Cypen & Cypen
APRIL 28, 2011
Stephen H. Cypen, Esq., Editor
1. STRONG INVESTMENT GAINS AND LEGISLATIVE CHANGES SPEED PUBLIC PENSION RECOVERY: Most state and local government employee retirement systems have substantial assets set aside for current and future retirees, according to a new Issue Brief from National Association of State Retirement Administrators and National Council on Teacher Retirement. State and local government pensions are not paid from general operating revenues, but rather, from trusts to which retirees and their employers contributed. These trusts are funded during employees’ working years and paid out over decades. Most public employees are required to contribute a portion of their wages -- typically five to ten percent -- and these contributions, plus earnings on trust fund investments, account for approximately 75 percent of public pension revenue over the past 30 years. The remainder comes from employer contributions, which, on a national basis, represent about 3 percent of all state and local government spending. State and local government pension trusts have regained much of the asset value lost during the 2008-2009 market downturn. While trust values even at the depths of the market decline remained above $2 Trillion, at the end of 2010, aggregate public pension asset values were $2.93 Trillion -- a 35 percent increase from their March 31, 2009 quarterly low. Some studies published since the market decline do not include the sharp increase in public pension asset values since June 30, 2009. In fact, market values have grown since then by nearly 25 percent. Reports that overlook these gains in state and local government pension trust funds since mid-2009 can be misleading. State and local retirement trusts accumulate and pay out assets over decades, and as such, have an extended investment horizon. While the recent rebound in asset values is noteworthy, long-term investment return performance is most critical. Median public pension fund investment returns for periods ended December 31, 2010, indicate that over longer periods (20 and 25 years) public pension funds have met or exceeded their investment return assumptions (typically 7.5 percent to 8.5 percent). In the past few years, nearly two-thirds of states have made changes to pension benefit levels, contribution rate structures or both to improve the long-term sustainability of their retirement plans. According to National Conference of State Legislatures, over 20 states -- an “unprecedented” number -- made such changes in 2010. Many local governments have made similar fixes to their plans, and other state and local governments are expected to consider similar modifications in 2011. Pension trusts have fluctuated dramatically in recent years. Just as the unprecedented market decline in 2008-2009 eroded asset values, notable changes and developments have occurred that largely restored trust fund levels. Rising capital markets, strong long-term investment returns and actions by many states to preserve or restore affordability and sustainability of their pension plans have all played a role. Use of point-in-time measures, particularly at the low-point of market recovery, can present a distorted or misleading picture of the condition of public pensions. Use of such measures also underscores the need for policymakers closely to analyze long-term programs such as state and local government retirement systems in order to avoid making major policy decisions based on short-term and outdated information. NASRA/NCTR ISSUE BRIEF – April 2011.
2. DISCOUNTING PUBLIC PENSIONS: While the market turndown that accompanied the Great Recession reduced the value of assets held by public pensions, it is hardly the crisis touted by some conservative critics, according to Economic Policy Institute. Unrealistic projections that inflate pension liabilities are stoking fears that future taxpayers will inherit large unfunded pension liabilities, absent some sort of intervention, but the critique is based on the assumption that pension funds will earn a very low rate of return on pension assets. Accepting these alternative valuations could spur unnecessary drastic actions, from doubling contributions to pensions to scrapping them altogether in favor of 401(k) plans. Public pensions now have an estimated $700 Billion in unfunded liabilities. Last year, public pensions had around 78% of what they needed to set aside to pay for pension benefits. To make up the difference, state and local governments would have to devote about 5% of their budgets to pension contributions over the next 30 years, up from under 4% today, assuming an average 8% return on fund assets. Though significant, such a bump is hardly untenable, especially for the majority of state and local governments that have kept up with their pension fund contributions. (The average funding ratio and required contribution cited above includes a few states like California, Illinois and New Jersey that short-changed some or all of their