Revolutionary pension game-changer, or bigger pension problems?

July 10, 2013

By Katy Grimes

CalPERS building

There is a potentially revolutionary way of restructuring public pensions being floated by U.S. Sen. Orin Hatch which would  park public pension liabilities with private insurance companies, and get government out of the pension business altogether.  The plan would allow state and local governments to invest in annuity contracts with private life insurance companies for employee retirement benefits.

This is a potential game-changer for U.S. cities and states, and especially California.

But the public pension plans, who stand to lose their massive and out-of-control investment power, oppose the idea. Imagine that. And some pension experts don’t lime the idea.

How it would work

A story in the New York Times yesterday explains the plan in extensive detail, and is worth taking the time to read.

Local government would write an insurance company a check to assume the government’s obligation to provide pension benefits for a given public employee.  Supposedly, once that is done, the taxpayers are off the hook on future pension obligations because it is up to the insurance company to hit the earnings targets necessary to pay out the promised pension benefits.

“Big players like MetLife and Prudential, to cite just two, might thus step into shoes now occupied by the likes of Calpers, California’s giant state pension system,” explained NYT reporter Mary Williams Walsh. “Working with insurers would not suddenly make trillions of dollars appear, but Mr. Hatch said it would make costs more predictable and protect both retirees and taxpayers.” And, the proposal does not include an explicit or implicit government guarantee.

A report by Sen. Hatch found that the states’ pensions were a valid federal issue because Washington would likely be called upon for bailouts. The plan was devised by specialists working for the finance committee after extensive talks with public-pension unions. But, union officials were adamant about holding onto their members’ defined-benefit pensions, according to the Times.

The reason the plan using insurance companies could make sense is because state insurance regulators perform oversight, something “unknown in the world of public pensions,” the NYT reported. “They require insurance companies to meet capital requirements, taking into account the riskiness of their investments. Insurers are also required to hold more assets than they estimate they will need, and if they burn through their surpluses, state regulators can close them down.”

“Public pensions, by contrast, have no capital requirements and can make themselves look stronger by taking on more risk.”

While this plan sounds like a viable solution for serious pension reform, public pension plans like CalSTRS and CalPERS obviously will fight it with everything they have. Not only would they stand to lose their massive investment power, but inducements  for kickbacks, fringe benefits, influence peddling, and left-wing activism would also disappear.

So that’s one reason to support the plan. But keep a skeptical eye on this. Insurance companies were a large part of the problem with the last financial meltdown, while politicians sat on their hands and allowed it to happen. Would this only make some insurance companies “too big to fail?”

Bond Buyer reported Dustin McDonald, director of the Government Finance Officers Association’s federal liaison center, has concern with “how governments could lose control over the funds and the important policymaking decisions made by the plans and participating governments and ensuring that defined benefit plans continue in this sector.”

William “Flick” Fornia, president of Denver-based Pension Trustee Advisors, an actuarial consultant to state and local pension plans, said Hatch’s bill is unworkable. “I don’t think it’s going to work because the capital requirements for insurance companies are much more stringent that the requirements that the states put on themselves for their pension funds. Public pension fund earnings tend to be higher than insurance companies’ [earnings] would be because of their investment flexibility and therefore the costs would go up quite a bit to try to have public employees insured.”

Read the New York Times story: “Pension Proposal Aims to Ease Burden on States and Cities,” and Bond Buyer’s story: “Hatch offers pension reform bill; experts say it wouldn’t work.

6 comments

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  1. Bob
    Bob 11 July, 2013, 07:18

    Today hardly any private sector workers have pensions, certainly not new hires.

    So why do gummit workers still have pensions, and lavish ones at that.

    Why don’t they have to have 401ks like everyone else?

    Reply this comment
  2. Rex the Wonderdog!
    Rex the Wonderdog! 11 July, 2013, 08:39

    So why do gummit workers still have pensions, and lavish ones at that. Why don’t they have to have 401ks like everyone else –
    ==
    It is called BRIBES…..errr…..I mean “campaign contributions” 😉

    Reply this comment
  3. S Moderation Douglas
    S Moderation Douglas 11 July, 2013, 09:02

    There are 43 million workers and retirees in private pension plans.

