A Good Debate: Pension Tension
Each quarterly issue of Citizens League Voice will feature a section that involves bringing people together to share their differing opinions on a timely issue.
We started with Just the Facts, designed to provide objective context for a specific question or area of disagreement. That was followed by Opening Arguments, written by policymakers, academics, and engaged community members representing a wide range of opinion and expertise.
Now, a Cross-Exam of each contributor. Conducted by the editors, this is an effort to further explore the nuance of each argument and provide a model for thoughtful questioning.
Questions for Mark Haveman
Minnesota’s public pension system is in peril, and legislators and citizens must wake to the severity of the situation.
- The state’s public pensions are between $16 billion and $24 billion in the hole.
- Short-term political concerns are preventing pragmatic, long-term solutions.
- Those in favor of the status quo are over-estimating future investment returns.
- Status quo politics are passing on an unprecedented level of risk to future citizens and public employees.
Q: Some argue that because Minnesota is in better shape than states like New Jersey and Illinois [which are much closer to insolvency], it’s reasonable to assume that the market will adjust over time to get things back on track.
MH: I’m always bothered when people benchmark us against states that are in the intensive care unit. It’s like showing up in a doctor’s waiting room with a 103 degree fever and being smug that you’re not hospitalized yet.
As far as the whole market is concerned: We earned 15.1 percent on investments last year, and the State Board of Investment’s average return has been, I think, over 9 percent for over 30 years. And that’s terrific. But then the question you have to ask yourself is how in the world can we be $16 billion in the hole when we’ve blown away the average annual expected return for 30 years or more? Something else is going on, and the big one is if a pension plan is significantly underfunded, even fantastic investment returns generate far fewer investment dollars. You are on a hamster wheel trying to get out from under this by simply investing your way out. It doesn’t work that way.
Q: Given that everyone doesn’t retire at the same time, why does it matter that the state is ever at a 100 percent “funded ratio”? In other words, the $16 billion shortfall will never come in to play all at once.
MH: Of course not everyone is going to retire at the same time, but that is not what we’re talking about here. Funded ratios tell us how much money we should have right now to pay for the benefits that have already been earned. The actuaries say we should have X dollars in the bank right now needing to earn 8 percent per year in perpetuity to pay those benefits, and we’re X minus $16 billion dollars right now. People who argue that 100 percent funding doesn’t matter are basically saying that over time we’re OK with not fully keeping the promises that we’ve made to public employees.
Q: You write that there’s still time to pursue reform both within and outside of traditional defined benefit pension plans. What are some examples of that approach?
MH: Well, first of all, there are hybrid systems that contain a piece of the defined benefit combined with some sort of 401(k)-type solution. So, for example, you could create a system where the first X dollars of an employee’s salary are eligible for defined benefit and then on top of that you have access to a variable, 401(k)-like option. The advantage? Lower-income or lower-wage public-sector workers get income security by having most, if not all, of their benefit in the form of a defined benefit, but at the same time we aren’t making a taxpayer-backed guarantee of higher-income workers’ pre-retirement lifestyles. Wisconsin has been doing this sort of thing for years and has one of the best pension systems in the nation. Cash balance plans, collective defined contribution plans, there are many options to explore.
Q: I think some of your critics would say they’re surprised that you’d be open to a hybrid-like compromise.
MH: I’ve always said: If someone could come up with a way to deliver a defined benefit plan that is affordable, responsibly funded, and doesn’t expose Minnesota taxpayers and future public services to unacceptable risks and costs, [the Minnesota Center for Fiscal Excellence] would sign on to it. But we are nowhere near that yet. I think certain stakeholders really rally their membership around the idea that the current way of doing things is the only way to go on providing a secure retirement for their employees. And I’ve never seen any real warming to or exploration of what I would call true structural reform. And frankly I think this only starts to actually gain traction once the handwriting is on the wall. The states that have sort of embarked on that path are some of the ones that are in the direst of circumstances. It seems to take that type of crisis to prompt action.
Questions for Tyler Bond
The so-called public pension crisis is overblown, and it obfuscates a looming retirement security crisis for all Americans.
- Minnesota has provided librarians, sanitation workers, correctional officers, and other public employees retirement security for generations.
- Bouts of economic insecurity impact all investments, but public pension plans can invest on a longer time horizon.
- Long-term investing means public pension plans can, and do, pay benefits while less than 100-percent funded.
- Most workers who have access to a 401(k) through their employer are not saving enough for an adequate retirement.
Q: If you were writing your essay for a publication in a state like New Jersey or Illinois [where the public pension funds are much closer to insolvency], would you make a similar set of arguments?
