The Cost Burden of Pension and OPEB Plans Jean-Pierre Aubry Center - - PowerPoint PPT Presentation

Jean-Pierre Aubry Center for Retirement Research at Boston College National Tax Association’s (NTA) Spring Symposium Washington, DC May 16-17th, 2019

The Cost Burden of Pension and OPEB Plans

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People often generalize about the costs of state pensions.

“Pensions pose time bombs for budgets.”

̶ The Pew Charitable Trusts

“States are staring at a trillion-dollar pension hole.”

̶ CBS MoneyWatch

“Debt woes: Can Illinois (or your state) avoid becoming the next Greece?”

̶ The Christian Science Monitor

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But this approach is too narrow to capture the liability burden facing governments…

Jurisdiction Pensions OPEBs Municipal Bonds States

X

Counties Cities

3

…and too broad to inform policy.

14.9% 0.9% 0% 5% 10% 15% 20% NJ, IL, CT FL, IA, NE Average: 4.3%

State Pension Costs as a Percentage of Own-Source Revenue for States with Highest and Lowest Burdens, 2014

Sources: Authors’ calculations based on various FY 2017 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2017).

4

So, we looked at all major liabilities for a broad sample of individual jurisdictions.

Percentage of State, County, and City Payrolls Covered by Sample

Source: Authors’ calculations based on U.S. Census Bureau (2017).

100% 43% 0% 20% 40% 60% 80% 100% States (50) Cities (173)

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The analysis involved four main tasks.

• 1. Choosing the revenue base to put liability payments in context.
• 2. Determining the debt interest payments for each government.
• 3. Allocating retirement plan liabilities to each government
• 4. Calculating the required payment for retirement plan liabilities.

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• 1. As our revenue base, we chose own-source

revenues from the Census.

Sources of Total Net Revenue, by Level of Government

Source: Authors’ calculations from U.S. Census Bureau (2014).

Level of government Intergovernmental transfers Own-source revenue Inflows from: Outflows Net transfers Federal State Local State 42.2% 0.0% 1.1% 40.2% 3.1% 96.9% County 3.8 30.4 2.5 3.7 32.9 67.1 City 6.8 13.1 3.1 2.7 20.3 79.7 Total 24.6 9.1 2.0 22.2 13.4 86.6

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• 2. We estimated debt interest payments based
• n data from the Census.
• We assume that governments maintain their current debt-to-

revenue levels going forward.

• We assume that interest payments are 5 percent of outstanding

debt.

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• 3. We allocated pension and OPEB liabilities

by who funds - not who runs - the plan.

City governments County governments State government Oregon PERS (covers state, county, and city employees)

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Once allocated, a large share of pension liabilities shifts from states to localities.

Distribution of Pension Liability by Government Administration and Responsibility, in Billions

Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014).

84% 4% 9% 2% 35% 15% 25% 25% 0% 20% 40% 60% 80% 100% States Counties Cities School districts By government administration By government responsibility

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• 4. Then, we calculated the required payments

for retirement plan liabilities, which involves:

• Selecting the expected rate of return, which serves as the

discount rate.

• Determining the method for amortizing unfunded liabilities.

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For the return, we follow Michael Cembalest

• f JP Morgan, who uses a 6-percent rate.

8.2% 7.3% 0% 2% 4% 6% 8% 10% 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

• Avg. Assumed Return for Public Pensions

Micheal Cembalest at JP Morgan

Public Plans’ Average Assumed Return Compared to Assumption used by JP Morgan Analyst

Source: Authors’ calculations based on Public Plans Database and The ARC and the Covenant 2.0 (2018).

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To amortize unfunded liabilities, we used level-dollar payments over the next 30 years.

Percentage-Point Increase in State/Local Funded Ratios Starting from 73 Percent, After Paying Full ARC for 30 Years

Source: Authors’ calculations.

27% 14% 0% 10% 20% 30% Level dollar ̶ closed Level percent ̶ open

0% 10% 20% 30% 40% 50% 60% 70% IL NJ CT HI KY MA RI DE MD LA AK SC WV PA CA TX ME IN NH VT CO MO NY MT NM MS MI AL WA GA VA SD OH NV OK KS WI AR OR NC ID TN FL UT WY MN AZ IA ND NE Debt service Required OPEB payments Required pension payments

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Now the results: the required payments for state governments vary substantially.

