Friday, September 30, 2011

How Much Longer Will Taxpayers be Suckers for Public Pension Plans?

Public employees customarily are enrolled in defined benefit pension plans. These plans often provide generous retirement benefits at little cost to the employee.

These public plans are usually poorly funded as well . As a consequence, taxpayers are the ultimate funding backstop. That means that we the people are firmly on the hook for the full amount of the promised pension benefits to public sector employees.

In contrast and unlike the public sector, employees of private companies usually are covered by 401k type defined contribution plans. Private sector employers are increasingly choosing this approach and by so doing, they limit the financial uncertainty of funding a fixed pension benefit far into the future.

If these private sector companies had continued to provide traditional pension plans in lieu of the now customary defined contribution benefits, their ability to adequately fund those guaranteed pension benefits would have depended upon the future investment performance of monies contributed by employees and employers. The adoption of 401k plans has eliminated this "blank check" funding uncertainty and associated liability. But the uncertainty of final funding costs is still in effect for public sector funds.

Let's further nail down the opposing public-private offerings in retirement benefits, as well as their funding. It will help us understand why "taxpayers are suckers."

Let's begin with two simple truths. (1) All other things being equal, both public and private sector employees would prefer free or inexpensive, but generous and guaranteed retirement benefits, to more costly and uncertain benefits based on the future investment performance of monies contributed and invested. (2) Taxpayers and private sector employers, however, would prefer lower taxpayer and employer costs, as well as certainty to uncertainty with respect to funding the future benefits of retirees.

Unlike in the private sector, taxpayer backstopped government pension plans continue to grant guaranteed and fixed pension benefits to retirees. Sponsors of private sector plans have concluded that they can't continue to bear the uncertain and open ended expense of a pension plan, as they seek to remain competitive in today's global economy.

The public sector offering is simply due to public employees not assuming the ultimate retirement funding risk. In other words, the final cost is not their problem. Instead that problem belongs to the taxpayers. Just as it does with respect to social security promises and the tens of trillions of dollars in unfunded liabilities associated therewith.

As employees within the private sector, taxpayers are usually covered by 401k type plans due to the cost and uncertainty associated with funding pension plans. But these exact same people, when acting as taxpayers alone, agree to assume the blank check funding obligation of providing fixed pensions to public sector employees, despite the difficulties and uncertainties involved. And that's why taxpayers are suckers.

Public employee projected pension benefits are $3 trillion greater than the projected funds that will be available to pay those benefits. How Not to Fix Social Security makes the point that two Republican presidential candidates both missed in their recent debate:

"Mr. Perry recommended that workers be able to opt out of Social Security just like "the state employees and the state retirees, they being able to go off of the current system onto one that the states would operate themselves."

About a dozen state governments don't enroll their employees in Social Security. The federal government in the 1930s allowed state governments to opt out of the program if they provided workers with defined benefit pensions that guaranteed workers a minimum retirement income. That was at a time when state pensions weren't much more generous than Social Security. Nowadays these plans provide monthly annuities that are usually three to four times greater than Social Security benefits. However, workers and governments don't contribute much more to their retirements than private sector workers and employers do to Social Security.

Mr. Romney could have pointed out that the state plans Mr. Perry seems to be endorsing are a huge drain on taxpayers. State pension plans are a $3 trillion unfunded liability and suck more than $20 billion from taxpayers each year to stay afloat. Texas provides its workers with more modest benefits than most states but still has a $40 billion unfunded liability."

So there we have it. Neither Republican presidential hopeful talked about the elephant in the room that state pension plans provide benefits on average that are three to four times greater than social security benefits. And they do this at essentially no extra charge to the beneficiaries. The taxpayers will get the bill, as always.

In another recent editorial on this same general topic, Tin-Hat Time for Pension Funds said this about the funded status of remaining private sector pension plans: "As of mid-August, Credit Suisse analyst David Zion calculated that S&P 500 companies with pension funds faced a deficit of about $388 billion, meaning they were about 77% funded. That compares with an about $200 billion deficit at the end of last year. Market moves since August mean the combined S&P 500 deficit has now likely grown to around $450 billion."

The article goes on to predict that as a result of this funding issue, private companies will likely step up their pension contributions to make up for the unplanned current funding shortfall.

For state and local governments, however, no such step up in contributions is anticipated:

"For state and local governments, the market's double-whammy poses more of a long-term challenge. That is because the plans aren't as sensitive to interest-rate changes in calculating their deficits. This means they may feel less compunction to take the pain of contributing more in the short term."

Remarkably, this three trillion dollar underfunded liability is described as merely a "long-term challenge" for public plans. As far as the public employees are concerned, it's a long-term problem only for the taxpayers, in other words.

The article continues, "But that, combined with what appear to be overly rosy return-rate assumptions, just puts a fig leaf on the problem. With plans set to be in even worse shape longer term, taxpayers and some municipal-bond investors are at even greater risk than they realize."

So there we have it. State and local government officials aren't in any hurry to fully fund pension obligations, nor are they moving quickly toward adopting 401k plans and away from defined benefit pension plans. It's not viewed as their immediate problem. The problem is that of future taxpayers' instead.

So the taxpayers will be required to pay in full when the time comes. Although I believe that this taxpayers as suckers routine won't go on forever, I do wonder when it will end.

We'll have to ask each other and our fellow taxpayers to answer that one.

Thanks. Bob.

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