As you may recall one of my reservations about Dean Baker’s paper yesterday was that his findings weren’t robust, i.e. a modest change in the assumptions can make a big change in the findings. Apparently, I’m not the only one who thought that. David Leonhardt, writing in the New York Times:
If state and local governments instead assumed a future return of 7 percent, their funding gap would nearly double, to $1.3 trillion, according to Alicia Munnell and her colleagues at the Boston College retirement center. If they assumed a 6 percent return, the funding gap grows to $1.8 trillion.
Hat tip: Tyler Cowen. Tyler also catches Dr. Baker making different assumptions about stock market returns when discussing the privatization of Social Security than when discussing public employees’ pension funds. A peculiar discrepancy to say the least.
Add to it that, as I documented yesterday, Illinois manifestly does not meet the assumptions the Dr. Baker makes in his paper then, yes, in Illinois at least there is a public employees’ pension crisis.
The RoR problem is, it seems to me, central no matter what retirement scheme is implemented. The major difference between defined benefit and defined contribution is who holds the risk of returns not panning out -it’s not like 401k’s are inherently more secure.
Personally, I’d like to see an option that operates similar to a defined-benefits plan except instead of a guaranteed income, income would depend on performance of the pension fund. That way you’d get the benefits of collective saving in a professionally-managed fund, but taxpayers wouldn’t be on the hook if things don’t pan out. Alternatively, the pension could guarantee (backed by the taxpayer) a minimal income based on a very conservative RoR and if the fund makes more then great, more money for retirement. In that regard I think expectations management is an important consideration – promises and predictions about the future should be very conservative.
In other news, it turns out that state governments aren’t very good and predicting their own tax revenue. Who knew?
I think that the problems that public employee pensions pose are complicated: problems with a predictable cashflow and the problems posed by defined benefit programs have already been mentioned. There are other problems.
Here in Illinois as in many states teacher pensions are the state’s largest liability. Pensions are dependent on terminal pay levels, local districts determine terminatal pay levels, and the state pays the pensions, presumably from the fund established for that purpose. Districts routinely make a practice of “bumping up” the pay of teachers five years before they retire to goose their pensions. I won’t try to justify the practice but it’s been going on for a long time.
That has the dual effect of increasing the state’s liability beyond what it otherwise should be and rendering it unpredictable—the liability depends completely on the terminal step of the teacher and that’s either unpredictable or extremely complicated.
Here are the top 100 teacher salaries in Illinois:
http://www.championnews.net/article.php?sid=1103
Andy –
The people who manage pools of money – pensions and endowments – are my clients. (I’m in the private equity business, which really makes me just another one of their money managers in the “alternative investments” allocation.) I could be wrong, but knowing the dynamics of their world I find it difficult to believe that under a guaranteed, taxpayer backed floor return arrangement they would not target a less risky, lower return portfolio. Its basically a scheme for guaranteed underperformance.
Now that said, different risk/reward portfolios are set up all the time due to the preferences and risk tolerance of individual clients, but it would systematically make public pensions laggards vis a vis private pensions and endowments.
Merde. I’m looking at the top of the list. A salary of $196,000 ain’t bad and Lemont isn’t that wealthy a district. And that was in 2007 so he’s probably making well over $200,000 in salary alone now. He’s the Fine Arts Division Chairman at Lemont High School. Master’s from Governor’s State and 38 years in harness. And he’s got a sideline business.
I notice that a lot of people in that list aren’t from particularly wealthy (or particularly good) districts.
In the stereo magazines the reviewers overuse the term “jawdropping” in describing the sound of newly introduced equipment.
Well. when I saw drivers ed and pys ed teachers making that much……my jaw dropped.
I’m guessing that a lot of those highly paid drivers ed. and phys. ed. teachers are coaches.
There were a lot of unconventional teaching positions on that list. It may be possible that these are end-of-career jobs, and may not reflect what they did for most of their career.
But assuming most of them are getting close to retirement, they will draw 75% of average pay for the last three years, plus annual cost of living adjustments. If young enough, they can still work, including part-time in the same public school they just retired from.
Yeah, I think that would be a feature. People would at least know ahead of time that their pensions probably aren’t going to be enough, which would (hopefully) encourage them to save. At the same time, it would, presumably, be a promise that’s easier to keep.
Of course, we already have the PBGC, so taxpayers are already minimally on the hook and pensions have a fallback.
I look at my father-in-law, a lifetime steelworker and union member. He worked for 30 years and the company pension died about a year after the company died. PBGC picked up about 1/2 the benefits, but no health care. So my FIL is still working, just like all the other older guys in the plant, and saving madly into the new company’s 401k. The union seniority system benefits him, but the downside is that there’s literally no one working at the plant under 50. Maybe things would be different had the promised pension been less generous, forcing him to save more in those early years.
