Research & Commentary: Massachusetts Public Pensions and the Assumed Rate of Return Update
In Massachusetts, as in many other states and municipalities across the country, the high cost of traditional defined-benefit public pensions has become an important issue as unfunded liabilities have grown out of control.
According to Jim Lamenzo, actuary for the state’s Public Employee Retirement Association Commission, Massachusetts’s unfunded pension liability has almost doubled over the past five years to approximately $24 billion. The situation is further complicated by the fact that regulators controlling the pension funds have in many cases overestimated the value of future investments and the rate of return they can expect from the investments held by the pension fund.
The Pioneer Institute, a non-partisan research organization based in Massachusetts, has released a report examining the state’s public pension funds. According to the report, unless steps are taken to reform investment management and restrict the growth of liabilities the state will continue to struggle to fund the pension plans, forcing the government to raise taxes, reduce services, and cut retiree benefits. Author Iliya Atanasov recommends the state require its retirement boards to lower their assumed rate of return to a more conservative 5 percent rate of return.
If the actual rate of return for pension funds continues to fall short of estimates, pension systems across the country may be in even more trouble than is currently thought. Fortunately, pension fund regulators and lawmakers are beginning to notice this problem and are moving to set more reasonable expectations for investment returns. According to the National Association of State Retirement Administrators, since 2008 19 public pension plans have lowered the assumed rate of return below 8 percent; pension plans in other states, including Minnesota and New York, are considering doing so. Decreasing the expected rate of return, which is used to determine the present value of the funds, will increase the unfunded pension liabilities, making the problem more obvious than it already is.
To protect taxpayers and pension beneficiaries in the short term, per-year pension payouts should be capped at a sensible level, the retirement age should be raised, double-dipping should be eliminated, and pension rate of return assumptions should be changed. While Massachusetts has made some strides in increasing worker contributions to the pension fund, more reforms are needed. In the long term, sustainability will require governments to follow the private sector’s lead and put new workers in defined-contribution systems.
The following articles examine state and local pension funds and assumed rates of return from multiple perspectives.
The Fiscal Implications of Massachusetts Retirement Boards’ Investment Returns
Iliya Atanasov of the Pioneer Institute examines Massachusetts’s state pension funds and how their assumed rate of return could create funding problems as investments come up short and funding gaps are created. Atanasov recommends the state reevaluate and lower its expected rate of return. “Consequently, taxpayers and public employees alike could benefit from a timely reevaluation of the retirement system’s actuarial standards and, most importantly, the pension funds’ assumed rates of return (ARR).”
Mass. Needs More Realistic Goal for Pension Fund Returns
In an editorial, the Boston Globe contends the State of Massachusetts needs to step down its pension expectations. The editorial argues for a deliberate approach to limit the impact on government agencies whose employees will have to contribute more to their own retirements.
Close Pension Loophole
In this editorial from the Boston Herald, the authors examine Massachusetts’s state pension issues and the funds’ assumed rates of return, arguing in favor of a decreased rate and reform to 401(k)-style plans. “Five percent is a good idea – but should be part of a transition to a system designed around self-financed pensions using things like 401(k) accounts. Some states have switched new employees to such plans; Massachusetts should learn from them.”
The State Public Pension Crisis: A 50-State Report Card
This Heartland Institute report examines problems currently facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of pension plans and suggests ways states might go about solving their pension system problems.
Are State Public Pensions Sustainable? Why the Federal Government Should Worry about State Pension Liabilities
Joshua D. Rauh of Northwestern University analyzes the flow of state pension benefit payments relative to asset levels and contributions. Even assuming future state contributions fund the full present value of new benefits, many state systems will run out of money in 10 to 20 years if some attempt is not made to improve the funding of liabilities that already have accrued. The expected shortfalls raise the possibility that the federal government will be asked to bail out states driven to insolvency by their pension programs.
Public Pension Plan Asset Allocations
Youngkyun Park of the Employee Benefit Research Institute reviews public pension plan contribution behavior from 2001 to 2006, pension asset allocations from 2003 to 2007, and the effect investment performance has on employer contribution volatility. Park concludes that in the short run a significant shift toward a lower-return investment policy in exchange for reduced volatility in employer contributions is unlikely to occur because of plans sponsors’ expected high returns from current asset allocations based upon historical rates of return, their ability to use the assumed investment rate of return as the discount rate in calculating liabilities, and the understandable tendency of investment managers not to deviate from peer group investments.
Unmasking Hidden Costs: Best Practices for Public Pension Transparency
In this Civic Report from the Manhattan Institute for Policy Research, Josh Barro makes several recommendations for improving the transparency of financial information related to governments’ pension and other poste-employment benefit obligations.
State Pension Funds Fall Off a Cliff
Barry W. Poulson and Arthur P. Hall consider different measures of historical and current funding shortfalls in state pension plans. Two case studies are examined in depth to explore fatal flaws that have caused funding crises in these plans: the Public Employee Retirement Association of Colorado (PERA) and the Kansas Public Employee Retirement System (KPERS).
The Market Value of Public-Sector Pension Deficits
Arthur Biggs of the American Enterprise Institute argues that because states currently assume plans can earn high returns without risk, they are underfunded by more than $3 trillion. Although states recognize their public-employee pensions are underfunded, Biggs argues the situation is far worse than their accounting demonstrates. Unless policymakers take proactive steps now, he says, taxpayers will have to cover an enormous shortfall when the bills come due.
The Origins and Severity of the Public Pension Crisis
Dean Baker of the Center for Economic and Policy Research examines the origins of the shortfalls in public pension systems and discusses the appropriate rate of return to assume for pension fund assets.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the FIRE Policy News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or firstname.lastname@example.org.