Making Sure Public Pension Plans are Sustainable

Thursday, March 3, 2016

Public pension funding levels are up and costs to manage the plans are down, according to the 2015 National Conference on Public Employee Retirement Systems (NCPERS) Public Retirement Study. Public pension funding levels are at 74.1%, up from 71.5% the year before. Among the nearly 200 public retirement systems surveyed, the average cost to administer the plans was 60 cents for every $100 managed, down from 61.1 cents a year earlier. By comparison, the study found most private sector equity and hybrid funds have an average cost of between 70-78 cents for every $100 managed. Investment income accounts for three of every four dollars in public pension system revenue.

Systematic and disciplined funding over the long term is therefore crucial to the stability of an employer’s pension fund. To ensure sustainability, a recent GFOA best practice – Sustainable Funding Practices for Defined Benefit Pensions and Other Postemployment Benefits – recommends that public officials and associated trustees should, at a minimum, adopt a funding policy with a target funded ratio of 100% or more (full funding). The funding policy should also stipulate that employer and employee contributions will be made at regular intervals. Failing to fund the plan’s actuarially determined contributions (ADC) during recessionary periods impairs investment returns by providing inadequate funds to invest when stock prices are low. As a result, long-term investment performance will suffer and ultimately require higher contributions.

Governments also need to take measures to reduce the volatility of their ADCs in order to create a more predictable operating budget and enhance their ability to meet their funding obligations. The best practice includes suggestions for doing so, including smoothing returns on assets, diversifying the investment portfolio, managing investments long term, and managing growth in liabilities.

To further ensure sustainable funding practices, design the plan to prevent calculation abuses of retirement benefit enhancements such as salary spiking, and any other ethical violations. These violations can create negative public perceptions that are harmful to all participants and can adversely affect the sustainability of the system. Policies to safeguard against ethical violations and benefit calculation abuses should be considered.