Academic journal article Atlantic Economic Journal

Funding Status Projections for Southern Public Teaching Pension Plans

Academic journal article Atlantic Economic Journal

Funding Status Projections for Southern Public Teaching Pension Plans

Article excerpt

Introduction

Alarms about the underfunded status of private defined-benefit pension plans have already sounded. Time magazine's October 31, 2005 cover, "The Great Retirement Ripoff," is certainly loud enough. These warnings are not simply media hype as large corporations such as United Airlines and Delta have completely unloaded their pension obligations on the Pension Benefit Guaranty Corporation (PBGC), a government agency that has recently been running annual deficits in the $20 billion range. As of 2006, PBGC faces another $73 billion in 'reasonably possible' underfunding exposure (PBGC 2006).

However, this underfunding financial crisis is not even half of what public pension plans face. As of 2006, private companies face a $339.9 billion shortfall (PBGC 2006), while a study by Barclays Global Investors calculates underfunding at public pension plans at more than $700 billion (Business Week 2005). Using the same accounting rules that corporations must use, Healey (2006) pegs the underfunded amount closer to $1.3 trillion. This translates into public pension funds being 64% funded, compared with 90% for corporate plans. (1) With no PBGC agency to fall back upon, taxpayers will be saddled with any funding shortages that come due. For perspective, this is over $4,000 for every person in the U.S. and over $8,000 for every worker.

This study analyzes a subset of this public pension problem by focusing on southern state pension plans used by employees at public schools and universities. (2) Initial findings show that only four of the eleven states defined by the Southern Association of Colleges and Schools (SACS) have funding ratios greater than 90%, while four other states, Kentucky, Louisiana, Mississippi, and South Carolina, are less than 80% funded.

Using Monte Carlo methods to project future funding statuses, findings suggest eight of eleven states will remain or become underfunded over the next 10 years based on their current structure. If underlying pension asset returns fall on the low side of standard confidence intervals, no state can expect to be fully funded, and only four states will have a funding ratio over 80%. (3) If these numbers are alarming, they are even more so in light of the fact that health costs are not incorporated in these figures. For some states, this would more than double the present value of future liabilities, and according to one off-the-cuff estimate, states' total unfunded retiree health care liability is already approximately $2.4 trillion (Boyle 2005).

Overview

Although defined-benefit plans have been in decline over the last 30 years in lieu of defined-contribution plans, 50% of workers are still covered by defined-benefit plans (US Department of Labor, Bureau of Labor Statistics, 2003). The difference between the two plans is that employee retirement payouts for defined-benefit plans are generally guaranteed by the employer and determined by years of service and a benefit formula. In contrast, for defined-contribution plans, the employer pays a specified amount into each employee's retirement account, and the retirement value is completely determined by the employee's asset allocation and the returns on those assets.

As an example of how a defined-benefit plan works, the typical state's benefit formula in this study averages an employee's last 3 to 5 years salary before retirement and multiplies this amount on average by 2.0% times years of service. For instance, if an employee averages $60,000 over the last 3 years before retirement and has worked for 30 years, the employee receives 60% (2.0%x30) of $60,000.

From the private sector perspective, the move toward defined-contribution plans has simply transferred the funding risk from the corporation to the employee. The employee now bears the entire risk of asset returns being less than expected given a particular retirement amount goal. Corporations no longer have to be concerned about underfunded pensions. …

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