State Pension Plans Research Articles

The In-State Equity Bias of State Pension Plans

This paper provides evidence on the investment behavior of 27 state pension plans that manage their own equity portfolios. Even though these state plans typically hold broadly diversified portfolios, they substantially over-weight the equity of companies that are headquartered in-state. The over-weighting of within-state stocks by these plans is three times larger than that of other institutional investors. We explore three possible reasons for this in-state bias: familiarity bias, information-based investing, and political considerations. While there is a substantial preference for in-state stocks, there is no similar tilt toward holding stocks from neighboring states or out-of-state stocks in the state’s primary industry. States generate excess returns through their in-state investment activities, particularly among smaller stocks in the state’s primary industry. We also find that state pension plans are more likely to hold a within-state stock if the headquarters of the firm is located in a county that gave a high fraction of its campaign contributions to the current governor. These politically-motivated holdings yield excess returns for the pension fund.

An Empirical Analysis of State and Local Public Pension Plan Funded Ratio Change, 2001-2009

Between 2001 and 2009, all public pension plans suffered losses and saw a drop in their funded ratios. However, some plans saw a much smaller decline than others. In this study, we explore why the ratios fared so differently during this tumultuous period for pension plans. By examining the changes in funded ratio for 84 large public pension plans, we find that the differences can be mostly attributed to variations in annualized investment return and changes in investment return assumption, and to a lesser extent, to the required contributions paid by employers, the contribution rates of employees, and cost-of-living adjustment provisions. The results suggest that pension plans seeking to improve their funded ratios may need to revise their investment strategies, pay a higher percentage of their required contribution, require employees to pay more toward their pension benefit, and limit the use of automatic or consumer price index–linked cost-of-living adjustments.

A Value-Based Approach to the Redesign of US State Pension Plans

This paper explores the financial sustainability of a typical U.S. state defined benefit pension fund under the continuation of current policies and under alternative policies, such as changes in contribution, indexation and investment allocation policies. We explore the "classic" asset-liability management (ALM) results, which indicate that a policy of conditional indexation may substantially improve the financial position of the fund. We also investigate the value-based ALM results, which provide a market-based evaluation of the net benefit changes to the various stakeholders of changes in the fund's policies. All cohorts of participants derive a substantial net benefit from the current pension contract, implying that tax payers have to make substantial contributions. The aforementioned adjustment measures can be instrumental in alleviating the burden on the tax payer, although this will happen at the cost of a reduction in the value of the contract to the fund participants.

Benefit Enhancement in Public Employee Defined Benefit Pension Plans: Evidence from Three Sources

This study examines the prevalence, costs, and deferred compensation levels associated with pension plan benefit enhancement provisions often referred to as pension padding or spiking. Due to the difficulty to obtain data, three diverse sources of evidence are used: (1) an examination of reports on pension benefit enhancement presented in the financial press; (2) a survey of managers of state and local public employee pension plans; and (3) an empirical evaluation of two unique datasets of retiree characteristics and salary histories. We find evidence of excessive costs in the financial press, prevalence of overtime inclusion and loose limits on salary growth in the survey, and excessive near-retirement salary growth in the retiree data sets. This evidence suggests a strong principal-agent conflict circumventing a primary advantage of defined benefit pension plans, the ability to retain personnel with low costs during the near retirement period.

Reporting for State and Local Government Pension Plans

Financial reporting for state and local government pension plans needs to be improved. Although these governmental agencies in recent years have required greater contributions by employees toward their pensions along with increasing the retirement age and service years, reducing cost-of-living benefits, and reducing overtime allowances, investment losses and declining tax revenues stemming from the recession have aggravated the underfunding of their pension plans. Financial reporting of these plans could be enhanced by reflecting more realistic measures of the underlying obligation and the expected long-term rates of return on plan assets. The Government Accounting Standards Board is finalizing a standard to require such information in order to enhance the transparency of reporting on these plans.

Statutes as Contracts? The 'California Rule' and its Impact on Public Pension Reform

State and local retirement plans are underfunded by trillions of dollars, at a time when many states are facing decreased revenues and increased social needs. The result is that many states are currently giving active consideration to how best to address the problem of state and local pension plan underfunding given a state’s limited resources. In many states, however, courts have held that the statutes creating state retirement systems create contracts between the state and employee that prohibit the state from making any detrimental changes to the benefits provided to current employees within such systems, even on a prospective basis. This article examines the development of such a rule in California, a state that has been widely influential in this area of law, evidenced by the fact that courts in twelve other states have simply adopted the holdings of the California Supreme Court as their own. This Article illustrates that in holding that benefits not yet earned are contractually protected, California courts have improperly infringed on legislative power and have fashioned a rule inconsistent with both contract and economic theory.

