Subject is Picasso, on exhibit at Nelson-Atkins in KC; ID’d by Marianne Boshuizen.
The full picture: 401(k) plans vs. public pensions, a recent article by fellow Curtis Shelton at the Oklahoma Council of Public Affairs, illustrates only that he does not understand how pension plans work and are analyzed by actuaries. Looking past his irrelevant swipe at retired Oklahomans who have faithfully served their state in many capacities, his announced effort to compare individual 401(k) plans to public pensions is a worthy task, but he isn’t up to it because he doesn’t know how to read a pension system actuarial report. The relevant report is the 2017 OPERS Actuarial Valuation Report, the most recent, and available here for Mr. Shelton’s study. If he wants to provide accurate information with sound analysis, he will do so before tackling the topic again; but he likely will not because the fellows at the OCPA rarely engage in thoughtful analysis since it distracts from espousing the predetermined script they’re hired to spout and echo about.
He uses a recent Vanguard study, How America Saves, for average data about individual 401(k) account contribution rates and performance. I’m choosing to accept that data because what he reports is reasonable and Vanguard is my investment company of choice. Here’s what he writes:
Starting with employee and employer contribution rates (measured as a percentage of the employee’s salary), you find significant differences between DC plans and the OPERS plan. According to the Vanguard analysis, the average DC employee deferral rate was 6.8% with an aggregate participant and employer contribution rate of 10.3%. The contribution rates for the OPERS plan must equal 20%. State employees have a contribution rate of 3.5%, which means the state contributes at a rate of 16.5%. Local government employees contribute between 3.5-8.5% and the employer then matches whatever the difference is to reach a combined 20% contribution rate.
Amusingly he goes on to ask, What do these numbers mean?, and then proceeds to demonstrate he hasn’t a clue. Look at this table from page 6 of the OPERS report:
A perfect defined benefit pension system will always have assets (investments from past employee and employer contributions) equal to its accrued liability (how much is needed to assure payment of all future benefits previously earned by employees; better definitions are in the report). OPERS as of July 1, 2017 was pretty damn close, lacking only $540 million against a need for $9.8 billion. A perfect board of directors of a perfect system will always have a plan for closing that gap; here’s the plan from page 22 of the Report:
Translated so perhaps Mr. Shelton can understand, the board wants the Plan fully funded by 2027, just nine more years from now. What that further means is that not every dollar being contributed is going to the benefit of the employees who are now actively paying in because part of the contributions are paying for the future benefits of former employees who are now retired, drawing benefits, but not making contributions. Some of the unfunded liability may also be attributed to past promises to current employees that were not funded. It’s my understanding that mostly the past sins had to do with COLA’s (cost of living increases) being granted without increasing the contributions. Regardless, it is clearly stated in every actuarial report for a pension system that is not fully funded how much of contributions is going to fund the future benefits of current contributing employees and how much is going to pay off what is owed for past promises, largely for those already retired. And here it is from page 7 of the Report:
None of the fellows at the OCPA have any business writing about Oklahoma’s public pensions until they understand what “Normal Cost” means. I didn’t know until former Executive Director of OTRS James Wilbanks explained it to a group of school district CFO’s several years ago. I’ve written about its importance for policy analysis in three earlier posts. Simply stated it is the contribution, as a percentage of compensation, that is required to fully fund the additional pension benefit earned by all active employees for the valuation year, i.e. it’s the contribution rate needed to pay for the pension benefits promised for working the new year. For OPERS that rate is 10.24%. Combine that with the 0.40% above for “budgeted expenses” and you get 10.64% which I believe is the “apples to apples” comparable number to Vanguard’s reported 10.3% referenced by Shelton, not the 20% he uses.
He is correct that 20% is being paid in for each active employee, but to state, as he clearly does, that the 20% inures entirely to the benefit of the contributing employees is false as demonstrated above. The Table uses a blended 4.14% employee rate, rather than 3.5%, which is consistent with Shelton’s note that employee rates vary from 3.5% to 8.5%, so its total is actually 20.64%. Here’s how the Table divvies it up. Normal Cost (the value to current employees) is 10.64% which is paid 4.14% by employees and 6.5% from employers. The remaining 10% is going to pay off the UAAL, unfunded liability, which is a legal obligation of OPERS and the State regardless of whether there are active employees or not. That 10% is clearly shown as the 3.5% listed which is estimated to eliminate the UAAL in the remaining ten-year target set by the board, and the 6.5% “surplus” at the bottom which is the amount of “overpayment” into the system meaning it’s not going to take anywhere near 10 years to fully fund.
