THE CONTOURS OF A CRISIS

Minnesota must come to grips with the grave state of its public pension system

By Mark Haveman

PANIC ATTACK

The overheated rhetoric around the future of public pensions obscures fundamental issues

By Tyler Bond

OWN YOUR OWN FUTURE

Only a courageous overhaul can save Minnesota’s insolvent, outdated public pension system

By Kim Crockett

The Contours of a Crisis

Minnesota must come to grips with the grave state of its public pension system

By Mark Haveman

COMPLICATED MATH, CONFUSING terminology, and heavy dependence on assumptions about what the future holds make evaluating the health of Minnesota’s public pension system a challenging task. The black box of actuarial practice isn’t exactly taxpayer-friendly. But if you study the pension plans’ own valuation and financial reports, this is the story that’s unfolding:

• We have significant unfunded obligations. As of today, the Minnesota State Board of Investment (SBI) should have $16 billion more invested in the markets just to pay for the retirement benefits that past and present state and local employees have already earned.
• That $16 billion is sufficient only if SBI’s retirement assets can earn an average of 8 percent or more every year forever. If we can only earn an average of 7 percent every year, that $16 billion needs to be $26 billion instead. According to the SBI, the median projected 10-year return of the SBI’s current investment policy is 7.3 percent.
• Because an increasing number of baby boomers are retiring and people are living longer on average, pension plans are now paying out about twice as much in benefits as they are taking in from employee and employer contributions. Last year alone, cash-flows out of Minnesota’s public-pension funds exceeded inflows by nearly $2.3 billion. As this trend continues, it becomes more and more difficult to rely on investment performance alone to meet our long-term obligations.
• For the 14th consecutive year, the state has failed to make stakeholders pay the contributions required to support the financial health and sustainability of Minnesota’s public pension plans. Those chronic contribution shortfalls are directly responsible for more than $6.5 billion in unfunded pension liabilities since 2002.

How does a state that prides itself on good government find itself in a situation like this?

The simple answer is that the expectations and demands of the present always prevail over future needs. Governments like to keep their contributions as low as possible so that precious tax dollars can fund government services. Employees like to keep more of their take-home pay. Retirees understandably want their retirement benefits to keep up with inflation. Those voices, rather than that of the fourth grader in 2028 who can’t get the extra help he needs in a class with 35 students, are the ones heard at pension commission hearings.

The more complex answer is that it has been, and remains, far too easy to ignore the true economic cost of these plans. In other words, we do a fantastic job of making public pensions look cheaper than they really are. For example, to determine required contribution levels, pension plans must calculate how much pension-promises cost in today’s dollars. But there is no logical connection between what an investment portfolio might earn and the present value of future liabilities; it’s a practice that literally can’t be found in any other area of private- or public-sector finance.

Additionally, when pension costs get politically uncomfortable, we push the dates for full funding further out, effectively refinancing the debt to keep our current costs down. Responsible pension practice would set this period to the average length of time the current group of employees will work before they retire from public service—thus preventing the next generation from paying for the current generation’s pension costs.

In short, we want to provide these benefits, but we don’t want to pay the price. We have avoided that by transferring cost and risk to future citizens and public employees on a scale never before seen in this state.

Legislators have enacted two rounds of pension sustainability repairs over the past 12 years that feature shared sacrifice from all stakeholders, including reductions in retiree benefit increases and phased-in contribution increases from both employees and employers. These fixes didn’t prevent the situation we’re in now, however, even though the S&P 500 was consistently above Great Recession lows—meaning the shared sacrifices were both absolutely necessary and absolutely insufficient. And there’s no sign that this legislative session will yield different results.

The good news is that Minnesota’s public pensions are better off than those in many other states, thanks to some sensible pension policy choices we’ve made over time. And there is still time to pursue reform both within and outside of traditional defined-benefit pension plans that can simultaneously result in a high-quality, secure retirement for public employees, and eliminate long-term risks to taxpayers and government services.

These options will narrow, however, if we keep pretending everything is OK. Minnesota must meet this problem head-on, and do it now. Recognizing the true cost of these plans is an essential first step.

> Read Voice editors’ cross-exam with Mark Haveman

Panic Attack

The overheated rhetoric around the future of public pensions obscures fundamental issues

By Tyler Bond

WHEN THE FINANCIAL CRISIS STRUCK in 2008, almost all investors lost money. From people saving in their 401(k)s to institutions like public-pension funds, investors lost an average of about 25 percent, according to the Employee Benefit Research Institute. The economic recovery since the recession has been uneven, with years of slow growth and low investment returns followedby years of double-digit returns and a surging stock market.