TB: I think my argument would in large part be the same. Public pensions have proven over the decades to be the most secure retirement plan for working families. As with everything in life, though, pension plans don’t work if you don’t treat them properly. If you don’t put money into the system, you can’t assume that money is just going to magically appear. The problem that we’ve seen in states like Illinois is that both political parties have consistently skipped payments, deferred payments, and done any number of things to avoid paying in what they should. That put them in a hole, so when the recession hit, they were already in a weak position. Minnesota is not in that situation. Minnesota has historically had healthy, well-managed, well-funded pension plans. That’s a really important distinction: It’s not the design of these plans that is at fault. It’s the poor management of the plans by people in various states.
Q: Minnesota is rapidly aging. Given that reality, isn’t there a higher risk that the state could reach a tipping point—especially as our pension plans aren’t 100 percent funded—at which too many people are retiring and not enough are paying in?
TB:Baby boomers were the largest generational cohort in history, and now they are eclipsed by the millennials. One underreported story of the past decade is that while pension plans have been recovering from the investment losses suffered during the recession, adjustments have been made to the investment-return assumptions and to the mortality tables. That’s what actuaries and plan managers do: They look at the data and say we need to tweak this here or we need to tweak this there and make adjustments so funds can stay sustainable for the long term.
Q: In Minnesota, the assumed rate of return on public-pension investments is between 7 and 8 percent. How do you respond to the argument that a 4 percent rate of return would be much more realistic—and responsible?
TB: The important thing to remember when you’re talking about investment-return assumptions is that public pensions are long-term investments, oftentimes between 20 and 30 years. Over this longer horizon, the plans often do meet or exceed their assumed rate of return. The other thing to remember—and one that is often ignored by critics—is that pension funds have no end date. When older workers are retiring and collecting their benefits, younger workers are joining and paying into this system. So this allows the pension fund managers to maintain an optimally balanced investment portfolio. They can balance investments across different assets and achieve consistent long-term returns.
The investment strategy of a pension fund is, in some ways, very different than the investment strategy of an individual saving in their 401(k). An individual stops investing at a certain point, and as they get closer to retirement age, they should shift into more conservative investments. That doesn’t need to happen in a collective public pension system.
Q: Would you be open to a hybrid solution that involves a lower defined benefit and a mix of variable investments?
TB: I think any time you talk about moving away from defined-benefit pension plans, that should be concerning for public employees and retirees. Defined-benefit pensions are the most secure and the most reliable retirement plan for public employees. 401(k)-style defined contribution plans have shown over the years that they provide an inadequate and risky retirement for working people. A lot of people who contribute to 401(k) plans don’t contribute enough, and as they get closer to retirement age, they are going to discover that they don’t have enough saved and will face a lower standard of living in retirement.
Questions for Kim Crockett
To avoid a systemic meltdown, Minnesota should shift all incoming public workers to 401(k)-like retirement plans.
- Public retirement funds self-report a $17.2 billion shortfall. It’s closer to $50 billion.
- Recent changes to the public pension system demonstrate good faith but are woefully inadequate.
- The system’s bias toward “career” employees is unfair to younger, more mobile modern workers.
- Portable retirement plans are more flexible, realistic, and sustainable.
Q: How do you respond to the notion that public employees deserve the security of a public pension?
KC: Everyone who contributes to a retirement plan should get the benefit of that investment. What’s not understood is that the system is set up to reward career employees who stay in their job for 30 years. They receive about 85 percent of their pre-retirement income. Everyone else gets a much lower benefit. This is called back-loading, and it’s indefensible. Defenders of the public pension system know most people don’t stay that long, especially teachers. I know people who counted every day of their last five years on the job to protect their full pension.
The average teacher, like a friend of mine who worked in the St. Paul system for 15 years, needs to understand that if they leave their position—to raise a family, to purse another career—how they would have done with a portable, individually owned contribution plan. They would have been better off.
Q: When asked about the burden defined benefits puts on the taxpayer, they counter that the average payout is just $21,000 a year.
KC: Pension systems love to use that number, but it’s dishonest, because it includes all those exquisite teachers and police officers and city clerks who left before they hit a 30 year pension payout. A more honest number would be the average payout for a career employee, but even that fails to fully account for the total cost to employees and taxpayers.
And, by the way: $21,000 a year? That’s awful. It proves that we all need to be much more intentional about putting money away. We need to be more like my grandparents and great-grandparents, who were squirreling money away. They thought retirement was their responsibility. They weren’t looking to government to bail them out if they had not saved.