States: Required Payments for Pensions, OPEB, and Interest Payments as a Percentage of Own-Source Revenue

Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Census Bureau (2014).

0% 10% 20% 30% 40% 50% 60% 70% Chicago, IL Detroit, MI San Jose, CA Miami, FL Houston, TX Baltimore, MD Wichita, KS Portland, OR Omaha, NE Boston, MA Mesa, AZ Milwaukee, WI Dallas, TX Tucson, AZ Phoenix, AZ New York, NY Oakland, CA Louisville-Jefferson, KY Las Vegas, NV Fort Worth, TX Sacramento, CA Minneapolis, MN Atlanta, GA Albuquerque, NM San Francisco, CA Los Angeles, CA Honolulu, HI Columbus, OH Philadelphia, PA Cleveland, OH Nashville-Davidson, TN El Paso, TX Fresno, CA Austin, TX Virginia Beach, VA Charlotte, NC San Diego, CA Jacksonville, FL Denver, CO Indianapolis, IN Kansas City, MO Memphis, TN Long Beach, CA Tulsa, OK Raleigh, NC Seattle, WA Oklahoma, OK Washington DC San Antonio, TX Colorado Springs, CO Debt service Required OPEB payments

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And the comparable results for major cities vary even more.

Sources: Authors’ calculations based on various FY 2014 plan and government financial reports and actuarial valuations; and U.S. Census Bureau (2014).

Cities: Required Payments for Pensions, OPEB, and Interest Payments as a Percentage of Own-Source Revenue

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In the worst cases, unfunded liabilities cannot be paid off with conventional methods.

Increase in Liability Payments Options for making increased liability payments Government Current Payments Required Payments Increase government revenue by: Increase employee contributions by: Achieve pension return of: Illinois 26% 51% 25%

• r

689%

• r

11.50% New Jersey 17% 38% 22%

• r

521%

• r

No solution Hawaii 21% 37% 16%

• r

117091%

• r

11.30% Connecticut 22% 35% 12%

• r

408%

• r

10.50% Kentucky 12% 28% 16%

• r

427%

• r

No solution

Cost Measures under Various Options for Making Required Contributions

Sources: JP Morgan, ARC and the Covenant 4.0 (2018)

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Many of these governments struggle with large legacy liabilities in their pension plans.

Government Entity Legacy Costs Inception Date of Oldest Plan 2001 Aggregate Funded Ratio State Government Connecticut 1939 67.4% Illinois 1939 63.5% Hawaii 1926 90.6% Kentucky 1940 108.5% Massachusetts 1911 84.9% Rhode Island 1936 77.6% Public Plan Average 1944 97.1%

Pension Plan Inception Date and 2001 Funded Ratio for the Highest Cost States

Sources: Authors’ calculations based on Public Plans Database.

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Legacy liabilities could account for a quarter of the Connecticut’s unfunded liability.

26% 13% 74% 87% $0.0 $5.0 $10.0 $15.0 $20.0 $25.0 Assume Legacy Liability is Amortized Last Assume Legacy Liability is Amortized First Legacy UAAL Additional UAAL $21.2 $21.2

Sources: Authors’ calculations based on Connecticut SERS Actuarial Valuations (1969 – 2018)

Legacy Liabilities as a Proportion of 2018 UAAL

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Governments might consider amortizing legacy liabilities differently.

• Legacy liabilities often stem from a large initial unfunded

liability due to a history of promised benefits that were not pre- funded.

• Most plans can muddle along without contributing the full

amount required to amortize legacy liabilities in 30 years

• So, why should one generation bear the burden of paying down

legacy liabilities in 30 years?

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And, separately addressing legacy liabilities would clarify the current cost of benefits.

• Separating legacy liabilities would disentangle the cost of

current employee benefits from those associated with historical underfunding.

• Plans could then introduce more risk-sharing in their future

pension promises to current employees so that we don’t end up here again.

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Conclusion

• A full analysis on the burden of employee retirement costs

should consider all jurisdictions and all major liabilities.

• While many governments are managing the costs just fine,

some face an alarming burden.

• Many governments with high retirement costs are struggling

with large legacy liabilities in their pension plans.

• Going forward, separating legacy liabilities from ongoing

pension costs and introducing greater risk-sharing both merit serious consideration.