Unless you have been living under a rock for the past two weeks, you are probably aware of the pitched battle currently taking place in several states over proposed changes to the rights and benefits currently extended to state employees. In fact, Democrat legislators from Wisconsin and my own home state of Indiana have fled to Illinois (apparently, the asylum hot spot for lawmakers on the lamb) in an attempt to deny their state’s legislatures the quorum necessary to enact the proposed reforms.
While I rarely shy away from expressing my opinion on the political issues of the day, it is not my intent to weigh in on the broader debate regarding the role of public employee unions. In fact, I would note that Bob Toth (with whom I practice) and I come from decidedly different sides of the political spectrum. However, as attorneys focused on retirement plan issues, there is one aspect of the current debate on which we agree; namely, that states, like most private employers before them, need to shelve their current approach of handling their defined benefit plans.
This is not a new issue for either of us. Bob actually penned an article and a follow-up noting the limitations of traditional pension plans back in 2009 and, in 2010, I based my campaign for the Indiana General Assembly on a pledge to address our state’s public retirement plans (which were estimated to face a funding gap of almost $47 billion). While my run for public office was unsuccessful, I was recently asked to testify in favor of a bill (SB 524), which would require the state to study the prospect of switching to a defined contribution plan to provide retirement benefits for public employees and teachers.
According to a recent article in the New York Times entitled “Pension Funds Strained, States Look at 401(k) Plans,” Indiana is not alone in realizing the risks posed by promising lifetime payments to public employees without proper funding. Furthermore, this trend is bound to continue as taxpayers become educated regarding the huge deficits currently faced by many public pension plans. As I noted in my testimony to the Indiana Senate Committee on Pensions and Labor, unlike private plans, public pension funds have been permitted to discount future liabilities based upon projected future annual investment returns.
For example, Indiana’s retirement funds assume a 7.25% annual return when projecting the current funding necessary to provide promised benefits to future retirees. However, according to Standard & Poor’s, the total return of S&P 500 over the past five years was just 2.4%! Furthermore, according to Joshua D. Rauh, who is with the Kellogg School of Management at Northwestern University, even if Indiana’s retirement funds were to achieve an average annual return of 8% on their investments, they would still run out of cash by 2019 (assuming cost of living adjustments based upon a 3% inflation rate).
Unfortunately, few state legislators know how to manage their own retirement portfolios, let alone the complex requirements of a multi-billion pension fund. However, as noted, the potential risk to future state finances posed by these plans is enormous. Our firm has offered its expertise to Indiana lawmakers to assist them in designing a program that will assist public employees in achieving income security at retirement while also protecting state taxpayers. In this regard, we are fortunate to have associations with several prominent think tanks from which we can derive additional support.
We would urge other retirement plan professionals to do the same; namely, take a look at the public retirement plans in your own state to determine if they are in need of additional professional guidance. As the saying goes, “The cobbler’s children go unshod.” However, let’s not let this maxim apply to the retirement plans managed by our state and local governments when we can offer assistance - either directly or through referrals to qualified experts. Our own financial future may depend upon helping them manage their way out of this current crisis.