pension funds over many years.) And such an increase is not unprecedented: state pension contributions were around 6% before the long bull market that began in the mid-1980s. Conservative critics, however, have gotten considerable political mileage from claims that public pensions’ unfunded liabilities are in the trillions, several times larger than conventional measures based on pension reporting, which hover around $700 Billion. Under their scenario, required contributions could double or more, thus imposing an enormous burden on taxpayers. Their arguments hinge on assumptions that current and future pension fund investments will earn historically low rates-of-return going forward. Specifically, the critics contend that when pensions calculate the amount of money they need to set aside today to make promised payments to retirees in the future, they should assume that pension investments will earn rates equivalent to those of Treasury bonds and similarly low- to no-risk assets. In economic terms, the argument is that low yields on Treasury bonds and similar assets should be used to “discount” future pension obligations (that is, translate the future stream of estimated payments to retirees into a single present value). Republican members of Congress have adopted the cause, introducing H.R. 567, which would require state and local governments to discount pension obligations using Treasury yields or else forfeit the right to issue federally tax-exempt bonds (see C&C Special Supplement for February 1, 2011 andC&C Newsletter for February 17, 2011, Item 7). Of course, one might instead choose to invest in normally higher-yielding assets like stocks, especially since short-term Treasury rates are very low right now. Most economists believe that the expected return on stocks is significantly higher than the risk-free rate. The Congressional Budget Office has estimated the difference, known as the equity premium, to be around 3.5 percentage points above the long-run rate of return on 10 year Treasury bonds. The higher expected return on stocks comes with a risk, however; in contrast, the rate of return on Treasury bonds, while relatively low, is both known in advance and virtually guaranteed. The risk-free rate is, however, a malleable yardstick: yields fluctuate with market conditions, vary according to maturity and are affected by monetary policy, among other things. In recent years, for example, yields have been depressed as the Federal Reserve engaged in expansionary monetary policy. The Fed action had little bearing on pension fund adequacy, yet would have adversely affected funding ratios if they had been calculated using risk-free rates. Instead of using Treasury yields to assess adequacy of pension reserves, public fund managers assume their funds will earn a long-run rate of return of around 8% in nominal terms. This return is slightly less than the 9% return these funds have averaged over the past 25 years, but is much higher than the yield on longer-term Treasury bonds, currently around 3.5% for 10-year bonds and 4.5% for 30-year bonds. Government Accounting Standards Board calls for public pensions to use a discount rate “based on an estimated long-term investment yield for the plan, with consideration given to the nature and mix of current and expected plan investments.” In practice, the rate of return assumed by most public pension funds is stable and varies little across plans, a tacit acknowledgement that such projections are not precise, and so a reasonably conservative standard should be adopted. Uniformity facilitates comparisons across plans and gives fund managers little incentive to load up on risky assets in order to inflate projections. Although GASB is revisiting its standards to require even more uniformity in financial reporting, it has rejected use of the risk-free rate in determining appropriate funding levels. The entire 7-page scholarly piece is worth reading at www.epi.org/page/-/epi_policymemorandum_179.pdf. EPI Policy Memorandum #179 (April 14, 2011)
3. PENSION PLAN FUNDING CONTINUES IMPROVEMENT: Defined benefit pension assets for S&P 500 Index companies increased by $117.9 Billion, from $982.3 Billion to $1.1 Trillion, while liabilities increased $108.3 Billion, from $1.18 Trillion to $1.29 Trillion. As a result, the aggregate funding ratio for all plans combined increased from 82.9% to 85.1% and the -$202.3 Billion funding shortfall at the beginning of the year shrank to a -$192.7 Billion deficit. Wilshire’s 2011 Report on Corporate Pension Funding Level, reviewed by plansponsor.com, says 91% of corporate pension plans have an unfunded liability, somewhat lower than the 93% for the previous year. The median corporate funded ratio is 81.9%, which represents an improvement from 78.4% last year. Pension fund performance in 2010 continued to recover from the significant losses of 2008, with the median investment plan returning an estimated 12% for fiscal 2010, building upon the 16.2% median plan return for 2009.