One consequence of the recession and the uneven recovery is that public-pension funds have maintained lower funding levels in recent years than in years past. This has led to much overheated rhetoric about a nonexistent pension crisis while ignoring the real challenges facing many Americans who struggle to save for retirement.

Public pension plans have existed in the United States for more than 100 years. In Minnesota, the Teachers Retirement Association Fund was established in 1931, and the Minnesota State Retirement System was established in 1929. Cities and states have offered public pensions for so long because they provide a secure and reliable retirement to teachers, firefighters, and other public employees after a career in public service.

Defined-benefit pensions provide a fixed monthly payment for the rest of a retiree’s life. Pension plans work by pooling contributions from many workers and their employers into one large fund and then investing that fund for long-term growth and returns. Pension plans can invest on a longer time horizon because new workers are always joining and paying into the fund as older workers are retiring and collecting their pension benefits. This is different from individual workers saving in a 401(k). While people can invest more aggressively when they are younger, as they age they must shift to more conservative, lower-return investments in order to protect against any sudden downturns in the financial markets that could wipe out their savings, as happened to many in 2008. Pension plans, unlike individual investors, have decades to recover investment losses.

Since public pension plans are focused on long-term investing, it is not necessary for a pension plan to be fully funded all of the time. To say a pension plan is 100 percent funded means that the plan has, at that point in time, all of the money it will ever need to pay full benefits to every active worker, retiree, and other beneficiary of the system. It means that if all active workers suddenly retired and began collecting their benefits immediately, the pension fund could pay all of them. Of course, this is not even close to the way the world works.

Even if every public employee in Minnesota retired this Friday, the pension systems wouldn’t have to pay their benefits all at once, which means the pension systems wouldn’t have to be fully funded on the universal retirement day. They would still have years to earn investment returns to pay pension benefits. Achieving full funding should be the goal of every public-pension plan because it demonstrates responsible management and prudent investing. It’s worth repeating, however, public-pension plans can, and do, pay benefits while less than 100 percent funded.

The hyperbole that has emerged around unfunded liabilities in public-pension plans obscures a much more serious problem facing society: a looming retirement security crisis. Roughly half of workers in the United States do not have access to a retirement plan through their employer. These workers are saving nothing for retirement, aside from what they are earning through Social Security. Most workers who have access to a 401(k) through their employer are not saving enough for retirement either. Many Americans face the prospect of falling behind their current standard of living in retirement. This is an urgent crisis that requires action by political leaders and policymakers.

Public-pension plans have long provided retirement security to our librarians, sanitation workers, correctional officers, and other public employees. Nationally, public-pension plans manage over $3.6 trillion in assets. While many public plans are funded at lower levels than they were before the financial crisis, many of them have also adopted more conservative return assumptions and adjusted mortality tables in recent years—examples of responsible management. States should always be considering the best policy to ensure full and timely funding of their public pension plans so they can meet their obligations to active and retired public employees. States should resist, however, the calls of some to radically alter or eliminate public pensions due to panic over a nonexistent “crisis.”

> Read Voice editors’ cross-exam with Tyler Bond

Own Your Own Future

Only a courageous overhaul can save Minnesota’s insolvent, outdated public pension system

By Kim Crockett

THE DEBATE OVER THE PUBLIC-PENSION funding crisis has overlooked a key question: Can Minnesota ensure that its public employees will have long-term access to a retirement plan that is both realistic and reliable?

One reason people don’t honestly grapple with the topic is because some don’t want to hear the answer: That the unfunded liabilities and inadequate design of defined-benefit plans—the standard construct for public employees—demand a shift to the sorts of portable, defined-contribution plans available to employees in the private sector.

No one disagrees that Americans should be putting aside funds for a secure retirement. There’s anxiety about our employees’ future security, though, because our contributions—thanks in part to a lack of legislative and cultural incentives—are often inadequate and unrealistic, especially given longer lifespans and an expectation of decades of leisure late in life.

Government employees have an even more specific reason to worry: State administered and taxpayer supported pension plans are underfunded. This poses a dilemma for all taxpayers, of course, since every Minnesotan contributes to the system. It’s especially daunting for those assuming the funds they’ve been counting on are solvent.

