharply modified defined-benefit plan that avoids subjecting taxpayers to investment risk.

Republican Utah State Sen. Dan Liljenquist, the architect of this reform, started his push by going to the state's actuary and requesting projections of future-year pension contributions. The actuaries reacted with surprise at that request, but complied - and produced figures showing a cost explosion similar to the one we expect to come in New York. Those projections convinced lawmakers that bold reform was necessary to avoid sharp tax increases and undesirably deep cuts to public services.

Most of the other states enacting reform last year took meager steps similar to the one New York did in 2009: establishing a new benefit "tier" for new employees, with tweaks designed to cut costs over time, while maintaining the traditional pension structure that exposes taxpayers to costs that swing with the stock market. In New York's case, the reform was called "Tier V" because, after the program was first established, the state had gone through three rounds of failed pension austerity designed to cut costs - all ultimately reversed at the behest of public employee unions.

If Gov. Andrew M. Cuomo hopes to achieve a Utah-style breakthrough when he reforms New York's pensions, better pension transparency will be a necessary first step. He - and lawmakers in capitals around the country - should insist on the pension fund disclosures that lawmakers need to make informed decisions about reform.

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