4. OPPORTUNITIES TO REDUCE POTENTIAL DUPPLICATION IN GOVERNMENT PROGRAMS, SAVE TAX DOLLARS AND ENHANCE REVENUE: U.S. Government Accountability Office has issued its first annual report to Congress in response to a new statutory requirement that GAO identify federal programs, agencies, offices and initiatives, either within departments or governmentwide, that have duplicative goals or activities. The objects of the report are to (1) identify federal programs or functional areas where unnecessary duplication, overlap or fragmentation exists, actions needed to address such conditions and potential financial and other benefits of doing so; and (2) highlight other opportunities for potential cost savings or enhanced revenues. To meet these objectives, GAO is including 81 areas for consideration based on related GAO work. The report is divided into two sections: Section I presents 34 areas where agencies, offices or initiatives have similar or overlapping objectives or provide similar services to the same populations; or where government missions are fragmented across multiple agencies or programs. The areas span a range of government missions: agriculture, defense, economic development, energy, general government, health, homeland security, international affairs and social services. Reducing or eliminating duplication, overlap or fragmentation could potentially save billions of tax dollars annually, and help agencies provide more efficient and effective services. The areas identified in the report are not intended to represent the full universe of duplication, overlap or fragmentation within the federal government. GAO will continue to identify additional issues in future reports. Section II of the report summarizes 47 additional areas -- beyond those related to duplication, overlap or fragmentation -- describing other opportunities for agencies or Congress to consider taking action that could either reduce the cost of government operations or enhance revenue collections for the Treasury. These cost-savings and revenue opportunities also span a wide range of federal government agencies and mission areas. The number of issues identified, particularly in the duplication area, span multiple organizations, and therefore may require higher-level attention by the executive branch or enhanced congressional oversight or legislative action. In some cases, there is sufficient information available today to show that if actions are taken to address individual issues summarized by the report, financial benefits ranging from the tens of millions to several billion dollars annually may be realized by addressing that single issue. For example, while the Department of Defense is making limited changes to the governance of its military health care system, broader restructuring could result in annual savings of up to $460 Million. Similarly, GAO developed a range of options that could reduce federal revenue losses by up to $5.7 Billion annually by addressing potentially duplicative policies designed to boost domestic ethanol production. Similarly, GAO identified a number of other opportunities for cost savings or enhanced revenue such as reducing improper federal payments totaling billions of dollars, or addressing the gap between taxes owed and paid, potentially involving billions of dollars. Collectively, the savings and revenues could result in tens of billions of dollars in annual savings, depending on the extent of actions taken. Considering the amount of program dollars involved in the issues GAO has identified, even limited adjustments could result in significant savings. But are Congressional debt-cutters really interested? GAO-11-318SP (March 1, 2011)
5. DETROIT PENSION FUNDS ASSAIL FINANCIAL EMERGENCY LEGISLATION: The General Retirement System of the City of Detroit, The Police and Fire Retirement System of the City of Detroit and four individuals have filed suit in federal court against the Governor and Treasurer of the State of Michigan. The object of plaintiffs’ attack is the Local Government and School District Fiscal Accountability Act, signed into law on March 16, 2011, after the legislation was rushed through both houses of the Michigan Legislature. Plaintiffs bring the action on their own behalf and on behalf of the more than 32,000 active and retired participants in the systems whose interests they represent and have a duty to protect. They seek to have Section 19(1)(m) of the Act invalidated. Said section provides that an emergency manager (hand-picked by the Governor and State Treasurer and vested with czar-like powers under the Act) may
The complaint is based upon violation of the Michigan State Constitution Home Rule Provisions; the contracts clauses of United States and State of Michigan Constitutions; the takings clauses of the United States and State of Michigan Constitutions; the due process clauses of the United States and State of Michigan Constitutions; the equal protection clauses of the United States and State of Michigan Constitutions; and the accrued financial benefits provision of the State of Michigan Constitution, which unambiguously provides that:
The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby. Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing unfunded accrued liabilities.
Considering the current assault upon state and local government pensions, this case should be closely watched. The General Retirement System of the City of Detroit v. Snyder, Case No. 2:11-cv-11686-SFC-LJM (E.D. Mich., April 18, 2011).
6. ILLINOIS WILL MAKE PENSION PAYMENT (FOR FIRST TIME IN TWO YEARS): The Illinois General Assembly has approved a plan to pay about $4.5 Billion into the state’s pension system next year, according to businessinsider.com. It will be the first time in two years that the state does not borrow to make its pension contributions. (Illinois borrowed $3.7 Billion this year to make its payment.) The state’s five public pension systems, which are now being investigated by the U.S. Securities and Exchange Commission, are underfunded by an estimated $190 Billion. The decision to make payment this year breaks a history of pension neglect, as explained by a University of Illinois economics professor:
If you don’t have enough money, what do you do? Well if you don’t want to raise taxes, you don’t want to make cuts, you simply don’t put all the money into the pension system that’s needed that particular year. And nothing bad happens right away, but you do that year after year after year and sort of the opposite of compound interest happens.
Someday, we hope to see the headline “Illinois will make pension payment on time … as usual.”
