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State Pension Payouts: A 'Q & A'

Written by “A Novice Journalist” – Nov. 18, 2018

Pension payouts are an important quality of life enhancement for employees of an organization. That's why we sat down with John Brooks, an assistant professor of political science and public administration at the University of Auburn at Montgomery and author of “Board on the Job: Public-Pension Governance in the U.S. States" to learn a little bit more about how payouts work and how they affect Americans.


  

Q: Are state pensions payouts an urgent problem? Who are the payments ultimately hurting?


A: Increasingly, I do think pensions present a serious policy issue that governments will have to grapple with for a while to come. The average retirement fund plan is underfunded, and many retirement funds are overly dependent on investment returns to cover their costs (hence why the 2008 Recession took such a toll on those funds). 


However, the problem is in most cases not immediate in the sense that government services will be compromised seriously in the short term. This compromisation is especially true at the state level. As is the case with many public policy issues, politicians often have a tough time dealing with longer-term matters and tend to focus on shorter-term concerns, such as keeping taxes low, getting re-elected, and generally keeping their public employees happy and around. 


Q: Are municipalities facing the same problem?


A: Yes. The underfunding issues at the local level are in some cases worse than those at the state level. Some localities have gone bankrupt or not followed through on marking their promised payments (usually the bankruptcies are not caused by pensions alone though - poor pension management is also more likely to be found in places doing poorly in other budgeting/governance areas, as well). 


I will also note that many municipalities have their pensions run by states, for reasons of efficiency/scales of economy. Nonetheless, several cities have gone bankrupt or come close to it in part due to rising pension costs. I think what is most likely to happen in many of these cases is that state governments will help prop up these governments - which also presents its own moral hazard problem regarding how local governments manage their pensions. 


Q: Has state payouts affected overall government efficiency?


A: This is an interesting question and one that probably will be continually studied in the future. There isn’t a clear answer to it since there are so many different ways to define efficiency, and also various sorts of impacts that pensions might have (some of which could very well counterbalance each other). Historically, though, pensions were intended to enhance the provision of public goods and services. 


Q: Are pension payouts a "necessary evil' that ensures its employees are managing an ever-revolving bureaucratic system?


A: As someone who studies pensions from an empirical perspective, I probably would avoid calling them good or evil, one way or the other. When functioning correctly, they can help employees save for the retirements, recruit talent into public-sector work, and incentivize retirement timing, all while operating in a fiscally sustainable manner. Of course, though, states need to commit to effective and responsible management over the long term, which may or may not be a top political priority. In such cases, when problems do arise (for example, investments underperform, or more employees retire than expected in a given year) ignoring them or pushing costs into the future is tempting, and can make the lingering problem more difficult to deal with down the line. 


Q: Which state has the highest amount of pension payout problems? Which state has the "least" amount of pension payout problems? What is being done to rectify this issue?


A: So far, employees at the state level have received their promised benefits, which generally are guaranteed by state law. However, there is variation concerning how ‘healthy’ plans are, meaning their ratios of assets to liabilities. Looking between 2010 and 2015, some of the worst-funded plans are in the following states: Alaska, Illinois, Connecticut, Kentucky, Mississippi, Louisiana, and New Hampshire. In comparison, some of the best-funded plans include California, Delaware, Idaho, Georgia, Florida, Minnesota, Nebraska, New York, Oregon, Washington, and Wisconsin. Note that I think it is interesting that there is no apparent partisan (‘red’ or ‘blue’) pattern in both poor and well-funded plans. Still, over this period, the average state plan is underfunded (this is also true in both red and blue states). Of course, there are other metrics that one could use to measure pensions’ problems or performance, but the funded ratio is a prevalent one.

 

Concerning policy solutions, it depends on the state’s governance. Raising employee contributions would help improve assets, but can be controversial and politically difficult. Increasing employer contributions also would help, but theoretically requires raising taxes. Alternatively, governments could make better investments, but this is easier said than done. Many governments also have reduced the size of pensions for new employees, or require that they pay more into the system. Some states have experimented with defined contribution plans, which place the risk on the employees rather than the government. However, it is essential to know both that these are not as popular among most employees, may not perform as well from an investment point of view, and most importantly, such employees no longer pay into existing defined benefit plans, so this solution exacerbates the under-funding problem for the state. 


Q: After researching this situation, what does the data suggest can be done to help states reach a semblance of efficiency?


A: I think in general, more attention should be paid to pensions, and that politicians and other pension managers thinking about sustainable stewardship. More open bargaining between governments and employees (often via pension management boards) is more likely than not to help make the policy adjustments needed to set pensions on a more sustainable course (or keep them viable in the better performing plans). My research also suggests that employees will be more likely to turnover from that position if they have to contribute more into their pension funds - so assuming that we wish to maintain the labor force in the public sector, improving pension funding should fall more on governments and employer contributions than on employees. Other studies have shown that riskier ‘alternative’ investments usually are not worth the higher fees associated with them, so plans would do well to limit side fees as they invest pension funds.


Q: What does the future look like for state governments and pension payouts?


A: When I began my research on pensions as part of my dissertation work some years ago, I was afraid that states might figure it out by the time I was done/had published anything. Luckily (for me), this has not been the case. I think the issues pensions present are going to be around for a long time. These programs play an essential part in public-sector compensation, and function over the long-term by design. I do think that pressure will build for more transparent and realistic accounting standards and practices over time (for example, using more realistic expected investment returns in projecting future assets, and moving toward or at least also reporting risk-less liabilities) will help governments and citizens better understand pensions.


Q: Is there anything we missed, or you would like to add?


A: State pension funds are incredibly complex and large - I think most people don’t realize that in most states pension assets and liabilities are more significant than the state’s total annual revenue in the general budget - in some cases, annual pension assets are three times larger than the state’s yearly revenue intake. 


However, pensions also exist outside of the state’s general budgets, in separate funds. Thus, it is not entirely correct to say that an additional dollar of pension spending means one dollar or less for something else.

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