The Hidden Costs of a Mandatory Public Pension Plan

Last week, I attended and testified at the hearings of the Legislative Commission on Pensions and Retirement. I am reluctant to admit it, but everyone knows I am a pension nerd, so why pretend? I kind of enjoyed being back at the hearings, getting an uncomfortable front row seat to hear how the biggest fiscal hole in our state finances is being plugged, or not.

As I recently reported in my updated Minnesota Policy Blueprint chapter on pensions, the unfunded liability increased from a reported $17.3 billion to $17.6 billion despite higher contributions, lower COLAs, big investment returns and very large cash infusions from state taxpayers (see below) into some of the troubled funds.

And as I note in the study, the collective unfunded liability is much higher, $30 billion or more, if you use a defensible return assumption and discount rate.

After hearing a sugar coated version of what is happening with the funds, and a state investment report heavily laced with pixie dust (both are annual rituals at the pension commission), the joint commission heard a good presentation by an outside firm on alternatives (e.g. 401ks, annuities) to the traditional pension plan that most public employees in Minnesota are required to accept. Like social security (another example of why government does not belong in the retirement plan business), contributions are mandatory.

This is what your state legislators, who run this $60 billion retirement system, and public employees who think they are getting a good deal, need to understand:

Every two weeks, employees and employers make a contribution to a retirement plan that is seriously underfunded. System-wide, the plans have been falling behind since about 2003; it is important to know that fact (and repeat it often) because the pension plans like to pretend that the problem started when the market crashed in 2008 (see Figure 6below).

Kim 11.15 Blog Fig. 6_0

As a result of large unfunded pension promises, a chunk of the contributions to the pension funds is dedicated to filling the hole so that current retirees get the benefit they were promised. Put another way, instead of the full contribution going toward a secure retirement for current employees, current employees and taxpayers are back-filling the financial promises made to an earlier generation of employees.

For example, in 2014 teachers and school districts in TRA paid $388 million to cover their own pensions but they also paid an additional $295 million toward the unfunded liability. Even worse, the Duluth teachers that just merged into the troubled TRA, paid $4.3 million in normal costs and more than twice that amount( $9.3 million) toward the unfunded liability. And the last “independent” teachers fund for St. Paul schools paid $24 million in normal costs toward their own pensions and an additional $30 million dollars toward the unfunded liability of teachers who came before them.

Can it get worse? Actually, yes.

TRA is getting about $20 million a year in direct state aid to prop up the fund. The newly merged Duluth/TRA fund is getting another $14.4 million a year, and St. Paul teachers’ is getting over $10 million. So school districts are being subsidized by state taxpayers by more than $44 million a year until these funds are deemed “fully funded.”

As you can see below in Figure 4, when you combine all of Minnesota’s pension funds, the cost of servicing the unfunded liability ($897 million a year) is getting awfully close to the annual or “normal” cost ($1.29 billion) of funding the pension promise to state and municipal employees across Minnesota. And Minnesota has not closed the gap, and is not expected to, for years.

Kim 11.15 Blog Fig. 4_0

What else could Minnesota be doing with that $897 million? How about higher take-home teacher pay, or portable retirement assets that teachers own and control? Or lower costs for school districts, counties and cities? What else could Minnesota do with that $44 million in direct state aid?

Pension expert Josh McGee noted in a new study that 401k plans achieve similar investment returns and offer a good, if not better, option for retirement than defined benefit or DB pensions.  McGee observed, “DB plans do not eliminate workers’ exposure to risk. DB plan sponsors that find themselves with growing pension-debt service are likely to pass a significant share of the cost on to workers, through reductions to wages, jobs, and benefits….”

Please pass this on to your favorite legislator and public employee.