Sunday, June 12, 2005

The looming public pension crisis

A recent Business Week cover story discusses the looming public employee pension crisis being faced by states and municipalities. It's caused by a combination of the recent bear market, underfunding the plans, lax accounting, and overly generous politicians ("can't give you public employees a raise today, but, sure..., how about a big pension boost?... which will be some other guy's problem in 20 years..."). Here's the paragraph on Houston:
Some of these giveaways are truly spectacular. In 1998 the city of Houston instituted a deferred-retirement option plan, or DROP, that would allow workers to in effect take their retirement when they became eligible for it but continue to work at their salary. The retirement income was put in a side account where it earned an attractive rate of return, and the employee could later have his pension adjusted upward to a higher level. The DROP, along with other pension improvements, drove the city's pension plan down from 91%-funded in 2000 to just 60% two years later. Houston had gone from contributing 9.5% of payroll toward pensions to more than 32%. Joseph Esuchanko, a Michigan actuary brought in to study the problem, discovered that things would only get worse. According to his calculations, it was possible for employees to become millionaires thanks to the system. Under one scenario, a lifelong city employee retiring with a salary of $92,000 could get $420,000 a year in pension benefits. The citizens of Houston agreed with Esuchanko's conclusion that the system was a "win-win for the employee and a lose-lose for the employer." Last May they voted to end the benefits.

And another good blurb:

This tendency to dole out goodies in fat times is the core moral hazard of public-pension plans. Politicians like to reward voters when they can, and public workers vote. It wasn't only in California that benefits crept up during the end of the bull market. Public employees saw benefit enhancements in New York, Colorado, Illinois, New Jersey, and many other states. "That was the mirage of cost-free benefits," says S&P's Young. "Nobody pays, nobody gets hurt." ....

Elected officials are hesitant to ask the rest of their voters to pay for these promises through higher taxes. One primary reason: Outside of government workers, very few employees have these kinds of deals anymore. "Our people at 55 years of age can get 75% to 80% of their salary [as pension], and it's a pretty nice salary," says Illinois State Representative Robert S. Molaro, a member of a commission convened by the governor to make recommendations for fixing the pension system. "It will be hard for us to go to the taxpayers and ask them to pay for our pensions with benefits you in the private sector couldn't even dream of."


Luckly, my impression is that Texas is in reasonably good shape: weak public unions and a young, rapidly growing population to help fund a smaller group of public retirees than other states like California, New York, and Illinois. I've read elsewhere that tougher new federal accounting standards are supposed to kick in soon, which should make it harder for politicians to hide the problems under the rug. Hopefully any potential mess in Houston or Texas will be uncovered and nipped in the bud before it really blows up like those other states.

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