What’s the state of our state’s pension system

With Detroit’s public pension woes on the front pages lately, it’s relevant to ask about the status of Iowa’s public pension plans.

The state of Iowa sponsors four statewide public pension systems that include separate plans for state and local employees, police and fire, peace officers and judges.  By far the largest is the Iowa Public Employees Retirement System (IPERS), which itself administers three separate plans.  IPERS’ largest plan covers 284,000 “regular” members including most current, former and retired state employees, teachers and most other local non-public safety employees.

Compared with other large public sector defined benefit plans, IPERS regular member benefits are moderate, contributions are reasonably shared between employers and employees, and the system is well managed.  It typically ranks in the top or middle tier of plans according to most measures.(1)

Unfortunately, although IPERS may look good in comparison with other defined benefit plans, this does not mean there is no cause for concern among Iowa taxpayers.

Any defined benefit plan is a promise to pay specific benefits at future points in time.  Benefits are funded through a combination of contributions (by taxpayers and employees) and earnings on investments.  Typically contributions make up about one-third of the funding, and investment earnings make up two-thirds.

Because defined benefits are promises made by government, ultimately taxpayers are at risk with defined benefit plans if contributions are insufficient, if investment earnings fall below assumed levels, or both.

The IPERS system has experienced both issues over the past decade.  It lost nearly 20 percent of its asset value in 2009, which unfortunately followed eight years of underfunding of liabilities.  The result: IPERS’ unfunded liability (dollars that should have been set aside in connection with past employment, but weren’t) has grown fivefold over the past 10 years, and now nears $6 billion ($6.8 billion for all plans).  And that’s assuming plan assets will return, on average, 7.5 percent per year for the next 30 years.  That’s a big assumption.

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Another way to look at it is in terms of the plans’ reported funded ratio, which compares assets with liabilities.  IPERS is funded at 79.9 percent.  Using this metric, Detroit’s two pension plans appear better funded than IPERS (82.8 percent and 99.9 percent).  Before 2008, 100 percent funding was always the goal for the best systems.  Now, 80 percent is a floor below which a system is considered “underfunded.”  In fact, under Michigan law, if funding falls below 80 percent the emergency manager is allowed to replace members of the pension boards.

IPERS Contributions have been increased

After nearly 30 years of stable rates, IPERS’ regular member contribution rates have recently been raised more than 50 percent to gradually erase the $6 billion shortfall and restore funding to 100 percent.  Iowa taxpayers are now funding a total of  $625 million each year for IPERS ($750 million per year for all defined benefit plans).  Compared with just six years ago, this is about $200 million more per year than what was then needed ($250 million all plans).

Much has been written about the impacts of this spike in pension costs on cities in Iowa.  Like Detroit, cities are cutting back on libraries, parks and even public safety services in order to afford the required pension payments.  And they are raising taxes.  The downward cycle has begun.

But there are impacts across all governments in Iowa.  For perspective, consider this $250 million per year “premium” payment is the same as the total dollar amount of the commercial property tax relief that was afforded through last session’s legislation.  Or that $250 million per year could place 3,700 more teachers in Iowa classrooms.  How far are we willing to go to fund public pensions?  What else are we willing to give up?  And what if the assumptions are wrong?

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Detroit’s emergency manager brought in an outside actuary to re-evaluate that city’s pension obligations using what were characterized as more realistic actuarial assumptions and methods.  This review had the effect of ballooning their pension obligations from less than $1 billion to $3.5 billion.(2)

New accounting standards in place

While some have questioned the motives for this particular outside review, there is no doubt that public pension actuarial practices are being questioned from many quarters.  The Governmental Accounting Standards Board (GASB) will be requiring the use of different assumptions for financial reporting purposes, and Moody’s Investor Services is using a different set of assumptions to determine its ratings for government entities.  Even within the actuarial profession there is active disagreement among public and private pension actuaries.  According to The New York Times, the Society of Actuaries, fearing reputational risk to the entire actuarial profession, formed a Blue Ribbon Panel to look into the reasons for underfunding of public pension plans.(3)

Applying Moody’s methodology, IPERS’ state share only of the system’s total unfunded liability would grow from the $1.1 billion reported by the system to $2.3 billion.(4) If the entire IPERS system were similarly re-evaluated, it is likely the IPERS’ unfunded liability would be closer to $12 billion rather than the reported $6 billion.  This level of debt nearly equals the combined total of all other public debt in Iowa(5)While it may appear that Iowa is now starting to keep up with most of its pension obligations, albeit at considerable expense to taxpayers and erosion in public services, there may be considerably more exposure than has even yet been disclosed.  Do we really want to take this risk?

Three quarters of private sector companies have moved away from defined benefit plans because they found the level of risk associated with them to be unacceptable.

What’s happened in Detroit – and what is starting to happen even in Iowa — should open our eyes to the risks inherent in public sector defined benefit plans.

Even the best plans like IPERS create sizable risk to taxpayers, and create an expectation for future generations to pay for services that were rendered in the past and from which they will not benefit.  Iowans need to understand the ultimate financial risk associated with these plans. They can then make a conscious choice about whether it is appropriate to ask taxpayers – particularly future taxpayers – to bear it, or whether it’s time to consider alternative structures that more equitably assign risk and make sure that in Iowa, at least, promises already made to public employees can be kept.

NOTES:

(1)    See, for example, Barkley, Rachel for Morningstar Credit Research, “The State of Pension Plans: A Deep Dive Into Shortfalls and Surpluses,” Nov. 2012. http://media.navigatored.com/documents/StateofStatePensionsReport.pdf
(2)    City of Detroit, “Proposal for Creditors,” June 14, 2013. http://www.freep.com/assets/freep/pdf/C4206913614.PDF
(3)    Williams, Mary, “Detroit Gap Reveals Industry Dispute on Pension Math,” The New York Times, July 19, 2013
http://dealbook.nytimes.com/2013/07/19/detroit-gap-reveals-industry-dispute-on-pension-math/
(4)    Moody’s Investor Services, “Adjusted Pension Liabilities for US States,” June 27, 2013, pp. 9-10.
(5)    State of Iowa Treasurer’s Office, “Outstanding Obligations Report,” August 2013. http://www.treasurer.state.ia.us/for_governments/outstanding_obligation_report/

One Response to What’s the state of our state’s pension system

  1. Pingback: Tax Roundup, 10/16/14: Tax-free public pensions proposed. And: Goodbye, 2010! « Roth & Company, P.C

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