Johnson: Reforming Government Pensions to Better Distribute Benefits – What Are the Options?

From the Introduction:

Efforts to reform the retirement plans provided to state and local government employees are gaining momentum across the country. From 2009 to 2011, 43 states significantly revised their state retirement plans (Snell 2012). Ten states made major structural changes to their plans in 2012 (National Conference of State Legislatures 2013). More recent reforms have passed in such states as Kentucky, Tennessee, and Illinois. These initiatives have been driven primarily by financial concerns. The 2007 financial crisis depleted much of the reserves held by many state and local plans. By their own accounting, plans had set aside enough funds in 2012 to cover only about three-quarters of their future obligations, about a $1 trillion shortfall (Munnell, Aubry, Hurwitz, and Medenica 2013). Outside estimates, based on arguably more realistic actuarial assumptions, put the shortfall much higher (Novy-Marx and Rauh 2011). Absent any reforms this funding gap will likely force state and local governments to increase their payments to pension funds, raising pressure on government budgets and threatening to crowd out other public services or lead to tax hikes. Government contributions to public employee retirement plans have already nearly doubled over the past decade (Johnson, Chingos, and Whitehurst 2013).

 

Available for download here.

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Baugniet: The protection of occupational pensions under European Union law on the freedom of movement for workers

ABSTRACT:

Occupational pensions are a key part of the pension system in many EU Member States where they provide workers with social protection in retirement. Their relevance should increase given Europe’s old-age pensions crisis. However, occupational pensions are characterised by the complexity and diversity of benefit structures, financing methods and membership rules. This conceptual mosaic has led to different categorisations at national and EU level although solidarity at work and dignity in retirement remain at the heart of European pension systems.

The EU’s new legal landscape supports the social vocation of the free movement of workers. Social security rights are already protected under Article 48TFEU and Coordination. This thesis argues that EU law must protect migrant workers’ occupational pension rights. Member States are clearly facing common demographic, economic, social and political challenges. Moreover, the notion of occupational pension in EU law supports its characterisation as social protection. The justification of a social rationale to the free
movement of workers is based on fundamental rights, the EU’s social objectives and values as well as the requirement of ‘social protection mainstreaming’ under EU law.

The second part of this thesis claims that EU law has historically failed to deliver adequate protection of migrant workers’ occupational pension rights, stemming from a longstanding regulatory gap in which the EU’s legislative process has been hamstrung by institutional constraints. Positive integration has remained limited but a recent breakthrough in secondary legislation will bring a new social protection dimension to the free movement of workers, albeit one based on minimum requirements. Negative integration has also been limited, especially in horizontal situations despite recognition of the indirect effect of Article 45TFEU. However, fundamental rights are capable of providing a tool for the interpretation of the free movement of workers to ensure a more holistic respect for their social protection.

 

Available for download here.

Lekniute, Beetsma & Ponds: A value-based approach to pension redesign in the US state plans

ABSTRACT:

This paper explores the financial sustainability of a typical U.S. state defined-benefit pension fund under the continuation of current policies and under alternative policies, such as alternative contribution, indexation and investment allocation policies. We explore the “classic” asset-liability management (ALM) results, which indicate that a policy of conditional indexation may substantially improve the financial position of the fund. We also investigate the value-based ALM results, which provide a market-based evaluation of the net benefit of the contract to the various stakeholders. All participant cohorts under our simulation horizon derive a substantial net benefit from the pension contract, implying that tax payers make substantial contributions to this pension arrangement. The aforementioned measures can be instrumental in alleviating the burden on the tax payer, though this will happen at the cost of a reduction in the value of the contract to the participants.

 

Available for download here.

Munnell, Aubry & Cafarelli: COLA Cuts in State/Local Pensions

From the Introduction:

One of the more surprising responses of public plan sponsors to the financial crisis and the ensuing recession was their reduction, suspension, or elimination of cost-of-living adjustments (COLA) for current workers and, in a number of cases, current retirees. The response was surprising because it has often been assumed that public plan participants have greater benefit protections than their private sector counterparts. The Employee Retirement Income Security Act of 1974 (ERISA), which governs private pensions, protects accrued benefits, but it allows employers to change the terms going forward. In contrast, most states have legal provisions that constrain sponsors’ ability to make changes to future benefits for current workers. Yet they were able to change the COLA for current workers and often for people already receiving it. This brief provides an overview of the COLA changes made to date, discusses the impact of eliminating COLAs on benefits, and explores the extent to which the courts view COLAs differently from ‘core’ benefits.

