Why should the State invest on workers’ behalf anyway?

Occasionally, almost by accident, the Rio Grande Foundation and “big labor” see eye-to-eye on certain issues. A representative of the Communication Workers of America union has an opinion piece in the paper today about the State’s “mismanagement” of worker pension funds. Amazingly, despite the stock market hitting record highs on an almost daily basis nowadays, the unfunded liability of PERA (Public Employee Retirement Association) is growing and is now at $4.8 Billion. Another pension fund the ERB faces liabilities of $7.8 billion and rising. Clearly, the State is not good at managing these retirement funds (and New Mexico is not alone)!

The union thinks this is unacceptable. So do we. As the union rep writes, “We’re demanding that PERA and the ERB get out of high-fee hedge funds and private equity, and start following Warren Buffett’s sage advice: stop trying to beat the market; instead, focus on reducing costs.”

That is a good start. Money managers rarely beat the stock market and paying them big bucks to manage these portfolios is hardly a wise approach.

But that raises a big question:

If the best move is to just invest money in a low-cost index fund, why get the state involved in managing retirement funds in the first place? Why not allow the workers to invest those dollars in their own individual retirement accounts that totally eliminate the state from managing the money and get taxpayers off the hook for multi-billion dollar liabilities (in a time of strong stock market performance) like Michigan did for its teachers recently?


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10 Replies to “Why should the State invest on workers’ behalf anyway?”

  1. 1. PERA and ERB are defined benefit pension plans. These plans are so expensive that almost no private sector businesses can afford them. The private sector overwhelmingly has profit sharing plans.
    2. PERA and ERB are underfunded. The under funding is hidden by using unrealistic expected rates of return between 7.5 and 8% per annum. If a more realistic rate of return of 4% were used, these funds would only be 30% funded. Remember that between, 2000 and 2010, the return of the S&P 500 was ZERO.
    3. Although states may not file for bankruptcy , counties and cities can file Chapter 9. Expect this to become a more frequent occurrence as localities begin to drown under pension debt (Detroit).
    4 If taxes get too high in a locality, people are just going to leave. The blue states of CA, NY, NJ and IL are hemorrhaging middle class families.

  2. Defined Benefits Plans, i.e. pensions, are going the way of the dinosaurs. But those that exist are part of a contract signed between labor and management, in this case the state. Both sides, at the time, saw advantages, many of which have evaporated with modern economy.

    Those contracts have to be honored, somehow, even if we go in a different direction. Or in the case of a Detroit, we all lose. Labor and management have to make these DBPs work.

    1. I understand and don’t disagree with you. The courts also agree with you in general. In good economic/stock market times, the focus must be on figuring out a transition. The problem is that no one really considers the problem until times are bad and the transition is more difficult.

      The only problem I have with your argument is that those “contracts” must be balanced against fiscal reality. If the State simply cannot afford to pay off the pensions, can it declare bankruptcy? If so, shouldn’t pensions be on the chopping block along with schools, roads, and public safety? Or, are taxpayers just going to pay off the pensions with nothing else to show for their money in which case they all leave?

  3. Full disclosure–I’m a researcher at CWA. The views here are my own, not those of CWA.

    Defined benefit pensions are basically the only tool that the State has to retain workers. Wages are consistently lower than the private sector–only when pensions come into play does working in the public sector become a good job. DB pensions ensure that retirees are able to maintain their standard of living in retirement–and aren’t plunged into poverty in a market downturn. Pension funds invest for the long-term, which means they can survive market downturns fairly easily. The same cannot be said with individual retirees.

    CWA has pushed for changes to the retirement board’s investing model because we know that when money is mismanaged the legislature tries to further reduce COLAs, increase employee contributions, and delay retirement ages. We are totally opposed to any further cuts to our pension–including a move to a 401(k) style system–a system that in the private sector is creating the largest retirement crisis in history.

    I’m guessing Paul doesn’t have a pension, and instead makes the maximum contribution to his 401(k) every year. Still even if he works till he’s 70 and investment returns are good, there’s a 0% chance that a 401(k) will maintain his standard of living if he lives past 90. And that’s with a cushy desk job–in the public sector, we’re talking cops and firefighters, bus drivers and janitors. You cannot work until you’re 70 if you do those jobs–it is physically impossible for 99.9% of humanity.

    The decline of private pensions has caused a massive spike in economic insecurity among the elderly–the only solution to that problem long-term is a massive expansion of Social Security financed via wealth and progressive income taxes. Until that happens, we’re not ceding any ground in the public sector. Especially if they get their investing priorities straight and move to an index fund model, the PERA and ERB are here to stay.

    1. Thanks for your comments and further explanation:

      In terms of compensation, I think what you are saying may have been accurate at one time, but it is no longer accurate. We did a study and found that (as of 2008), state and local workers in NM received compensation 11.5% greater than similar work in the private sector.

      Also, while RGF opposes defined benefit pensions for most government workers, I think police and fire are a reasonable exception. There may be other innovative solutions, but we’re not as opposed to them in that case.

      No, I don’t have a pension just like most private sector workers. As I am 42 I don’t know whether I’ll be able to maintain my standard of living, but many former government workers are able to enhance their living standards because of the overly-generous pensions we the private sector workers must support or our indebtedness is supporting.

      We will agree with you that PERA and ERB should consider the index fund model as one sensible reform, but those $11+ billion in unfunded liabilities between ERB and PERA are not simply the result of poor management.

  4. Again, views are my own, not those of CWA. Thanks for your cordial response. A few points–

    1) The average pension for New Mexico workers is around $30,000 per year. I don’t think that’s “overly generous.”

    2) Unfunded obligations are amortized over 30 years. On an annual basis, for PERA that liability is about $250 million annually. Then divide that by 110,000 members and retirees for PERA–it adds up to a little under $2,300 annually per member or retiree. Considering public bodies would not be able to operate without these workers, it’s a pretty reasonable expenditure.

    3) At PERA the unfunded liability has ballooned because of a recent ill-advised decision to lower the assumed actuarial rate of return to 7.25%–this despite the fact that the historical return (1926-2016) of a 70/30 index fund (lower risk than PERA’s current asset allocation) is 9.1%. The Nevada pension, which follows a 95% index model, has an assumed rate of 8%. If the PERA had the same assumed rate, unfunded obligations would be significantly lower.

  5. This is a bit off-topi but in the same neighborhood…
    A City of Albuquerque employee can accrue unlimited sick leave and receive a check for all unused sick leave upon retirement (I do not know if it applies equally to termination.). This can be tens of thousands of dollars and often is.

    What private sector company could afford this?

    Should’t some of these $$ be infused into the retirement funds that are in dismal shape?

  6. An 8% (or even 7.25%) assumed actuarial rate of return is rather absurd in current economic environment. To start with, the 9.1% return on a 70/30 fund between 1926 and 2016 isn’t inflation adjusted. (After inflation adjustment this falls closer to 6-7%). This would also assume population growth and productivity increases greater than those seen in the middle of the 20th century, which no responsible financial analyst is willing to project going forward, since both of these have been dropping across the developing world for the last twenty years. To get a more realistic number, go look up the market price of annuities and you will find that a more reasonable assumed actuarial rate is around 5%.

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