I just read the older Dean Baker piece on Social Security. Wow, what a perfect illustration of cognitive bias at work:
The goosing of salary before retiring is, I believe, more common.for police. Our local police got a pension based on their last 30days. People were retiring at age 40-45 with 100-140k pensions.
Drew-It appears, if I read those studies correctly, they really were averaging 8% returns. Is that believable? At any rate, adefined contribution plan solves the pension. Should their salaries be increased to make up for that loss?
Steve
“I’m guessing that a lot of those highly paid drivers ed. and phys. ed. teachers are coaches.”
My jaw is still on the floor.
steve – If one looks at the gold standard study on equity returns over 70-80 some years its published by Ibbotson. Last time I looked it was 11% for public equities, so let’s say its 8% real just for shits and grins. This may be dated given the last 3-4 years.
Now, a more balanced portfolio’s return with bonds, RE, etc in the mix would trend downward from that. Further, given the equity bubble, we may go somewhat sideways for a period, although multiples right now are admittedly not outrageous. (but beware margin sustainability) So that may be more than you wanted but, yes, I think 8% in a bubble was doable, but 8% sustainable was a pipe dream.
Lastly, just so you know, our (private equity returns on a net post carry basis) run in the high teens. But now we have to go on into theoretical discussions about risk adjusted returns blah, blah, blah…………
Lastly, lastly……….so you see what happens if you load up a portfolio on risky (equities) assets – you get volatility (the academic definition of risk). Great during the good times. In the rough times……..not so much.
Andy –
Which steel mill?
Drew,
I’m not sure the name, but it’s a plant near downtown Cleveland that used to be owned by LTV. Next time I talk to my in-laws, I’ll ask.
Andy –
Its probably the original Republic Steel……..turned LTV………..turned Wilbur Ross out of bankruptcy……….and now Mittal/Arcelor, which is where Inland Steel – my old firm – ended up.
Drew, it’s the “Cleveland Works” and yes, it’s currently owned by Mittal/Arcelor, though I think through a subsidiary called ISG.
Uhhmmm no. Many defined benefit programs can be gamed. For instance working lots of overtime to spike your pay in the final years could ensure that an employee retires at 100% of his final baseline pay. And there is less of a principle-agent problem with a defined contribution plan as well.
To be fair the salaries are adjusted using a formula to account for earlier retirement, tenure and shorter working year. In other words the salary of $196,000 isn’t all in take home pay, but factors in retiring 5 years earlier, the 182 day work year, and tenure (secured after working for 4 years). So, the $196,000 is actually about $107,000/year. To find the actual pay dollars you take the salary figure and divide by 1.835. Still, some of those pay levels are pretty darned nice.
Retiring with a salary that is at 85% that level guaranteed till the day you die is also very nice as well. Beats the Hell out of my 401k.
I guess we know how to rank Baker in terms of intellectual honesty.
“I guess we know how to rank Baker in terms of intellectual honesty.”
Heh. A lot of that going around. Must be a virus or sumthin’.
.
” Tyler also catches Dr. Baker making different assumptions about stock market returns when discussing the privatization of Social Security than when discussing public employees’ pension funds.”
So we take privatization off the table?
Steve
Steve Verdon, I’m disappointed that the salary figures are adjusted. That certainly was not transparent to me. I thought the site had a number of good suggestions, and now I’m somewhat leary.
My point about looking at the high salaries is not simply cherry-picking. I was essentially called a liar at OTB for pointing out that there was a teacher in Wisconsin making a $116,000 salary, plus almost $50,000 benefits. The final year(s) of salary create the long-time pension obligation. I assume people start at far lower salaries, and the school or teacher contribute accordingly, but it’s the final years that create the long-term liability to the taxpayer for the unfunded difference.
According to the Chicago Trib, 4% of Illinois teachers make over $100,000 (5,457 teachers) — and I assume most of them will retire shortly and get paid far more than a teacher starting out.
http://articles.chicagotribune.com/2010-07-14/news/ct-met-six-figure-salaries-20100714_1_school-teachers-salaries-six-figure
I don’t think Steve’s right about that. I think those are W-2 wages. My evidence is that I’m aware of what a couple of Illinois teachers are actually earning in W-2 wages. They’re not on the list and, if the formula that Steve mentions were in force, they would be.
RoR isn’t a problem? I do agree that pensions with poor rules and governance make it easy to game (and I suspect those that are set up that way on purpose), and I agree that is a big problem, but not all of them are like that.