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.

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