California voters OK pension cuts

The botched gubernatorial recall campaign in Wisconsin got all of the headlines last week, but equally noteworthy were two elections in California.  Voters in San Diego and San Jose approved cuts in pensions for local government employees.  The NYT report indicates that new employees will be converted to defined contribution plans, whereas continuing employees would contribute more and see smaller payouts.  Retirees would not be affected.

If voters in California and Wisconsin support pension cutbacks, the writing appears to be on the wall for many other states.  Voters see government employees getting better benefits than they can get in the private sector.  They also see the loss of public services, including rotating closures of firehouses in San Diego and laid-off teachers and police.

The story is not over, as there will be court challenges.  I find it ironic that California and Wisconsin voters have way more courage to face long term budgetary imbalances than our elected officials of both parties in Washington DC.

Looking for a guaranteed 8% return?

Me too, especially in today's market where long term bond yields are at historic lows.  Where might one find such an investment?  We need to ask the advisors of state and local government pension plans.  Researchers at Boston College have calculated that the average plan assumes it will get an 8% return and adjusts its annual contribution accordingly, reports today's NYT.  The hitch, of course, is that pension plans are highly unlikely to see such returns, so in future years taxpayers will have to kick in more to cover obligations to retirees.  So some political leaders such as NYC major Michael Bloomberg have pushed plan managers to lower the interest rate assumption to something more realistic. 

Although this looks like basic good government, public employee unions are not happy.  They realize that if governments have to kick in more dollars for future pension obligations, there will be fewer dollars to spend on raises and there might even need to be cutbacks in state services. 

In the private sector, the average plan assumes it will earn 4.8%.  Although I am not the sort who usually looks for ideas for new regulations, would it be unreasonable to ask state and local pension plans to use the same interest rate as plans in the private sector? 

Two different takes on state employee benefits

Today's N&O runs a front-page story about retirement benefits for state and local government workers which can best be summed up as "What? Me Worry?" The article notes that pensions account for a mere three percent of budgets, which is close to what the private sector spends.  The pensions are 78% funded, which on the surface looks ok, or at least no worse that Social Security. 

Bill Gates sees things a bit differently, as reported in WSJ and his Gates Notes website, emphasizing accounting gimmicks that are being used to vastly underestimate the true cost of future benefits.  Gates has been looking at this issue carefully for over a year because he sees burgeoning benefit obligations crowding out future spending on education.  He has been advised by a number of top experts on pensions (including my NC State colleague Bob Clark) and has picked up on the key concerns: failure to make sufficient contributions, unrealistically high interest rate assumptions (which make future costs look unrealistically low), and the real ticking-time-bomb of retiree health insurance.  Of course none of this is mentioned by the N&O, which confuses what state and local governments are currently spending with what they should be spending if they are going to meet future obligations.

State pensions start to face reality

Research by economists, accountants and actuaries (including by NC State colleague Bob Clark) shows that most state and local governments have pension obligations that far exceed projected assets.  The options are not attractive: raise taxes, cut services, or cut promises of future benefits.  Today's WSJ reports that Colorado and Minnesota are starting to take modest but painful steps to reduce future benefits.  Colorado had been providing an annual automatic "cost-of-living" increase of 3.5 percent, whereas Minnesota had been providing 2.5 percent.  Under laws passed in each state, Colorado increases will be capped to 2 percent and Minnesota increases will be limited to 1 to 2 percent. 

The article quotes some state employees who retired counting on these future increases and notes (no surprise here) that lawsuits are being filed.   The article says nothing about retirees from the private sector who typically receive no pension benefit increase at all.  It also says nothing about current and future state employees who will undoubtedly have to settle for even smaller pensions.  How will we decide to balance the obligations to retirees with other commitments made by state and local governments?  This will be an interesting story to watch in the years ahead.