7. CASH AND DEBT MANAGEMENT ISSUES PREVENT EMPLOYEES FROM SAVING FOR RETIREMENT: PricewaterhouseCoopers’s 2011 Financial Wellness Survey finds that lingering cash and debt management challenges continue to dilute employee confidence and overall financial wellness. Almost half of working American adults find it difficult to meet their household expenses on time (up from 43 percent in 2010), and over one-third of those earning $100,000 or more say it is a challenge. Additionally, nearly one-quarter of employees surveyed report using credit cards to buy monthly necessities because they could not afford them otherwise, up 9 percentage points from 2010; among those earning $100,000 or more annually, that number jumps to one-third. Half of survey respondents consistently carry balances on credit cards (in line with last year), and 42 percent find it difficult to make minimum credit card payments on time (up from one-quarter last year). Given these cash and debt management challenges, it is no surprise that 61 percent of survey respondents say they find dealing with their financial situation stressful, and 56 percent say their stress level has increased over the last 12 months. Meeting day-to-day expenses is now more of a concern than funding retirement. According to the survey, primary financial concerns include not having sufficient emergency savings for unexpected expenses (25 percent), not being able to meet monthly expenses (20 percent) and not being able to retire when they want to (18 percent). These issues were followed by concerns around not being able to keep up with debt (13 percent) and being laid off from work (11 percent). The results clearly show that retirement is not the most pressing financial concern weighing on employees’ minds. In addition, financial distractions and resulting levels of stress may cause loss of productivity and have an impact on employee health. While it is important that employees put money aside for retirement, they may be hesitant to save for the future if it will exacerbate existing debt and cash flow problems in the near-term.
8. ADVISORY COMMISSION’S POLICIES OUTWEIGHED APPOINTMENT SEEKER’S RIGHT TO FREE SPEECH: A town council refused to reappoint Foote to an unpaid advisory commission after he publicly criticized certain of the council’s policies. He sued, but the district court jettisoned his case at the summary judgment stage. His appeal presented a nuanced First Amendment question about the relationship between policymakers and policy-related speech in the public sector. After careful consideration, the circuit court of appeals concluded that the refused reappointment, though premised on a lawful exercise of Foote’s right to free speech, did not transgress the First Amendment, and, consequently, affirmed the judgment. Previously, in an analogous case involving a challenge to dismissal of two policymaking employees on both free speech and free association grounds, the court held that it is a reasonable working rule that, where the employee is subject to discharge for political reasons, a superior may also -- without offending the First Amendment’s free speech guarantee -- consider the official’s substantive views on agency matters in deciding whether to retain the official in a policy related position. Foote v. Town of Bedford, Case No. 10-2094 (U.S. 1st Cir., April 21, 2011).
9. MAN CHARGED WITH BARKING AT POLICE K-9: If you are not exactly sure what would possess a man to bark at a police dog, Ryan Stephens has an answer for you: The dog started it. Unfortunately for Stephens, that answer was not good enough. He was cited for a misdemeanor after barking at Timber, the police dog. Officer Bradley Walker was investigating a car crash early in the morning, when Timber began barking in the back of the cruiser. He found Stephens barking and hissing at the confined Timber, reports findlaw.com. When Officer Walker asked Stephens why he was barking at Timber, Stephens told the officer that the dog had started it, and that Timber was actually harassing him. In many cities, Timber and his fellow K-9's are considered to be full-fledged officers. This status means they are protected by the laws that prohibit certain conduct toward human law enforcement, including assault and harassment. Some states have specific statutes protecting police dogs from behavior that puts them in danger. Most departments across the country take the care of their dogs very seriously. Harassing a police dog, especially when confined, can cause the dog to injure itself in an attempt to break free. And if they do break free? Well, let's just say that Stephens is very lucky Timber, the police dog, won't be exacting his punishment. Indeed, a rare “man-bites-dog” story.
10. REMARKABLE QUOTES FROM REMARKABLE JEWS: A spoken contract isn't worth the paper it's written on. Sam Goldwyn
11. BLESSED ARE THE CRACKED, FOR THEY LET IN THE LIGHT: A hangover is the wrath of grapes.
12. PARAPROSDOKIAN: (A paraprosdokian is a figure of speech in which the latter part of a sentence or phrase is surprising or unexpected in a way that causes the reader or listener to reframe or reinterpret the first part. It is frequently used for humorous or dramatic effect.): War does not determine who is right -- only who is left.
13. QUOTE OF THE WEEK: “There are good times and bad times, but our mood changes more often than our fortune.” Thomas Carlyle
14. ON THIS DAY IN HISTORY: In 1987, NBA announces expansion to Miami, Florida in 1988.
15. KEEP THOSE CARDS AND LETTERS COMING: Several readers regularly supply us with suggestions or tips for newsletter items? Please feel free to send us or point us to matters you think would be of interest to our readers. Subject to editorial discretion, we may print them. Rest assured that we will not publish any names as referring sources.
16. PLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not limited to the number of people who choose to enter a free subscription. Many pension board administrators provide hard copies in their meeting agenda. Other administrators forward the newsletter electronically to trustees. In any event, please tell those you feel may be interested that they can subscribe to their own free copy of the newsletter at http://www.cypen.com/subscribe.htm. Thank you.
Copyright, 1996-2011, all rights reserved.
Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.