This will have to be brief as I’m working on something related, but I wanted to share something I discovered today as it touches on the increasingly political subject of public pensions and underfunding.
In my research, I came across a statistic that 60 cents of every dollar in funding for public sector pension funds comes from investment returns. That sounded surprising, so I followed the trail of citations from the Pew Center to a lobbying organization called NASRA, which included the following graph in a 2011 report:
This jumped out at me for two reasons. First, it undermines any notion that public sector pensions are bleeding the public dry – it appears as though public funds have been relying on the market rather than funding. This is consistent with Moody’s findings in its recent review of public sector pension funding, where the analysts noted that the most frequent cause of underfunding in the worst-funded pensions was inadequate contributions.
The second reason was that this figure covers a very long time period that includes both positive and negative market returns, which would make an average like this less meaningful. How would this look over time?
Thankfully, the Census makes the data very easy to access and use, and provides annual surveys going back to 1993 (all available here). There are a number of ways to look at the data, but I’ll focus on contributions, which the Census provides both in dollars and as a percentage of all sources of funding.
To evaluate the Pew/NASRA figure, I converted contributions from the three main sources of public pension funding – employee contributions, employer/government contributions and investment returns – into percentages of the total, and removed fiscal years with negative market returns to focus on the trend (and avoid messy percentages). The picture looks a lot worse than what the Pew/NASRA figure implies:
What we can see from these figures is that the relative contributions of governments and employees have been dwarfed by those of Mr. Market. And pace the Pew Center and NASRA, investment returns today account for nearly 80% of public pension funding – the 60% figure they cite stopped being relevant during Clinton’s first term. This leaves state and local taxpayers – meaning, us – at the mercy of the financial markets when it comes to pension funding.
This is admittedly far from the whole picture. Pensions are effectively a kind of insurance, which means that both the assets (the funded portfolio) and their liabilities (the promised benefits) are important. Even there, however, financial markets play an enormous role given that the discount rate used to calculate the truly big numbers in terms of liabilities are a function of market rates and returns.
I’ll leave that for another post, but for now it’s worth noting that we’re living with the fallout of policy decisions to turn social insurance into unfunded market risk.
For now, it’s also worth looking past the percentages to see the actual numbers, especially given the widespread belief that cash-strapped governments are plowing money into pensions. The data certainly support that view, though here again, the picture is more complicated than that political view would imply. Here are the dollar figures just for employee and government contributions:
A taxpayer’s take on this might be outrage – after all, the red bars have more than doubled, confirming that governments are sending more and more taxpayer dollars to fund public pensions. And the taxpayer would be right to be outraged, but so would employees. The blue bars representing employee contributions have also more than doubled over the period, so it’s not only governments that are paying more. Moreover, employees have been increasing their contributions steadily since 1993 – governments, by contrast, appear to have taken a funding holiday for most of the 1990s bull market, and only woke up to the need to fund pensions after the end of the tech bubble (if memory serves, there was also a GASB rule change right around then, though I could be wrong). Had governments kept pace with increases in employee funding, the current mess of widespread underfunding would likely be very different.
My political leanings should be clear by now – I think the underfunding of both public and private-sector pensions was a deliberate choice that we are all going to pay for. Whether you believe that or not, it’s imperative that we use the correct data when we discuss what happens next.
7/9/13 – slight copy edit