 

Available for download here.

Domonkos: Cure or Kill – The Global Financial Crisis and the Changing Domestic Politics of Pension Privatization in Central and Eastern Europe

From the Introduction:

Between the mid-1990s and the early 2000s, a significant number of countries in Central and Eastern Europe – but also in other regions of the world such as Latin America – decided to  partially replace their public pension systems with mandatory individual retirement savings  accounts managed by the financial services industry (Müller 1999; Orenstein 2008; Guardiancich 2013; Madrid 2003, see also; Weyland 2007; Brooks 2009). Yet, in the wake of the 2008 global financial crisis, policy-makers in those countries began scaling down these private “second pillars” and restoring the role of public provision. They did so in different ways: Thus, for example, Hungary almost entirely nationalized and suppressed its private pension savings plans in 2010-2011. By contrast, Poland kept its mandatory second pillar operational, but started decreasing the level of contributions paid into them from 2011. Finally, a country like Slovakia saw its governments alternate between a willingness to maintain or to weaken the role played by mandatory private pension funds. How can we explain this weakening of the earlier trend towards radical pension privatization? But also why have countries’ trajectories diverged so dramatically?

 

Available for download here.

Feng, Gerrans & Clark: Understanding superannuation contribution decisions – Theory and evidence

From the introduction:

Though the Australian superannuation system can trace antecedents to the 19th century, the modern phase emerged only as recently as the 1980s through the industry wide employment agreements (Awards) and cemented through the Superannuation Guarantee Act of 1992. The modern system is built around compulsion which currently results in 9.25 percent of salary being contributed to a complying superannuation fund by employers on behalf of employees. The rate is legislated to increase in increments to 12 percent by 2019. The compulsory employment based system complements the means‐tested government age pension and the voluntary savings of individuals. This paper is focused on the latter third “pillar” of the retirement income system; in particular, the voluntary savings undertaken and managed within the superannuation system. . . .

The direction of recent reviews, most recently the Super System review (Commonwealth of Australia 2010) and subsequent policy changes (MySuper), previously Simpler Super (Commonwealth Treasury 2006) and the Review of Australia’s Future Tax System (Commonwealth of Australia 2009) reflect a direct challenge to the assumption of an informed and engaged membership of funds. As the Super System Review bluntly assessed it “many consumers do not have the interest, information or expertise required to make informed choices” (Commonwealth of Australia 2010, p.5). In light of such evidence, this paper provides a review of individual retirement savings decisions with a focus on the contributions or savings behaviours. In particular, the paper examines lessons learned from international retirement saving systems and the limited number of studies examining the Australian superannuation system in order to provide a better picture of who and why people do or do not make voluntary contributions. We start with a brief introduction of the regulations governing voluntary contribution to superannuation and incentives offered. Then, the international literature is reviewed to examine the modelling of contribution behaviours. Particular attention is given to the role of demographics, plan specific features as well as tax incentives. We also provide evidence from the study of several publicly available micro‐level databases in Australia.  The final contribution is a preliminary analysis of member contribution behaviours using a new database provided by Mercer Australia.

 

Available for download here.

Rose & Seligman: Alternative Investments? State & Local Pension Portfolio Use and Performance

Please take a look at new research from my colleague Jason Seligman and me on alternative investments by public pension funds.  Comments welcome.  Here is the abstract:

Over the last decade, Defined Benefit (DB) public pension systems have come under greater stress. Pensions have experienced two recessions, demographic shifts and generally bad public budget circumstances. Pensions have modified their allocation strategies over this period, generally shifting away from equities and fixed income allocations in favor of alternatives. What’s more, the stated justification for alternatives has shifted as well, from an emphasis on relative performance (alpha) towards diversification away from systemic shocks (beta).