We are a long way from beginning to address a looming, full-blown crisis. The experts can’t even agree on what assumptions to use when analyzing future liabilities. What is a reasonable assumed rate of return on assets? How important is it to be fully funded? These sorts of questions, like the debate itself, are as complex as they are existential. Worse, if the state fails to accurately communicate what’s really happening, neither citizens nor lawmakers will be in a position to craft informed solutions.

To varying degrees, Minnesota State Retirement System (MSRS), Public Employees Retirement Association (PERA), Teachers Retirement Association (TRA), and the St. Paul Teachers’ Retirement Fund all report stubborn unfunded liabilities. In aggregate, these plans self-report a $17.2 billion shortfall. Other experts, using more conservative (and I would argue, realistic) assumptions, say it is $50 billion or more.

To try and stop the bleeding, there have been modest changes, which have included increasing employee contributions, lowering cost-of-living adjustments, and dipping into Minnesota’s general fund. (TRA gets $34 million a year in cash, for example. The St. Paul Teachers’ Retirement Fund gets $11 million and has asked for another $5 million).

Although TRA has yet to follow suit, in 2017 the other plans lowered the assumed rate of return and discount rate from a high of 8.5 percent to 7.5 percent. This last move brought more honesty to the discussion. But none of these reluctantly adopted changes—like those currently being discussed at the capitol—are enough to root out the real problem.

Although it will be one of the hardest things Minnesotans have ever been asked to do, the only way to stop accruing economically crippling liabilities is to close defined-benefit plans to new entrants and shift all incoming public employees to defined-contribution plans. If this were done, the unfunded liabilities on the state’s books would be paid over time just like any other debt and we could honor our promise to current employees. It would also ensure that employee retirement benefit obligations would be fully funded at the time of service.

While this move is particularly sensible given the state of affairs, it is not a recommendation born solely out of crisis. It would be prudent even if defined-benefit plans were fully funded.

Defined public benefits were designed decades ago to attract and reward people who spent their entire working lives in the public sector. In practice, according to the data analyzed by Center of the American Experiment (where I serve as vice president), this means that people who change jobs before the prescribed retirement age get significantly lower benefits than “career” employees, who—when they add benefits earned over a 25- to 30-year career to standard Social Security payments—receive about 85 percent of their pre-retirement income into perpetuity.

In other words, the value of these pensions is quite low until employees reach their later years of service. This practice is called backloading and is particularly unfair to employees who get fired or laid off, exit the workforce to care for family, have spouses who get transferred, or who just want to do something else for a living. Backloading forces employees who exit “early” to subsidize “career” employee pensions, and leaves them without the full benefit of their own contributions. (In this day and age, how many people stay with any career, let alone one employer, for 30 years?)

There are better options, of course. Minnesota’s university employees already enjoy the ability to contribute to individually owned, portable retirement plans for different risk appetites. “This is where the pension world is moving, and for public institutions, it makes a lot of sense,” University of California President Janet Napolitano told the Sacramento Bee in 2015 when the university reached a deal to shift new hires to defined contribution plans beginning in 2016. “It’s much more portable, so for many people that will be an attraction.”

Why would Minnesota deny the same option to the rest of its public employees? One argument you’ll hear is that portable plans increase employee turnover. There is turnover anyway, however, without any assurance that the promise of defined benefit plans actually serves to recruit or retain talent. If pension contributions, which represent deferred wages, were going into a portable defined contribution plan, employees would get control over that earned benefit no matter where they work or for how long.

According to a study for the Manhattan Institute by Josh B. McGee, defined contribution plans achieve healthy, sustainable investment returns and offer a good, if not better, option for retirement than financially vulnerable defined benefit plans. McGee’s opponents fret that defined contribution plans are “too risky.” This argument ignores the fact that defined benefit assets are invested in the same marketplace in which employees in the private sector participate.

In theory, defined benefit plans have many virtues, and defined contribution plans are far from perfect. But Minnesota, like so many states, has failed to properly fund and manage its funds. Retirees are still getting paid—as of now, at least—but the poor fiscal condition of public pensions demands our immediate, unflinching attention.

> Read Voice editors’ cross-exam with Kim Crockett

No Pensions, No Security

Abandoning defined benefits is both an over reaction and bad public policy

By Katie Hatt

REMEMBER THE CHICKEN LITTLE FABLE? Just like the chicken who believed the world was coming to an end, some politicians and researchers are provoking unreasonable fear about the health of Minnesota’s public pension funds.

Teachers and government workers have deferred their wages for a guaranteed pension that allows them to retire with dignity. Yet their retirement security is continually under attack by conservative organizations, whose stated intent is to transition pension plans into defined contribution plans.

