Summer for me came to an end Friday when I lost my summer job being chauffeur and companion for my two 11 year-old grandchildren. They have returned to school so I’m beginning to have more time to review the OCPA’s postings. I started browsing a bit but my eye caught the “Featured Links” section with an enticing “Oklahoma Pension Bomb”. As I said in my first post on this blog, “Hello World”, my interest in exposing the shoddy “policy research” performed by the OCPA came out of my study of Oklahoma’s public pensions and particularly the largest and one I now happily draw from—Oklahoma Teachers Retirement (OTRS).
Clicking on the link takes you to an outside site maintained by the Manhattan Institute which is an older and likely better funded version of OCPA based in New York City. The page you arrive at is the “Oklahoma Pension Calculator” and is described as this “…tool is intended to inform the pension debate. In addition to estimating the pension that you would collect after a career in government, the calculator will also provide an estimate of the total annuity cost, or how much someone would need to save to replicate that guaranteed income stream in retirement.” Translated we’re going to show you how much better lazy government workers will be off when they retire and how much it’s going to cost you.
Here’s an example that I tried.
What is your target retirement age? 65
How many years of service will you have at retirement? 30 (most teachers are females and have some career interruptions along the way)
When were you hired? On or after 7/1/1992, but before 11/1/2011.
What is your final average salary? $50,000 (imagining a teacher who began in the 90s and will retire in the 2020s and hoping for salary increases some time soon)
Here is the response:
Your Pension Benefit: Monthly, $2,500; Annual, $30,000.
Your Lifetime Annuity: The amount of cash you would need at the same retirement age to yield the same annual income as this public pension.
Male: $453,494 Female: $496,609
Half a million! How am I ever going to save half a million?! Damn teachers!
At least that’s how OCPA and Manhattan want you to react. Let’s take a closer look at these “Statistics”. Don’t get real hung up about the choices I made above. The mathematics that follows will apply to any example.
First, a compliment. Manhattan could have made this seem “worse” by using retirement formulas other than OTRS (i.e. OPERS, Firefighters, Judges, etc.) that may be more generous. However, OTRS is the largest and that choice is best if trying to keep this simple.
Next a lesson on how annuities work. A pension is a lifetime payment that in its simplest form lasts as long as the pensioner lives and ends as soon as she dies. The cost of providing an annuity is driven by two primary factors: life expectancy and rate of return. The longer the life expectancy the more it will cost to provide for; the shorter the less it will cost (which is why the Male cost is lower above).
Rate of return is also important because the problem Manhattan poses is how much money do you need at the beginning of retirement to purchase a lifetime benefit. The money is available now but will be paid out over the retiree’s lifetime. No pension plan manager or insurance annuity provider will keep the money in a shoe box, rather it will be invested. The higher the return on investments over the retiree’s lifetime the less that is needed up front; the lower the return the more needed up front.
Gratefully Manhattan has the integrity to state the assumed rate of return—by clicking the “i” encircled in blue we get this information: “Estimated payment for a Single Premium Immediate Annuity, indexed to inflation on the same basis as the simulated public pension, with an insurer who assumes a 3% rate of return.” The comment on inflation does not apply since there is no automatic cost of living adjustments to OTRS benefits, not since about 2011.
Now we turn to two data sources to check out Manhattan’s $496,609 needed for our school teacher at age 65. I found what seems like a pretty credible life expectancy table on the CDC site, “National Vital Statistics Reports, Vol. 57, No. 1, 8/5/2008, Table 3” which is a Life table for females: United States, 1999-2001. It shows the life expectancy for a female at age 65 is 19.12 more years. The other data source is my trusty C. R. C. Standard Mathematical Tables published in 1959. It provides a table for calculating The Present Value of Annuity for various periods (the number of years our teacher will receive the $30,000 pension) and rates of return.
First I tried 20 (life expectancy is 19.12) and the factor for a 3% rate of return is 14.8775 which multiplied times $30,000 tells us $446,325 will be needed. So I am close. To get closer I find the factor for 23 years is 16.4436 which results in $493,308 compared to Manhattan’s $496,609. Makes sense to me that the insurance company is going to cushion the risk by a couple of years (plus there are commissions, profit, etc.) and consider this from the Economic Policy Institute cited in my retirement study “Ten Facts” linked in my first blog post “Hello World”:
“DC plans (what OCPA advocates) do not pool longevity risk. When individuals convert their accumulated savings into an annuity – a fixed payment until they die – their annuity payment is lower because the provider of the annuity knows an individual is more likely to purchase an annuity if they are in good health and have a longer-than-average life expectancy. Since defined benefit plans do pool longevity risk across tens of thousands of plan members, they can base annuity payments on the average life expectancy of the population.”
OTRS assumes a return of 8% and over the long run has managed that rate. Even during the most recent 10-year period which included the Great Recession OTRS achieved over 7%. Investing billions over a very long term horizon simply generates a much greater return than individuals can do on their own and apparently much better than the annuity companies that Manhattan shopped. So let’s be nice and use 7% over the same 23-year period as above. The amount OTRS needs to have to support our teacher’s pension is $337,166 (factor 11.2722). At 8% it is $311,133 (factor 10.3711). And, if I want to really drive home the point, how about having OTRS use 20 years, much closer to our teacher’s real life expectancy, and their long, long run rate of 8%: $294,543 (factor 9.8181). An eye-popping 40% savings from what OCPA recommends.
Translated so maybe even the “research fellows” at OCPA can understand, using Manhattan’s numbers, OTRS can deliver the same retirement benefit to our teacher at 60% of what it costs to do it the OCPA/Manhattan/Free Market way. To this taxpayer that sounds like pretty smart government.
It’s too bad the OCPA’s and Manhattan’s want to frame this retirement debate as DC vs. DB. What makes OTRS a better vehicle for school employees retirement is because it is big, it is mandatory and it can continue to invest for the long term while still annuitizing individual pensions. Those characteristics don’t have to be unique to DB plans. But as long as the discussion is “informed” by lies, damned lies, and (especially) statistics, the strategy for those of us who appreciate how the public benefits from well managed public sector pension plans is, unfortunately, to oppose change.
By the way, Mark Twain is one of those who uttered those words.
Lunch on me if you can name the photo location. Has to do with amazing statistics!