Stanford Symposium Features Innovative Ideas for the Future of U.S. Public Sector Pensions

Stanford Graduate School of Business, 1/31/14.

The top performers out of 44,000 participants in the first massive open online course (MOOC) offered by Stanford Graduate School of Business converged at Stanford on Friday, January 24, 2014, to present during a live symposium titled “Innovative Ideas for the Future of U.S. Public Sector Pensions.”

These participants — from California, Florida, Illinois, Mississippi, Oregon, and Pennsylvania — were from high-performing teams that took part in The Finance of Retirement and Pensions, an open online course created and led by Stanford Graduate School of Business Professor Joshua Rauh. The event was co-hosted by the Hoover Institution, which paid for travel-related expenses to allow a representative from each team to come to Stanford for the event.

“People are more responsible for preparing for their own retirement than ever before, and I believe the class has given participants the knowledge to make better financial decisions for themselves and also to be more informed participants in public policy debates,” said Rauh.

Chief among the public policy debates that concern Rauh are those relating to public sector pensions, to which he dedicated the second half of the course, including the livestreamed, on-campus symposium. During the event, he elaborated that underfunded public pension systems “are threatening to eat away at the governments’ ability to provide vital public services,” among other dangers. His concern was clearly shared by the course participants, a majority of whom indicated in a survey that they are worried about the impact of government budget problems on their taxes and on municipal and state governments’ ability to fulfill their obligations.

Six teams were chosen to present at the symposium based on the course’s final project, an analysis of a state or local pension system that covers public employees, including policy recommendations about how to improve those plans. The winning proposals were selected through a rigorous process as having the most promising ideas to address trillions of dollars in unfunded pension liabilities that are threatening the financial future of U.S. state and local governments.

The proposals addressed challenges faced by the California State Teachers’ Retirement System (CalSTRS); Cook County Pension Fund, Illinois; Police and Fire Pension Fund, Jacksonville, Florida; Public Employees’ Retirement System of Mississippi (PERS); State of Oregon Public Employees Retirement System; and the Pennsylvania Public School Employees Retirement System.

While there were some significant differences among the recommendations brought forward, many of the participants proposed adjustments to the retirement age, the conversion of defined benefit plans to defined contribution plans (or the creation of hybrid plans), reductions in money management fees, changes to the investment mix, and adjustments to the discount rates used to calculate future streams of income.

A panel of Stanford pension and finance experts was on hand during the symposium to discuss the public pension crisis and the merits of the various proposals. The panelists supported many of the recommendations, while noting the practical realities of political reform. As Stanford lecturer and president of Govern for California David Crane observed, there were many innovative ideas brought to light, but a fundamental issue is motivation for change. “This pension problem can continue for a long time without anybody doing anything,” he said. “We need to come up with a clever way to motivate people to make change happen.” Otherwise, it “will clobber the next generation.”

Top pension reform proposals

California State Teachers’ Retirement System (CalSTRS)
With over $170 billion in assets and 860,000 current employees or retirees linked to CalSTRS, the system is the nation’s second-largest public pension fund. The key operational reform recommended by the symposium team was a voluntary buyout of pension liabilities via a lump-sum payment to current employees, thereby reducing their future benefits and improving the system’s finances. The team also recommended a fundamental structural reform that would eliminate the defined benefit plan and transition it to a hybrid defined benefit/defined contribution plan for all future employees, while extending the retirement age in a phased manner.

Cook County Pension Fund, Illinois
This five-person team reverse-engineered the cash flows of the pension fund and estimated its unfunded actuarial accrued liability (UAAL) to be $9.4 billion. After running simulations that tested how different measures would help reduce unfunded liabilities over the next 100 years, the team recommended an optimal combination of measurements that included some benefit reductions (increased retirement age, reduced cost of living adjustments, changes to pensionable salary, and discontinuation of healthcare), as well as changes in the annual required contribution calculation that would guarantee the solvency of the fund in the long term.

Police and Fire Pension Fund, Jacksonville, Florida
This four-person team analyzed the Jacksonville Police and Fire Pension Fund, which is only 39% funded, and has an unfunded liability of $1.7 billion that has grown over 13 times since 2000. The team has proposed a comprehensive package of reforms, with the cornerstone being a “Freeze & 40” policy that would freeze the current defined benefit pension system and replace it with a robust, portable, and immediately vesting defined contribution plan for current employees. In addition, the team recommended changes to the current paradigm of fixed cost-of-living benefit adjustments and large reductions in fund investment management expense fees.

Public Employees’ Retirement System of Mississippi (PERS)
This top team analyzed the Mississippi PERS and recommended a constitutional amendment that would require the PERS Board to invest its funds only in index funds, stable value funds, and cash or cash equivalents, a step the team believes would save nearly 1% of net assets annually; revert benefit accrual rates, employee contribution rates, and cost of living adjustments to those that were in place prior to 1999; increase the normal retirement age to 62 and base final earnings on a 4-year average; and require the legislature to bring public employee salaries up to the average levels of the contiguous states (which are about 26% and 14% higher for non-teaching and teaching positions, respectively).

State of Oregon Public Employees Retirement System
The Oregon PERS system has an unfunded liability of $11 billion that is unsustainable, according to the team that analyzed it. The team proposed reforms that would result in savings of $3.35 billion, including capping the maximum retiree benefit to 90% of final annual salary (FAS); disallowing vacation and sick pay to be calculated as part of FAS; and requiring 10 years of service for cost of living adjustment eligibility. To generate income, the team recommended modifying current legislation to eliminate selected tax refunds until the UAAL reaches zero. They also proposed long-term reforms such as adjusting the investment mix from 75% equity to a more balanced portfolio and changing the discount rate from 8% to 6%.

Pennsylvania Public School Employees’ Retirement System (PSERS)
The Pennsylvania Public School Employees’ Retirement System serves over 600,000 individuals and is 66.4% funded, with a UAAL of $29.5 billion. The team focused on legislative, funding, performance, and investing trends beginning in 2001 to understand the source of the UAAL, and developed recommendations to reduce or eliminate it through changes to PSERS’ governance, risk strategy, reporting, revenue generation, fees, and plan features. Some specific proposals include the introduction of a natural gas fracking tax and the appointment of a chief risk officer. Team members have recently shared their findings with school districts, state and federal legislators, and PSERS officials.

With these many proposals on the table, Joshua Rauh concluded the symposium with the observation that “pressure to make changes comes when people feel the squeeze on services” and the hope that all of the course participants will continue to think about how to effect change within their state and local governments.

Link to original article: http://www.gsb.stanford.edu/news/headlines/stanford-symposium-features-innovative-ideas-future-us-public-sector-pensions