    Many are new hires.

    Reply this comment
  4. Tough Love
    Tough Love 11 July, 2013, 10:21

    What never ceases to amaze me in proposals like Senator Hatch’s proposal is either (a) the lack of full understanding of the implications of THEIR OWN proposal, or (b) the full disclosure of its consequences.

    Being well versed on pension funding, here’s how this proposal shakes out …

    (1) the Annuity-writers will “price” their products very conservatively to minimize the risk that they will be assuming. In other words, the cost to Taxpayers to fund the SAME level of pensions currently promised will skyrocket. Essentially the 7%-8% assumptions for earnings growth (currently used by all Public Sector Pensions Plans) will drop to the 2.5%-4% level used by the annuity-writers. These rates are even considerably below the (roughly 5%) rates Moody will use in evaluating such Public Sector Plans for the Credit worthiness of their sponsors, and below the rates Private Sector Plans are REQUIRED to use in their pension valuations. Did Senator Hatch think that off-loading that significant risk would be cheap ?

    (2) While the Unions would love the strong “guarantees” AAA or AA rated annuity writers would bring to the table, there isn’t a snowballs chance in hell they will accept the significantly lower pensions that could be bought with today’s Taxpayer contribution levels. Of course they would gladly let the Taxpayers pay perhaps 100% MORE for the SAME pension levels promised today. If Senator Hatch thinks this proposal is (even remotely) a “solution” to this problem, clearly the Utah Citizens have elected someone incompetent to do the job.

    (3) The ROOT CAUSE of the pension-generated financial mess many States and Cities are in today is BECAUSE the promised pensions are simply FAR TOO GENEROUS, and THEREFORE very costly to fully fund without SIGNIFICANT Tax increases and/or completely unacceptable reductions in govt-provided services. And when I say FAR TOO GENEROUS, I mean pensions for which the Taxpayer paid-for share is ROUTINELY 2-4 times (4-6 times for safety workers) greater in value at retirement than the pensions typically afforded Private Sector workers retiring at the SAME age, with the SAME years of service, and with the SAME Age at retirement.

    (4) REAL pension reform MUST include either (a) or (b) below, with (a) being the MUCH better choice. Unfortunately, we have yet to find a politician with the guts to confront the very Greedy Public Sector Unions, and Senator Hatch’s proposal certainly does NOT put him in that category:

    (a) hard freeze the ALL current Public Sector Defined Benefit (DB) Plans (meaning ZERO future growth) for all CURRENT workers, and replace them for FUTURE Service with 401k-style Defined Contribution Plans with a Taxpayer “match” of 3%-5% of pay which is what Private Sector workers typically get from their employers …. and with all Gov’t workers participating in Social Security, or

    (b) IF (a) above simply CANNOT be accomplished (and only AFTER exploring all avenues to do so), then continue the DB Plans, but reduce the pension accrual rate for future service by A MINIMUM of 50% (66% for Safety workers with the richest pensions).

    Reply this comment
  5. Tough Love
    Tough Love 11 July, 2013, 10:29

    S Moderation, Your statement is not true,

    VERY few companies place new workers in “Traditional” DB Plans (like the ones Public Sector workers get). And while Traditional DB Plans still exist in the Private Sector, in 80-90% of these Plans, the Plans have been frozen … meaning no Future Service accruals for CURRENT workers.

    The SOLUTION to the financial mess in the PUBLIC Sector is to do the same.

    Reply this comment
  6. Lee Welter
    Lee Welter 12 July, 2013, 07:56

    Thanks, Katy, for your consistently great reporting. This time “…experts don’t lime the idea….” sent me to the dictionary: is that a typo, or simply an unusual version of “whitewash”?

    Tough Love: I also enjoy your explanation which implies other problems: 1) few if any politicians play a fiduciary role; 2) moral hazard is a consequence of such programs under political control. Are Social Security and these pension plans simply legalized Ponzi Schemes?

    Reply this comment

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