Benefits Are Better Than Contributions. Today, most public workers in Minnesota have a modest defined benefit pension of some $21,000 a year, guaranteed no matter what happens in the stock market or how long they live after retirement. In many cases, this money, combined with Social Security, is the difference between dignity and the ravages of poverty.

Not all workers are so fortunate. Nearly a million Minnesotans don’t have access to a retirement plan at work. One in every seven Minnesotans age 65 and older lives in poverty while relying only on Social Security. The typical working-age household has only $3,000 in retirement assets, while near-retirement households have only $12,000.

Under a defined contribution plan, loyal and essential public workers would lose their guaranteed retirement income. Their savings would be subject to investment risk and their future income would depend on their ability to save. As with a 401(k), most retirees would see their savings run out before they die.

Pension Envy. We’ve seen the playbook on pension envy. Wall Street works to convince young people that pensions are for a bygone generation, pitting them against older workers while pitching the benefits of portable 401(k)s, which seem attractive to those just entering the workforce. What goes unsaid is that when it comes to retirement security, nothing beats a real pension. There’s nothing “old school” about retiring with dignity and defined benefits that last a lifetime.

Healthy Pensions. Eliminating defined benefit pensions has become trendy for corporate giants, and now it’s becoming fashionable for government. So far, Minnesota has resisted the trend, largely because our system—contrary to the fear mongering headlines—is in good shape.

Minnesota’s three public pensions—Minnesota State Retirement System (MSRS), Public Employees Retirement Association (PERA), and Teachers Retirement Association (TRA)—are all well managed and have $64 billion in assets. Today, according to Retirement Systems of Minnesota, MSRS is 81.5 percent funded, PERA is 78 percent funded, and TRA is 77.5 percent funded.

Even more important—and what’s often overlooked by anti-tax forces—Minnesota taxpayers as a whole pay only 14 cents of every dollar of public pension benefits; the remaining 86 cents comes from employee contributions and investment returns. Most private pensions are 100 percent employer paid.

Economic Engine. Every dollar that Minnesota taxpayers invest in public pensions pays off with $9.98 in economic activity across the state, according to Pensionomics 2016, a report by the National Institute on Retirement Security.

Pension spending keeps Main Street businesses open, especially in Greater Minnesota. In Stearns County, for example, there are 5,151 retirees with $106 million of annual pension benefits, according to the Minnesota Public Pensions Systems. An estimated 90 percent of retired public workers stay in Minnesota and spend their pension checks on local goods and services. They purchase food, clothing, and medicine at local stores, pay housing costs, and make larger purchases, like a car or laptop. These purchases create a steady ripple effect that directly supports 41,839 jobs and $2 billion in wages in Minneapolis.

Public-sector retirees also paid $499 million in federal, state, and local taxes directly out of their pension benefits in 2016.

Shared Sacrifice. While it’s sometimes been painful, government workers have supported every comprehensive pension reform over the last decade. In 2010, for example, they fixed a $4 billion funding gap by increasing their employee contributions and capping benefit increases. These sorts of reforms, coupled with strong investment returns, have stabilized Minnesota’s pension funds.

Living Longer. It’s true that state employees, teachers, and retirees have a life expectancy that is two years longer on average. This is not a reason to panic or abandon a system that has worked for generations, however. The challenge is to offset up to an additional $1.4 billion in future liabilities.

Unions that represent government employees recognize this. To cite just one example, AFSCME Council 5, the largest union of active and retired state employees, supports a combination of sustainability measures to keep pension funds sound. They’ve endorsed an MSRS proposal to raise employee contributions from 5.5 to 6 percent, raise employer contributions from 5.5 to 7 percent, and reduce the cost-of-living adjustment from 2 to 1.75 percent. Those measures alone would make up $400 million in future liabilities.

We’re Different Here. In Minnesota, our public pension systems are healthy and well managed. There’s no reason to fix what isn’t broken. We have had a budget surplus for most of Governor Dayton’s tenure. In 2017, USA Today ranked Minnesota the nation’s best-run state, and the AARP called it the best place to retire.

We should oppose any attempt to transition secure pensions into risky savings plans. That would hurt Minnesota’s economy and undermine our state as the best place to grow old.

Instead, policymakers should work in partnership with the pension systems and unions that represent public workers. Together, we can all strengthen our already stable pension funds without breaking the bank or burdening retirees and taxpayers.

> Read Voice editors’ cross-exam with Katie Hatt