Defined benefit pension plan sponsors and boards must take into account intergenerational equity to ensure fairness of their decisions across generations.
The deep underfunding of many plans heightens the issue. That underfunding risks shoving off to the next generation —or generations not yet born — responsibility for funding benefits of participants who could already be retired now. At the same time, those future generations have to provide funding for their own retirement benefits.
Future generations must be protected from decisions contracted against their interests by the current generation. Keith P. Ambachtsheer in his book, “The Future of Pensions Management,” published this year, calls for a legal mechanism to secure such protection.
“The next generation is typically not at the (defined benefit) bargaining table,” he writes. “Hence, they typically have no voice to press their interests.''
Public pension sponsors typically haven't treated surpluses as rainy day funds to help support funded levels in weaker economic years, either using the excess to increase benefits, reduce contributions or some combination of both.
As fiduciaries, boards must begin to act to embrace their responsibilities to serve future generations, not only the immediate generation. Boards should include a representative of future generations, whether an ombudsman or a trustee. Pension plans have long-term horizons. Indeed, public plans officials often declare their plans have a horizon in perpetuity. If so, the plans need to begin to better serve future generations.
Under the Pension Protection Act, a modification to the Employee Retirement Income Security Act of 1974, corporate plans must amortize unfunded liabilities over seven years. Public plans should adopt a similar funding policy. It is the only way to ensure benefits are funded by the generation that earns them and receives the benefit of services provided by active participants.
But public retirement plans have leeway in funding to do whatever their state legislation or municipal laws allow because they don't fall under ERISA. Some don't even have a goal of reaching a fully funded level as part of their funding policy. Illinois statute, adopted in 1995, requires state plans reach a 90% funded level in 50 years, or 2045. The statute puts off onto future generations the cost of fully providing pension benefits already accrued, essentially acknowledging the current generation cannot pay for its own pension benefits.
The intergenerational challenge faces Taft-Hartley, jointly trusteed pension plans, as well. The Department of the Treasury's rejection in May of the application of the Teamsters Central States, Southeast and Southwest Areas Pension Plan to reduce benefits to try to avoid insolvency means both younger, active participants who pay into the plan and newer retirees risk losing all benefits if the plan runs out of assets as it projects will occur by 2026.
In Minnesota, Gov. Mark Dayton in June vetoed legislation that would have reduced the cost-of-living adjustment for retirees in the Minnesota Teachers Retirement Association and Minnesota State Retirement System, saying the bill would place “sole responsibility for reducing plan liabilities on current retirees. It is not fair, and I cannot agree to it.” Plans of both systems are underfunded.
The teachers' plan, with its most recent funded ratio at 77%, cannot even fully fund accrued benefits, let alone assume the funding of COLAs. Under statute, once its funded ratio reaches 90% on a market-value basis for two consecutive years, its annual COLAs would increase to 2.5% from 2%. But its COLA projections show its funded level won't reach 90% over the next 50 years. In fact, its funding projections show the plan funded at 74% in 2045, the most distant year projected, assuming an 8% expected annual return.
The projections suggest future generations, who will be obligated to make up the funding shortfalls, have not been taken into account.
The challenge for pension plans is to give future generations representation in decision-making now because the funding bill is already being tallied to present to them when they are born. n