In this paper, we investigate motives for the employment of alternatives and the performance of these investments, considering both governance and financial performance motivations. We consider possible principal-agent and herding problems that may be unique to these portfolios, and find that the prudent person standard is of little protection against herding risks due to its relative benchmarking schema.

Controlling for changes in governance, we find that private equity and other less liquid alternatives can be of value because of their relatively consistent pricing, whereas more liquid assets are more susceptible to price volatility. In fact, improvements in diversification (beta) can arise as an artifact of illiquidity.

 

Available for download here.

Conti-Brown & Gilson: Judicial Intervention in Public Pension Crises – An Institutionalist Critique

ABSTRACT:

Legal scholars have long debated the role for courts in with respect to governmental action in response to crisis. Most of those crises, however, are exogenous to the political process. The courts’ role in response to politically endogenous crises is more complicated. We evaluate the role of the judiciary in those endogenous crises, looking most closely at the judicial treatment of public pensions. Assessing institutional competence schematically with reference to an institution’s democratic accountability and fact-finding ability, we argue that, where institutions function properly, judicial intervention in politically endogenous economic crises should be close to nonexistent. But because parties invoke the courts’ jurisdiction to resolve fiscal disputes, and that jurisdiction is not otherwise barred, judicial determinations will continue to occur. We argue that, in those circumstances where the judiciary must intervene, that intervention should respect the judiciary’s comparative institutional incompetence by treading lightly, constitutionally speaking: where the legal question leaves the court room, and where a non-constitutional determination is possible, courts addressing the state’s fiscal policy-making apparatus should avoid constitutional pronouncements entirely. We then apply this framework to two areas where courts have or might breach it: the out-of bankruptcy application of the Contracts Clause to public pensions (in favor of public employees), and the in-bankruptcy application of the Supremacy Clause (against those employees). The critique, then, is an institutionalist one: the point is not to promote or demote the interests of a single class or faction active within the fiscal policy-making process—whether bondholders, public unions, taxpayers, or the government—but to locate that policy-making process within the most democratically responsive and empirically competent institutions.

Available for download here.

Romp: Procyclicality of Pension Fund Regulation and Behaviour

ABSTRACT:

This paper studies the labour market effects of pension fund restoration plans at a business cycle frequency.  During a recession, pension funds’ funding ratios typically drop significantly and regulations force funds to restore their buffers by increasing their contributions, lower future indexation or cut liabilities immediately.  Using a standard search and matching model of the labour market, I find that especially raising contribution rates has significant amplification effects on the key labour market statistics.  A less distorting solution is to let pension rights fluctuate with the value of the pension assets and to use pension contributions only to finance new rights.  This paper shows that risk sharing via the pension system will amplify labour market fluctuations, something not taken into account by standard risk sharing recipes.

 

Available for download here.

Illinois Legislature Passes Pension Reform

Illinois has finally, finally, made a real attempt at fixing its drastically underfunded pension system.  From the Chicago Tribune, here’s what the plan does:

• Establishes a payment plan to fully erase pension shortfall by 2044.

• Allows a retirement system to sue to force state to make required pension payment.

• Reduces public employee pension contribution by 1 percentage point.

• Limits future cost-of-living pension increases to 3 percent multiplied by the number of years worked times $1,000 — or $800 for those who also get Social Security. The $1,000 and $800 figures will be adjusted yearly by the rate of inflation. For example, a state employee who worked 30 years could see a $900 pension bump in year one of the plan.

• Skips some cost-of-living increases for current workers. Those 50 and older will miss one bump. Workers 43 and under will miss five bumps spread out over the years.

• Raises retirement age by up to five years for workers younger than 46.

• Creates a 401(k)-style defined contribution plan that a worker can opt into instead of continuing with the state pension plan.

• Prohibits future members of nongovernmental organizations from participating in state pension systems and bans new hires from using sick or vacation time toward their pensionable salary or years of service.

Predictably, unions are going to sue, based on an Illinois constitutional provision that prohibits reductions to pension benefits.