Q: Another piece of data that I’m curious how you would respond to estimates that for every dollar Minnesota taxpayers spend on pensions, nearly $10 of economic activity is generated.
KC: That’s another pension marketing myth. Pension critics call it the “magic bean theory.” Like Minnesota pension dollars somehow grow taller and faster than regular dollars. Plus, it ignores what would happen to the dollar if it stayed in the economy. There’s such dishonesty around the system, and I think that’s partly why we’re having such a hard time fixing it. But the math is catching up with the myths.
Q: What do you think of creating a hybrid solution, which would combine defined benefits and defined contributions?
KC: Well, there are really smart people who advocate for a “cash balance” approach. Where everyone would have a small guaranteed amount, and then the rest of their investment would be in a defined contribution. I understand why this is on the table. Not because it’s the best approach, but because some see it as a way to get something done. But here’s the thing. The defined benefit portion suffers from the same moral hazards as the current system. And I’m not convinced that if this were legislated, the politicians wouldn’t just do what they always do. We would fix it, and then all of a sudden it would start creeping in the wrong direction. We would guarantee too much. We wouldn’t fund it. And then we’d be back in the same hole. So, no, I’m not a fan of anything that leaves defined benefits in place.
Questions for Katie Hatt
Defined contributions are too risky and would leave loyal Minnesota workers economically vulnerable.
- One in every seven Minnesotans age 65 and older lives in poverty while relying only on Social Security.
- For every dollar in public pension benefits, Minnesota taxpayers pay only 14 cents. The rest comes from employees and investments.
- Every dollar Minnesota taxpayers invest in public pensions results in nearly $10 of statewide economic activity.
- When it comes to retirement security, nothing beats a real pension.
Q: If Minnesota’s public pension system isn’t in crisis, why are people on both sides of the aisle so concerned?
KH: I think we’re living in a time when pensions are a political football and, sadly, saying there’s a crisis is also a way that conservatives have found to be a primary avenue of attack on public workers and government. The other problem is that we’re not thinking about the impact these conversations have on people’s individual lives. One in seven of our senior citizens is living in poverty. That’s not a future we should wish on anyone after a lifetime of work. So, numbers are important, but numbers never tell the whole story. We need to approach public policy through a lens of, How does it impact people and how do we make sure people in Minnesota feel safe and secure in their retirement?
Q: Why not set up a system around defined contributions, which essentially functions like a 401(k), and let the worker—as opposed to the taxpayer—assume the risks? Wouldn’t that be more equitable and fair to everyone?
KH: Well, the first thing to keep in mind is that taxpayers as a whole pay only 14 cents of every dollar of pension benefits. The remaining share, 86 cents, comes from worker contributions and from investment earnings or investment returns. Not only that, but pension spending keeps main streets open for business.
In the end, we should oppose any attempt to transition pensions into [individual] savings plans. It’s unnecessary and it’s unstable. Instead, policymakers need to be working within the existing pension system, with public workers, and with the unions that represent those public workers. This is about protecting retirees, who are taxpayers, by the way. This is about honoring promises and the people we made them to.
Q: How do you respond to the notion that young people don’t stay in jobs long enough to reap the benefits of a pension system (which is geared toward career employees) and would be better off with a portable 401(k)?
KH: Well, first of all, I would reiterate that, when it comes to retirement security, nothing beats a real pension. What’s more, a pension is a way where savings can accrue at a time when people would otherwise not be saving at all. It’s stable. And, by the way, it’s portable and continues to accrue interest over time. You never “lose” what you put in. Another way to put it is that pensions are one-leg of a three-legged stool, which includes savings and social security. It all fits together. It’s not a zero-sum game.
Q: How do you respond to the argument that public pensions are at risk in part because of unreasonable expectations on the part of beneficiaries? That they can enjoy a pre-retirement lifestyle for decades?
KH: People don’t work in public service to get rich. They care about educating our kids. They care about helping people who need essential services, who need to connect to housing, who need to connect to jobs. These are the people who plow our roads and provide essential services. We should take care of them. And I can’t help but think that people making this argument are not only anti-worker and anti-union, they’re fundamentally opposed to a functioning government. The other thing that troubles me about the mindset you describe is that the average pension is $21,000 thousand a year. Even if you add Social Security to that number, it’s nowhere near enough. Finally, if you’re going to talk about “expectations,” let’s put it into proper context. Keep in mind rising housing costs, the rising cost of groceries, and rising healthcare costs. If you agree that economic security is important, then you need to have a real conversation about how much more financial pressure seniors are facing today.
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