Pension contributions are being politicized in the state budget debates sparking protests in Wisconsin, Ohio, Indiana and elsewhere.
That is a good thing. Pension promises, and their affordability, should be a major part of the public policy debate, and the attention ultimately will strengthen the systems.
Unfortunately, the true cost of the high benefit levels of public employee pension plans generally has been taken out of politics, as taxpayers and politicians alike assigned pension issues a low priority, or ignored them altogether, in favor of other public spending matters.
A promise of a certain level of retirement income is worthless unless the pension plan funding, through contributions and investment returns, is adequate to secure the benefits.
At least 24 public employee pension plans have cut pension benefits to address unsustainable funding issues, while some of the same systems, and others, have raised contribution rates, according to reports by Pensions & Investments over the past year.
The situation is urgent. Some state retirement plans will begin to run out of assets in 2017 and none will be sustainable beyond 2042, even assuming an 8% annual return on investments, a typical rate for public plans, and contributions equivalent to the present value of newly accrued benefits, according to a study last year by Joshua R. Rauh, associate professor of finance, Kellogg School of Management, Northwestern University.
At many public retirement systems, the current pension promises are unsustainable in part because the issue generally has not received the consideration it deserves. The billions of dollars of assets in the pension funds seemed to defer any problem for decades, even forever.
State and other public plan sponsors are meeting resistance from taxpayers in raising more revenue for contributions, and also from public employees fighting changes in their retirement programs. To improve funding, some systems are stepping up the level of risk in their portfolios, or allocations to new strategies, to achieve higher investment return.
The State of Wisconsin Investment Board, for instance, plans to leverage up to 20% of its fund in a risk parity strategy as a way to achieve its 8% rate of return assumption. A lower assumption would mean a higher level of contributions, creating more contention between plan participants and taxpayers on the affordability of the promised benefit levels.
However, retirement systems cannot simply invest their way out of the problem, even though investment returns generally make up the bulk of the funding.
Bringing the issue into the public debate now rather than later will provide a better chance to strengthen the systems and secure benefits.