Despite Trend Toward Pension Freezes, Fund Administrators Report Growing Confidence in Sustainability of Plans
Freezing traditional pension plans has been a popular strategy to reduce the unfunded liabilities and long-term debt associated with underfunded retirement benefit plans.
Despite a Trend toward Pension Freezes, Fund Administrators Report Increasing Confidence in the Sustainability of their Plans
By Mark Johnson, Ph.D., J.D.
Freezing traditional pension plans has been a popular strategy to reduce the unfunded liabilities and long-term debt associated with underfunded retirement benefit plans.
The Archdiocese of Philadelphia recently announced that it will freeze its traditional pension to keep the plan’s estimated $150 million deficit in check and shrink it over time. The Archdiocese’s current plan, known as a “defined benefit plan” because it guarantees certain benefit levels to participants, held $478 million in assets June 30, 2012, about 76 percent of the $630 million it needs to meet anticipated long-term obligations. Defined benefit plans are commonly called “traditional pension plans”.
The change will be effective June 30, 2014, after which time almost 8,500 current employees of the Archdiocese of Philadelphia—including parochial school teachers, church office workers, and other lay employees—will no longer be able to accrue benefits under the plan. Instead, a 401(k)-style plan will be offered in its place.
In recent years, freezing of pensions has taken hold as a viable approach in many nonprofit and religious sectors. For example, archdioceses in Boston, Chicago and Minneapolis-St. Paul have placed freezes on their traditional pension plans for lay employees. Also, a national trend points to more employers offering retirement plans that establish a contribution rate, as opposed to plans which guarantee a pension benefit upon retirement.
The City of Detroit’s emergency manager, Kevyn Orr, proposed a pension freeze as part of a broader strategy to get the city out of bankruptcy. Orr argues changes are necessary to stabilize pension funds, which he says are underfunded by $3.5 billion, for current workers and those nearing retirement. His proposal aims to reduce Detroit’s staggering legacy costs to help resolve about $18 billion in long-term debts and liabilities overall.
Under the proposed plan, about 9,700 current city workers, including police and firefighters, would be affected. As of January 1, city workers could enroll in a 401(k)-style account, and the city would contribute 5% for non-uniformed workers and 10% for police and fire. Workers also could deposit their own money into the accounts. As part of the proposal, employees who were not yet completely vested in the city’s pension plans (8 to 10 years depending on the position), would have their pension service credits erased at the end of this year. However, any money they contributed in the past from their paychecks would be repaid and placed in an annuity account.
Pension reform is not easy to tackle, as the state of Illinois has painfully found out. Underfunded by $100 billion, the state’s pension liability is causing cuts in funding for other state services and is a key reason why credit downgrades have left Illinois at the bottom of ratings among U.S. states.
On December 5th, Illinois Governor Pat Quinn signed into law an ambitious financial, legal, and political effort to reinvigorate the state’s falling credit ratings and unstable economy. Taking effect June 1, 2014, the new law aims to save $160 billion over the next thirty years by curbing cost-of-living increases to retirees and requiring many current workers to abstain from up to five annual cost of living bumps when they become retirees. It also will boost the retirement age for current workers by up to five years.
Governor Quinn states that the law is a sign that “Illinois is moving forward.” Both union representatives and Republican Party members, however, are less optimistic about the law’s implications.
The GOP and Democrats are presently debating the constitutionality of the new law. At issue is a clause in the 1970 Illinois state constitution which states that public pensions are enforceable contracts with benefit that cannot be diminished or impaired.
In order for the law to be considered constitutional, employees would need to give 1 percentage point less to their salaries, and pension systems would be allowed to sue to force the state to pay the mandatory employer share to retirement. Also, a limited number of workers could join a 401(k) style defined contribution plan. Whether or not Governor Quinn’s new law is constitutional is up for the courts to decide.
Even though the focal point of pension reform has been on freezes, public pension plan administrators are increasingly upbeat about their funds’ outlook as well as their readiness to address future retirement concerns, a new survey by the National Conference on Public Employee Retirement Systems (NCPERS) reveals.
The 2013 NCPERS Public Retirement System Study also shows continuing financial strength for public funds, with ongoing improvement in long-term investment returns.
In conjunction with Cobalt Community Research, NCPERS surveyed 241 state and local government pension funds with more than 12.4 million active and retired members and with assets exceeding $1.4 trillion. For the first time, NCPERS included nonmembers’ responses.
Noteworthy findings from the research coalition’s survey include:
• There is a slight uptick in confidence among public pension plan administrators about their ability to address future retirement trends and issues.
• Returns on long-term investments continue to rise. Three-year investment returns were 10 percent, up from four percent in 2012; 10-year investments were seven percent, up from five percent in 2012; and 20-year investments remained steady at eight percent, versus nine percent in 2012.
• The overall average expense to administer public pension plans and to pay investment manager fees drastically decreased from the 2012 level of 73.1 basis points to 57.3 basis points (100 basis points is equal to one percentage point).
• Public pension plans are taking a number of steps to strengthen funding levels, including:
1. Lowering the actuarial assumed rate of return
2. Raising benefit age and service requirements
3. Tightening retiree return to work rules
4. Shortening amortization periods
5. Lowering the number of employees receiving health care benefits
• Overall, funds reported domestic equity exposure at 35 percent, down slightly from 36 percent in 2012. International equity exposure remained steady at 17 percent. Over the next two years, funds plan to increase allocations to international equity, domestic fixed income, private equity, and hedge fund investments, slightly reducing domestic equity.
• The average funded level of all responding public pension plans was 70.5 percent. Among NCPERS member plans, the level was 71.5 percent, less than 2012’s figure of 74.9 percent. For non-NCPERS plans, the level was 69 percent. Lowering the actuarial assumed rate of return and market volatility were the two most noteworthy reasons for the decline.
According to NCPERS Executive Director and Counsel Hank Kim, Esq., survey results run counter to what public perception of pension funds has been.
“What it tells us is that despite the hyperbole of some high-profile politicians, public pension plans are not in crisis. To the contrary – they are alive and thriving, more than adequately funded, inexpensive to operate and sustainable for the long-term,” he said in a NCPERS news announcement.
December, 2013
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.
