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The Overdue Death of Pensions August 6, 2006

Posted by David Bookstaber in Economic Policy, Finance, Government Spending, Pensions, Regulation, Retirement.

The Wall Street Journal expounds on the latest legislation to overhaul private pensions, noting, “the idea of a single company guaranteeing retirement payments for decades is no longer practical, if it ever was.”  Frankly, that is an understatement.

Defined-benefit pensions are annuities.  Annuities are an insurance product.  Unless you happen to work for an insurer, your employer has never been regulated as an insurer or rated for the health of its reserves.  What business does an airline or car manufacturer have writing insurance for its employees?  Yet that is what all these private companies were doing with their defined-benefit pensions.

It would have been fine if they had literally been funding a deferred annuity written by a proper insurer.  But as we know they neither fully funded their pensions nor did they offer the sort of portability that would come with a true annuity contract.

Fortunately, that scam seems to be coming to an end.  But there is still the matter of government defined-benefit pensions: Many federal, state, and local government agencies offer these to their employees.  I suppose that since they are being backed by governments they do not suffer the same credit risks associated with private companies.  Many agencies also collude to provide some degree of pension portability, so an employee can switch jobs without losing his benefits.

But government pensions still suffer from the underfunding hazard — with the cost and risk being dumped on taxpayers.  I suspect pensions will persist in government if for no other reason than that they are a convenient way to hide the cost to taxpayers of benefits provided to one of the classically strong special interests: government employees.  For this reason, taxpayers should demand that governments fully price and fund their pensions.  Or better yet: abolish them and let people buy their own annuities if they want.


1. federalist - August 12, 2006

WSJ today details some city governments behind on their pension funding. “The real problem may fall on the taxpayers who would have to make up the shortfalls if the cities’ investments don’t catch up.”

2. federalist - August 15, 2006

Here’s another WSJ editorial about the total compensation of federal employees, quoted in full:

Welcome to Club Fed

The closest thing to a lifetime sinecure in America is a federal government job, and now it turns out that it’s also a very lucrative way to make a living.

New data from the U.S. Bureau of Economic Analysis confirm that the average federal civilian worker earns $106,579 a year in total compensation, or twice the $53,289 in wages and benefits for the typical private worker. This federal pay premium costs taxpayers big bucks because Uncle Sam’s annual payroll is now $200 billion a year. No wonder that, with a per capita income of $46,782 a year, Washington, D.C. is the fourth richest among the nation’s 360 metropolitan areas.

And this pay disparity keeps widening. The Cato Institute’s Chris Edwards tracks government compensation, and he finds that in 1950 the average federal bureaucrat received $1.19 for every dollar that a private employee earned. By 1990 that ratio had risen to $1.51 and is now $2. In 2005 federal wages rose 5.8% compared to 3.3% in the private sector.

Since 2000 only one major industry, the booming oil and gas sector, has kept pace with the automatic pay increases for employees of “Club Fed.” Federal pay has risen by 38%, double the 15% pay increase in private pay from 2000-2005. This is roughly double the rate for private workers in manufacturing, retail, finance, health care and construction. (See nearby chart.)

It’s true that many federal employees are in white collar occupations that often command high pay, but studies find that public sector workers enjoy a 20-30% pay bonus above comparably skilled private workers. And this differential does not account for one of the biggest benefits of a government job: civil service rules giving virtual lifetime job security. Airline mechanics, auto workers and software designers must all worry about business-cycle downturns or changes in technology or outsourcing, but Uncle Sam’s 1.8 million civilian employees live in a recession-proof bubble.

As for performance, Mr. Edwards reports that only one in 5,000 federal non-defense employees is fired for cause each year. One federal manager recently told us of an administrative assistant who missed work “about half the time” thanks to an assortment of ailments, sick children and funerals for a mother who died on three separate occasions. When the agency heads finally fired her, they were slapped with an anti-discrimination lawsuit and the half-time worker pulling down a full-time salary was reinstated.

Public-employee unions continue to say their members are underpaid, believe it or not. But one market test is the voluntary quit rate of these workers, and data for recent years show that rate for federal employees is only one-fourth that in private sector occupations. High-paying federal jobs are so coveted that they are now like rent-controlled apartments in Manhattan: Once you’ve got one, you hold on to it for life.

The big villain here is Congress, which rubber stamps public employee union demands for automatic promotions and annual “cost of living” pay raises. The result is a system in which taxpayers in private America subsidize the salaries and rich benefits of government workers who make double what they do. Once upon a time liberal politicians would have called this “unfair,” but modern liberals care more about support from government unions than they do about the fate of private labor. As for Republicans, they haven’t done much better in controlling the rise in federal pay.

3. federalist - August 18, 2006

WSJ editorial details the pension crisis in San Diego, where, “five former pension-fund officials were indicted in January and the mayor resigned last year over the issue.”


[P]ublic pensions are inherently political institutions. A more “independent” board can’t stop current politicians from giving away too much in future benefits under union pressure.

The long-term solution is for government to follow the private sector and wean public workers from the defined-benefit pension model to a defined-contribution plan where an individual worker owns and controls his own retirement investments.

4. federalist - August 22, 2006

E.J. McMahon confirms that the shenanigans are as bad as I thought:

Only 43 of the 125 retirement systems in the most recent Public Funds Survey were within 10% of full funding status; one-quarter had actuarial funding ratios below 80%. But if private-sector accounting standards were applied to these systems, they would all look much worse.

In determining a system’s necessary funding levels, a crucial consideration is the discount rate applied to future obligations: The lower the rate, the larger the contributions required to maintain “fully funded” status. Private plans are required to discount their liabilities based on corporate bond rates — which are usually lower than these plans’ projected returns on investments.

Public funds, however, are allowed to discount their long-term liabilities based on the assumed annual rate of return on their assets — which, for most public funds, is pegged at an optimistic 8% or more.

Estimates of the nation’s real public pension funding shortfall range from an added $500 billion for state retirement systems to at least $1 trillion for all public systems.

McMahon’s prescriptions for fixing the problem may sound familiar, including:

Shift to defined contribution plans for all future workers.

Immediately recognize and fund the full cost of any benefit increase. The ability to amortize benefit increases over decades is one reason why politicians and unions have been able to sell pension sweeteners as a free lunch. Closing this window would be a disincentive for future giveaways.

5. federalist - June 1, 2007

E.J. McMahon returns to the WSJ editorial page:

Retiree health benefits amount to an exceptionally cushy deal for America’s public-sector workers. Texas, for example, not untypically pays 100% of health insurance premiums for state employees who can retire in their early 50s. Unlike pensions, these other retiree benefits generally are financed on a pay-as-you-go basis.

These benefits impose huge and growing future liabilities on taxpayers — liabilities that states and localities have long hidden from public view, deceiving citizens about the true costs.

Three years ago, the Government Accounting Standards Board (GASB) promulgated a new requirement for state and local governments to begin calculating and reporting the net present value of their retiree benefit promises. GASB 45 is based on the sensible premise that future retiree benefits, like pensions, are essentially a form of deferred compensation that should be recognized as their costs accrue. The rule becomes effective in fiscal 2007-08 financial reports for the largest government employers.

Why is this a big deal? Because the total unfunded liability for state and local retiree benefits (other than pensions) has been estimated at $2 trillion….

6. federalist - March 4, 2009

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