Legacy Debt in Public Pensions: A New Approach

The brief’s key findings are:

  • The inclusion of “legacy debt” – unfunded liabilities from long ago – with current liabilities impedes effective pension policy.
  • A new approach would separate legacy debt from other unfunded liabilities in order to:
    • spread the legacy cost over multiple generations; and
    • properly identify fixed vs. variable costs.
  • It would also use the municipal bond yield – rather than the assumed return on assets – to calculate liabilities and required contributions.
  • This approach, by properly allocating costs, would improve intergenerational fairness, government resource decisions, and public credibility.

Forensic Analysis of Pension Funding: A Tool for Policymakers

The brief’s key findings are:

  • State and local policymakers face a growing pension cost burden, but often lack understanding of the root causes.
  • One underappreciated cause is “legacy debt” – unfunded liabilities accumulated long ago, before plans adopted modern funding practices.
  • Legacy debt still exists today because historical unfunded liabilities were ultimately paid in full using some of the money intended to fund later benefits.
  • In a sample of plans with particularly low funded ratios, legacy debt averaged more than 40 percent of unfunded liabilities.
  • A failure to recognize the legacy debt has provided misleading information about benefit generosity, hindering progress toward effective solutions.

How Many Public Workers without Social Security Could Fall Short?

The brief’s key findings are:

  • About 5 million state and local workers are not covered by Social Security on their current job.
  • The law requires that their pension plans provide a benefit equal to what they would have received upon retirement if they were covered by Social Security.
  • While all plans meet the letter of the law, a prior study found that 43 percent of them do not provide lifetime benefits equal to Social Security for some workers.
  • The workers who lose out are those who leave in mid-career, as their pensions are based on wages when they depart, whose real value erodes over time.
  • This new study finds that this group accounts for about 17 percent of current noncovered workers, so hundreds of thousands could fall short.

Has COVID Affected Pensions for Workers without Social Security?

The brief’s key findings are:

  • At the outset of the pandemic recession, many feared it would undermine workers’ employer-sponsored retirement plans.
  • State and local employees who are not covered by Social Security would have been particularly vulnerable, as they lack the buffer this program offers.
  • Their employer defined benefit plans would have been hurt by a long recession with poor investment returns and reduced contributions due to tax shortfalls.
  • Instead, these plans exceeded their return targets; tax revenues held up; and government sponsors got stimulus aid, so plan funded ratios actually improved.
  • And long-term structural headwinds such as negative cash flows and aggressive return targets still pose little risk to their ability to pay future benefits.

What Do We Know About Public Teacher Compensation?

The brief’s key findings are:

  • Whether public teachers are over- or under-paid is a source of lively debate.
  • This study sheds new light on the topic by using more accurate estimates of benefit costs.
  • The results show that teachers earn roughly the same as similar private sector workers.
  • However, given cuts to pension benefits for teachers hired in the past decade, relative compensation is likely to decline over time.
  • And uncompetitive compensation may make it harder to recruit high-quality teachers, potentially leading to worse outcomes for students.

Do All State and Local Workers Receive an Annuity in Retirement?

The brief’s key findings are:

  • The conventional wisdom is that all state and local government workers receive a lifetime annuity in retirement from their employer pension plan.
  • The analysis confirms this presumption for most workers, but also finds that a small share will receive some income that is not annuitized.
    • About 6 percent of all state and local workers convert part of their defined benefit annuity into a lump-sum payment.
    • And another 8 percent will potentially enter retirement with un-annuitized assets from a defined contribution plan.

2021 Update: Public Plan Funding Improves as Workforce Declines

The brief’s key findings are:

  • The aggregate funded ratio improved from 73 to 75 percent from FY 2020 to 2021. At the same time, contribution rates rose from 21 to 22 percent of payrolls.
  • While initial expectations for public pensions were low due to COVID, financial markets rebounded and municipal tax revenues were quite resilient.
  • Yet one other COVID-related factor – cuts to the state and local workforce – impacted public pension finances in FY 2021.
  • These cuts had little impact on funded status and required contribution amounts, but they do explain the rise in contribution rates, which are expressed as a share of lower payrolls.

Do Public Workers Without Social Security Get Comparable Benefits?

The brief’s key findings are:

  • About one quarter of state and local workers are not currently covered by Social Security.
  • Federal standards require that state and local plans provide their noncovered workers benefits equivalent to Social Security at the full retirement age.
  • This study explores whether the plans satisfy the federal standards, and whether the standards themselves ensure equivalent benefits.
  • The results show that public plans do adhere to the standards, and the standards satisfy the letter of the law.
  • But looking beyond the standards to see if plans also provide equal lifetime benefits suggests that a significant portion fall short for some of their members.
  • Policy options include updating the standards to a lifetime measure or, more importantly, requiring all public workers to be covered by Social Security.

Do Smaller Public Employer Pensions Spur More Saving?

The brief’s key findings are:

  • In theory, workers would increase their supplemental saving in response to lower pension income, but do they in practice?
  • The answer matters for state and local workers, as pension income varies, some plans are poorly funded, and not all workers have Social Security.
  • The results show that workers with less expected pension income are more likely to save, but the effects are small, and they do not respond to the other factors.
  • The takeaway is that if public employers reduce pension benefits, workers are unlikely to make up the difference by saving more on their own.

Internal vs. External Management for State and Local Pension Plans

The brief’s key findings are:

  • As state and local pension plans have increased their investments in alternative assets, they have taken on more external asset managers.
  • However, due to concerns about fees, some large plans have started to reevaluate the size of their external team.
  • This study explores how the number of managers affects fees and after-fee returns, controlling for plan size, asset allocation, and extent of external management.
  • The results suggest that a significant reduction in the number of managers could reduce fees somewhat, but, in terms of after-fee returns, it matters who gets cut.

Would you like to take a short survey about the Public Plans Data website?

Yes, take me to it.       No, thanks.      Not now, but ask me later.

Step 1 of 2