Why pension benefit cuts won't cut it

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AUSTIN, Texas — Municipal pension experts argued Wednesday that addressing governance and economic problems, rather than cutting benefits, is key to solving local and state pension funding woes.

That consensus emerged during the final panel discussion of The Bond Buyer’s Texas Public Finance Conference here. The explosion in public pension liabilities over the past couple of decades has heightened public interest in the subject. Bond market participants have become increasingly aware of the potential for pension obligations to crowd out the interests of bondholders in distressed municipality scenarios.

But many of the policy discussions surrounding the pension crisis are incorrectly focused or avoiding the facts, panelists said, and fail to address the necessity of paying down pension costs and adopting assumed rates of return that create less economic risk.

Thomas Aaron, a vice president and senior analyst at Moody’s Investors Service, said that total public pension liabilities nationwide stand at around 40% of U.S. gross domestic product. Only the riskier asset classes, such as in emerging markets, are generating investment returns for those plans at anything near the typical 7% many pension administrators use as their assumed rate of return. That creates a potential pitfall because investment options in sectors like emerging markets expose the plans investing in them to greater economic uncertainty.

“Those carry the highest expected volatility,” Aaron said.

Pete Constant, chief executive officer at the Retirement Security Initiative, said it is important for the discussions about fixing the pension funding problem to focus on plan governance. Constant said that unfunded pension liabilities are growing around the country, even for plans that are not nearly as generous as those in Illinois and California where the struggle has been highly publicized.

“What you see is a consistent pattern of mounting debt,” Constant said.

Douglas Offerman, a senior director at Fitch Ratings, said it appears possible that the low economic growth environment of the last 20 years may be the new normal, and that the post-World War Two economic boom was actually the exception. The average discount rate (or assumed rate of return) for major plans around the country is still over 7%, Offerman said, well below the investment performance plans have gotten for years.

Constant said that he often hears from pension plan executives that things will turn around when the economy returns to normal.

“I hear this every time,” he said.

Offerman cautioned localities against counting on their states to provide them a safety net if they can’t corral runaway pension obligations.

“States are not going to bail out local governments with cash,” Offerman said. States responded with cutting local aid during the economic downturn 10 years ago, he noted. “We think that carries to pensions as well.”

Josh McGee, chair of the Texas Pension Review board, said that the problem with pensions has often been “misdiagnosed” as one of plan generosity and loopholes.

“If we’re going to fix these things we need to fix some of the governance structure,” he said, calling for more transparency and accountability.

Constant said that even when money is available to pay down pension debt, that discussion is often not happening. Aaron said he believes that successful pension plans will start paying down their obligations in greater amounts sooner, while de-risking their investment portfolios, and those that don’t will serve as the unsuccessful examples.

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Pension reform Public pensions De-risking Pension derisking Moody's Fitch Texas California Illinois Washington DC