The New York State Retirement Fund, which oversees more than $184 billion in assets held in trust for most of the Empire State’s non-teaching public employees, is managed by a sole fiduciary: a partisan elected official, currently Democrat Thomas DiNapoli, a former legislator who lacked meaningful financial experience before assuming his role.
“NY's pension woes are hardly unique. Since 2000, America’s public pensions funds, in the aggregate, have gone from fully funded to 74% funded.”
Last month, the fund announced that it would fall short of its 7% return target for the fiscal year ending March 31. That inevitably means higher costs for already-strained municipalities around the state.
New York’s pension woes are hardly unique. Since 2000, America’s public pensions funds, in the aggregate, have gone from fully funded to 74% funded — and that’s crediting the pension funds’ own unrealistic rate-of-return assumptions. In 2014, 63% of plans were less than 80% funded (the level deemed “at risk” for private-employer pension plans under federal law), and 20% were less than 40% funded. Nationwide, the unfunded liabilities of state and municipal pensions total $1 trillion.
Unaddressed, this pension hole threatens to crowd out necessary state and local funding on education, health and infrastructure. In 2014, for example, California Gov. Jerry Brown signed legislation that will require school districts to increase funding for teachers’ pensions from less than $1 billion in the last school year to $3.7 billion by 2021.
A big reason why pension funds have gotten into this mess is that they lack adequate governance. It isn’t hard to see how poorly governed boards have contributed to the pension funding shortfall. In 1999, near the height of the dot-com bubble, the board of the California Public Employee Retirement System (CalPERS) lobbied aggressively for benefit enhancements that ultimately contributed to the steep underfunding of the state’s public pension system; and in 2014, the CalPERS board voted to allow temporary pay increases to be figured into pension calculations, thereby raising the amount that some retiring workers can collect.
In Detroit, even as the city spiraled toward bankruptcy, its pension board paid out nearly $1 billion in bonuses to retirees.
While these examples are extreme, the underlying governance failures are not: Most public pension funds are governed by boards that lack diversity or financial expertise, and most lack basic fiduciary duties and have more substantive powers than their private-sector counterparts.
To be sure, the New York State fund is an outlier, but most state and municipal boards charged with overseeing pension funds don’t offer much more in the way of professional oversight. The vast majority of pension boards are dominated by elected officials, or workers and retirees who benefit from the plans, and lack any financial experts. A study by the National Education Association of major public-education pension plans similarly found that 73% of boards did not require at least one citizen financial expert on the board of trustees.
Unlike the boards overseeing private pension plans, those that manage state and municipal funds are not subject to federal fiduciary duties and are instead subject to a hodgepodge of typically more lenient state-law requirements. Only three states — Maryland, South Carolina and Wyoming — have adopted fiduciary duties as recommended by the Uniform Law Commission’s model Uniform Management of Public Retirement Systems Act.
The boards of government retirement plans also typically wield considerably more substantive power than their counterparts in the private sector. According to one survey, 68% of public retirement boards have some control over benefit decisions and 89% control the funds’ actuarial assumptions. In contrast, under the federal Pension Protection Act, private-employer pension plans have limited capacity to alter benefit payouts unless fully funded; must project future liabilities using market-based discount rates; and have specific time windows for valuing assets and making up shortfalls.
Filling the pension-funding shortfall for America’s states and municipalities will be a Herculean task — and one that we hope legislators will tackle sooner, rather than hoping for a return to the 1990s bull market to bail them out. Indeed, the stock market has averaged double-digit gains since 2003, even as the pension hole has gotten deeper.
Beyond filling funding shortfalls, however, responsible government leaders will work to reform pension board governance to mitigate the risk of such problems recurring. Public pension boards should be dominated by neither public employees nor retirees nor elected officials; should include citizen financial experts and a “taxpayer advocate”; and should vest investment authority with professional staff overseen by a separate board.
Public pension boards, like their private-sector counterparts, should be subject to strict fiduciary duties. Boards should be forced to use market-based discount rate assumptions and standard amortization periods, and they should be prohibited from investing a plan’s assets based on political or social agendas or from distributing surplus funds to today’s retirees.
In recent years, public pension funds — notably those from California and New York — have launched aggressive campaigns at publicly traded companies to increase corporate boards’ responsiveness to shareholders. America’s taxpayers deserve no less.
This piece originally appeared at Investor's Business Daily
This piece originally appeared in Investor's Business Daily