Mismatch Risk, Government Guarantees, and Financial Instability: The Case of the U.S. Pension System

Failure to take account of the mismatch between the assets in defined --benefit pension plans -- primarily equities -- and the liabilities -- deferred fixed annuities -- has long been a major unrecognized source of financial instability. The underfunding problems now facing state and local government pension plans and the Pension Benefit Guaranty Corporation are a direct consequence of this conceptual failure. Yet the source of the problems and the policies needed to correct them remain unrecognized by many, if not most, mainstream economists. This paper summarizes the principles for the efficient management of financial guarantees, demonstrates how option pricing theory is used to determine the amount of capital required to insure such guarantees when there is a mismatch between assets and liabilities. It concludes with some observations on how failure to properly manage government guarantees can lead to financial instability and crisis. The destabilizing feedback loop caused by government guarantees of too-big-to-fail financial institutions, moral hazard, forbearance, and ever bigger government bailouts is familiar to analysts of the U.S. banking system. It is less familiar, but no less pernicious, in the case of the pension system. In the case of pensions, however, the vicious cycle is less transparent because of the fallacious belief that the risk of equities goes away in the long run. Until there is a recognition that equities are not a match for the fixed liabilities of defined-benefit pension liabilities, it will remain a serious source of financial instability for the U.S. economy.

Legal Obstacles to State Pension Reform

Nationwide, the collective underfunding of state pension plans is at least a trillion dollars under the most optimistic assumptions, and more like $2 or $3 trillion dollars with more realistic assumptions. These onerous financial liabilities will soon cut into everything that state governments do. In Rhode Island, for example, the state treasurer has reported that state payments to pension plans were 3% of tax receipts in 2002, but will soon rise to 20% of tax receipts, thereby forcing the state to cut back on firefighters, police, roads, health care, and everything else.The solution, painful as it might be, is to cut back on pension benefits for current workers or even for retirees. But the problem is how to do this in a way that is most fair to workers and in a way that is consistent with state or federal Constitutional provisions that prohibit states from impairing the obligations of contracts. These have generally been construed to protect benefits promised to state employees. In some cases, state courts have ruled that state workers are entitled to the highest pension benefit that was ever put in place their entire working lives, and that benefits cannot be changed even on a going-forward basis. On the other hand, some state courts have recently held that retirees may be retroactively denied a benefit that was promised to them for a substantial portion of their careers.I suggest a middle ground approach as most consistent with what was contractually promised: to the extent that state employees were promised a particular accrual formula for some portion of their career, they were giving consideration for those benefits and should therefore be presumptively entitled to that accrual formula for a proportionate share of their pension benefits.

A National Study of the Net Benefits of State Pension Plans for Educators

A National Study of the Net Benefits of State Pension Plans for Educators

Labor market aspects of state and local retirement plans: a review of evidence and a blueprint for future research

AbstractTraditional defined benefit (DB) pension plans remain the overwhelming norm for teachers, policemen and other employees of state and local governments. The incentives for workers with DB pension plans to stay in their jobs shift dramatically over the course of their careers. Moreover, limited transferability of pension wealth across states and between public and private jobs impedes mobility in the labor market. Yet, little is known about the labor market effects of pensions on state and local government workers. The literature on private-employer pensions has made contributions on some of these fronts in recent years that can shed light on policy concerns raised by the possibility that pension plans will be modified in coming years. Moreover, some of the limitations constraining research on pensions may be overcome by focusing on government workers, with recent work on public school teachers pointing the way. Very recent studies are finding strong retirement responses to age- and tenure-related incentives built into state pension plans.

The Investment Behavior of State Pension Plans

This paper provides evidence on the investment behavior of 20 state pension plans that actively manage their own equity portfolios. We find that while these states tend to hold a diversified portfolio that approximates the overall market, they nonetheless substantially over-weight the holdings of stocks of companies that are headquartered in-state. The extent of this over-weighting of within-state stocks by state pension plans is three times larger than that of other institutional investors. We explore three possible reasons for this in-state bias, including familiarity bias, information-based investing, and non-financial/political considerations. State boundaries are important for predicting state pension plan holdings – while there is a significant preference for instate stocks, there is no similar tilt toward holding stocks from neighboring stocks. We find evidence that states are able to generate excess returns through their in-state investment activities, particularly among smaller stocks in the primary industry in the state. However, we also find evidence that is at least suggestive of political influence playing a role in the stock selection process. State pension plans are more likely to hold a within-state firm in its portfolio if the county where the firm is located gave a high fraction of its campaign contributions in the last election to the current governor.

The Intergenerational Transfer of Public Pension Promises

The value of pension promises already made by US state governments will grow to approximately $7.9 trillion in 15 years. We study investment strategies of state pension plans and estimate the distribution of future funding outcomes. We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true intergenerational transfer is substantially larger. Insuring both taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today, even though governments portray state pensions as almost fully funded.

