That’s the title of a very informative policy paper commissioned by the Oklahoma Policy Institute and posted to their website during the 2014 legislative session when legislators, against the advice of the policy paper, ultimately acted to essentially close, and ultimately end, the defined benefit pension plan, administered by the Oklahoma Public Employees Retirement System (OPERS) for Oklahoma’s state employees. The authors are Stephen Herzenberg of the Keystone Research Center and Ross Eisenbrey of the Economic Policy Institute, both seemingly reputable think tanks with real thinkers employed. The Oklahoma Policy Institute (www.okpolicy.org) is based here in Tulsa and is also the real deal with real thinkers. The vehicle for closing the OPERS retirement plan was House Bill 2630 of the 2014 session.
As I outlined in my recent posts, “Fouling Our Nest….Egg” and “What’s Up Doc?”, what was done in 2014 to state employees with the HB 2630 “stick” is now proposed by Representative McDaniel to be done to Oklahoma’s teachers and other education employees with a big juicy “carrot” contained in House Bills 1162 and 1172 during the 2017 session. In those posts I show that according to the most recent OTRS actuarial report for every $7 a teacher pays into the current OTRS defined benefit (DB) system the employer pays in about $3.50 and the employer and state pay another $13.50 to pay off the unfunded liability of the state to the OTRS DB plan putting it on track to be fully funded in about 20 years. The proposed legislation would establish a new defined contribution (DC) plan for all new teachers beginning with the 2018-2019 school year. The new plan would require teachers to contribute only $4.50, in comparison, yet employers would pay $6.00 as a match into the plan. This means that, roughly, a new teacher can get the same potential retirement value ($10.50) by only contributing 65% of what a veteran teacher is required to pay. Additionally, and most important, the extra $2.50 contributed by the employer is diverted from the amount being paid to fully fund the current DB plan, worsening its financial condition in a way no one has yet attempted to determine.
Rational newly hired teachers in 2018 and thereafter will elect to join the richer DC plan to be created by HB 1172. As a result, large sums of funding, previously counted on to pay off the state’s unfunded liability for the OTRS DB plan, will now be diverted to the new DC plan. This will clearly worsen the financial stability of the existing DB plan but no one yet has called for an actuarial analysis to determine what the impact of this proposed legislation will be. If the bills were increasing the benefits to current or future retirees under the current OTRS DB plan, the Oklahoma Pension Legislation Actuarial Analysis Act (OPLAAA) would mandate an actuarial study be done and a two-year legislative process. But McDaniel’s proposed legislation does not increase benefits for current or future retirees, rather it strips away funding from the DB plan that supports their current and future retirement income. OPLAAA works effectively to prevent an increase in the unfunded liability caused by raising benefits, but it does not prevent an increase in the unfunded liability caused by diverting away needed funding.
If the legislature does not seek an actuarial analysis of the impact of these bills on the current OTRS retirement system, then the Oklahoma State Pension Commission should at its February 22nd meeting. Its members include state treasurer Ken Miller, state auditor Gary Jones, and appointees of the governor, senate and house leadership. Here are some of the statutory “duties” listed for the Commission on its website www.okpension.ok.gov:
“The Oklahoma State Pension Commission was formed to provide guidance to public officials, legislators and administrators in developing public retirement objectives and principles, identifying problems and areas of abuse, projecting costs of existing systems and modifications to those systems, and recommending pension reform programs…the Commission makes recommendations on administrative and legislative changes which are necessary to improve the performance of the retirement systems.”
Another public body with a clear duty to understand the impact of this legislation is the Board of Trustees of OTRS. They meet the following day on February 23rd. Here’s hoping one of these boards takes action to fully understand the impact of HBs 1162 and 1172, working in tandem, on the financial stability of the current DB plan.
Now back to “If Ain’t Broke, Don’t Break It“. For anyone with authority in Oklahoma to impact our public employee pension systems or with an interest in those systems this paper is a must read. I can’t make their argument any better or shorter, but I do want to emphasize two important takeaways: a large, pooled investment fund is more cost effective and will yield higher returns than individually managed funds; and the purpose of public retirement systems is and should be retirement income security, not wealth accumulation.
The OTRS DB plan has about $14 billion in assets. When investing, size matters. A fund of that size can command the lowest advisory, management and transactional costs available. As a perpetual fund with an infinite life expectancy its investment decisions are not hamstrung by a short investment horizon—translated, its managers can seek investments with the greatest yield regardless of maturity, whereas an individual must invest for stability, not yield, as their life expectancy shortens. Even an advantage as small as 1 per cent over a twenty-year period amounts to at least a $3 billion savings to Oklahoma taxpayers. Here are some calculations that demonstrate this: OTRS 1% Matters. The policy paper explains other advantages of a collective approach and concludes:
Two recent National Institute on Retirement Security studies gauge the combined impact of all of these DC plan inefficiencies. These two studies conclude that defined contribution retirement plans cost 45% to 85% more in employee plus taxpayer contributions to deliver the same level of retirement security. An Economic Policy Institute/Retirement USA report independently came to a similar conclusion.
Part of the policy discussion that needs to occur is whether the goal of the Oklahoma Teachers Retirement System should be retirement income security or wealth accumulation. If the goal is retirement income security, meaning we don’t want retired schoolteachers going on food stamps or begging at street corners in their 70s, then the reward to the member for participating is a guaranteed lifetime income, what is called an annuity. If the goal is wealth accumulation, then the reward to the member is a lump sum payment upon retirement that may or may not provide retirement income security but that can be left to their heirs if they don’t use it all while alive. By far the cheaper, more cost effective way to provide retirement income security is a guaranteed lifetime income commitment, i.e. a lifetime annuity.
When I taught Personal Finance at Tulsa Community College I would explain how an annuity works by showing how it is the opposite of term life insurance. Term life insurance is income protection against dying too young. When I was younger, had dependent children and many years left to work I faithfully paid for term life insurance every year, probably not enough coverage but at least something. The bad news is I wasted every dollar I spent on those premiums because those policies never paid my family a dime. Of course the good news is that they didn’t pay because I’m still living. My premiums, primarily, went to those families whose breadwinners did die. By paying the premiums my family was part of a collective pool that in a very cost effective way provided the lump sum benefit paid to those unlucky families to help offset their reduced future income. I was willing to do so because there was a possibility my family could have been unlucky.
By contrast, a lifetime annuity is funded with an up-front lump sum amount that pays out an income for life to the beneficiary/retiree. That money is pooled with many other beneficiary/retirees, collectively invested, and then, after factoring in everyone’s life expectancies, paid out in monthly pension payments to each as long as they live. Some die earlier than their life expectancy; some die later, but all are provided a retirement income for the rest of their lives. Those who die early are, in effect, subsidizing those who die later in much the same way as my life insurance premiums subsidized the unlucky families. Overall it costs less to provide every beneficiary/retiree with a lifetime income, and not a dime more or less, than it would, collectively, if each had to save enough lump sum to be absolutely sure they would not outlive the funds available. A pure lifetime annuity leaves no funds to be inherited, but again is the most cost effective way to assure a lifetime income for every beneficiary/retiree.
When the policy paper enumerates and further explains the advantages of defined benefit public pension systems, it is primarily about the greater returns received and lower costs incurred by a large collective investment fund and about the ability to annuitize lifetime income payments in the most cost effective way. There are an endless variety of ways to tweak retirement options such as by providing for beneficiaries and lump sum pay out options, but at the core a smart public pension plan, one that delivers the greatest bang for the taxpayer’s buck, will incorporate the collective investment pool and the ability to annuitize lifetime income.
As always lunch on me for the first to identify the photo location.