Risk aversion, regional welfare state and private pension plans

The investment decisions of individuals are influenced by their perception of risk. The article investigates from an empirical viewpoint the role of risk aversion and of local government as a provider of public services in shaping the decisions of individuals to subscribe to private pension plans. It finds that risk aversion is a relatively important factor in the pension funds subscription decision, and that the greater the provision of local social services, the lower the probability of subscription.

Participant Perceptions and Decision-Making Concerning Retirement Benefits

From 1964 until 2002, the State of Nebraska sponsored a defined contribution plan for its employees. During this period, the plan was unique among state pension plans because it was an individual account-type plan that offered participants the choice of a lump sum or annuity distribution upon retirement. Such a choice presents the opportunity to learn more about how individuals perceive financial risks and weigh various factors when deciding how to access their retirement benefits. This study reports the results of a new survey of Nebraska state workers who retired or terminated employment in 1997. The results offer a perspective on how individuals perceive their decisions 10 years later. The findings reveal three general themes. First, retirees tended to underestimate the financial risks associated with uninsured health care expenses. Sixty-five percent of retiree respondents said that they had initially underestimated such risk. Second, federal policies may influence the distribution decision. For example, many respondents cited tax penalties on lump sum distributions as a major factor in their decision, which is consistent with a high percentage choosing a nontaxable direct rollover distribution. Finally, the results provide a basis for cautious optimism that retirees will be able to successfully manage a present value sum distribution during retirement. Over 90 percent of retiree respondents reported that they were able to cover their living expenses 10 years after their retirement.

State public pension management over the business cycle

The surging stock market in the late nineties lifted the funding level of most pension plans and led to plan management decisions that left them vulnerable to the stock market decline of 2000-2002. In this study, an analysis was conducted on the descriptive data of 51 state pension plans for the period 1998-2003 and it was found that overfunded plans were more likely to substantially increase benefits while simultaneously reduce contributions. This led to widespread underfunding and a need for sudden increase in contributions as market conditions grew worse and funding levels dropped sharply. This investment cycle emphasizes the need for more prudent surplus management strategies to protect pension plans from the consequences of stock market volatility.

Funding Status Projections for Southern Public Teaching Pension Plans

The average funding status for eleven southern state pension plans used by teachers as of 2005 is 86%, which translates into over a $40 billion shortfall. Employing Monte Carlo simulation, this study projects the expected future funding status along with confidence intervals for each of these states over the next 10 years. Projections suggest the average underfunding will remain virtually the same based on current state pension contributions and asset allocations. However, if underlying pension asset returns fail to meet expectations due to high funding risk, the average underfunding could fall to 73%, a shortfall of over $150 billion.

Generation Riester

Abstract The shift in the demographic structure of German society results in an ever smaller amount of workers having to support an ever increasing number of pensioners. For this reason, it is necessary to revisit the so-called »generational contract«. A review of the history of this generational contract, from the biblical commandment to respect your elders through the social laws under Bismarck on to Adenauer‘s reform of pensions shows that the flaw of the state pension plan resides in the fact that the generational contract only governs the relations between those who are gainfully employed and those which are retired, without sufficiently takink into account children and the contribution made by families raising them. In this regard, it is only possible to ensure the long-term viability of the generational contract by correctly understanding the self-interest of all parties rather than by issuing calls for solidarity

Social Security Laws Threaten Retirement Income

Social Security Laws Threaten Retirement Income

Placing Election Bylaws on the Corporate Ballot

This piece provides our amicus curiae brief in the case of American Federation of State, County & Municipal Employees Pension Plan v. American International Group, which is now under consideration by the Second Circuit Court of Appeals. In this case, a shareholder submitted a proposal to amend the company's bylaws to require the company in certain circumstances to place candidates nominated by shareholders on the company's ballot, and the company sought to exclude this proposal from the ballot. We suggest in our amicus curiae brief that companies should not be allowed to exclude form the company ballot bylaw amendments concerning corporate elections. Prohibiting companies from doing so, we argue, is required by a reasonable interpretation of the proxy rules and necessary to advance the policy goals underlying the rules. As an appendix to the brief we attach a letter to the SEC sent by forty-eight law professors including ourselves that expresses a similar position.

Are Bigger State and Local Public Pension Plans More Cost Efficient? An Analysis of Economies of Size

State and local public pension plans cover a significant number of workers and represent a major component of the nation's retirement system. This study examined the size‐administrative cost relationship of public pension plans to ascertain whether cost savings can be realized by increasing pension plan size. The results indicated that while the consolidation of smaller plans will generate administrative cost savings, the consolidation of larger plans will generate savings only up to an optimal membership size at which point cost savings will end. In addition, optimal size was found to differ for active and beneficiary members indicating that membership composition needs to be considered when assessing the potential for cost savings.