I didn’t readily see an estimate in the Report but looks to me like it will be fully funded in less than half that time, maybe in four years around 2022. After that happens OPERS could rock along with its existing benefits structure keeping employee contributions at their current levels and reducing employer contributions 10 percentage points to 6.5% which would free up about $170 million or so for other state priorities. The simple math is four more years at $170 million each is enough to fund the $540 million UAAL; but simple math is outside the reach of the fellows at the OCPA. They’d rather have you believe it takes a 20% contribution to fund today’s OPERS benefits when in fact it takes only a little over half of that.
The remainder of Mr. Shelton’s article is pretty worthless since it is based on a wholly inaccurate foundation. The state pension benefit he claims has a value at retirement age 62 of $323,200 to a private sector worker does not require a combined contribution rate of 20% of that state worker’s compensation; it only requires 10.64%. And he tells us the state worker’s private sector counterpart with a slightly smaller contribution rate of 10.3% ends up with a retirement nest egg at age 62 of only $71,105. If I could follow his logic we’d probably find that’s not apples to apples either, but it’s kind of fun because it looks like to me the private sector pension world could learn a thing or two from the OPERS and other public systems. More on that shortly, but one more demonstration of how Stink Tanks like the OCPA operate. Here’s how Shelton finishes:
Oklahoma taxpayers paid more than $1.2 billion into public pension programs in fiscal year 2017. In all, Oklahoma public pension programs received $1.7 billion in contributions, with $443 million coming from employee contributions. Oklahoma legislators have done a good job ensuring these pension liabilities are adequately funded. According to a Tax Foundation report, Oklahoma’s public pensions had a funding ratio of 72% in fiscal year 2016. This ranked Oklahoma 20th among all 50 states. Having a clear and full picture of public employee compensation is important when debating government employee pay and the tax burden on Oklahomans.
I’m being a little picky but why does he go to the Tax Foundation for dated information when the Oklahoma State Pension Commission’s 2018 Actuarial Report was published six months ago and shows our state plans had a funding ratio of 78.6% in fiscal year 2017. Is it because it makes government look a little worse?
By passing the Oklahoma Pension Legislation Actuarial Analysis Act (OPLAAA) the legislature did place our state’s public pensions on the path to full funding by stopping the practice of approving unfunded COLA’s (like Senator Inhofe does with Social Security). At the same time the legislature moved new state employees out of OPERS assuring that many of our future public servants will face the same underperforming, high cost, individualized retirement plans that are failing workers in the private sector as Shelton’s corrected analysis above demonstrates. That move was fully supported and advocated by the OCPA. Here’s a comment from the OPERS Actuarial Report, page 6:
I think this comment is preparing the OPERS Board for the inevitable higher cost per benefit dollar of operating a pension plan that is going to steadily dwindle in size. As the paper If Ain’t Broke, Don’t Break It published by the Oklahoma Policy Institute during the 2014 legislative debacle that ended OPERS for new state employees pointed out, a collective pension plan has advantages of higher rates of return, lower transaction and administrative costs, and greater annuity payouts than individualized, do-it-yourself, 401(k) style plans advocated by Stink Tanks like the OCPA. While OPERS will continue on, it’s smaller size will reduce its efficiency meaning taxpayers pay more per dollar of pension benefit realized by our state workers. Shelton’s $71,105 to $323,200 comparison above, rightly viewed, illustrates the result of pooling retirement contributions into a huge collective plan that can invest for the long term and in asset classes not available to individuals (think limited partnerships, commercial real estate and private stocks) for higher returns, demand lower transaction and administrative costs, and amortize higher benefit payouts. Those are the advantages the OCPA pushed the legislature to throw out the window.
What is left is an opportunity for a real research group, or maybe the State’s Pension Commission, to test what I just said and plagiarized from If It Ain’t Broke, Don’t Break It. New state employees are being forced into individualized plans where they have the “freedom” to participate in the “competitive markets” of the investment world, i.e. they get to be overcharged and misled by professionals who are compensated not based on performance, but based on often misunderstood fee structures. I hope not, but it does happen. Even if every state employee is honestly advised, still they will struggle to match the higher returns and lower costs inherent in a large, collective pension plan. So Mr. Shelton, why don’t you figure out a way (not holding my breath) to measure over the coming decades just how well new state employees are faring with their retirement accounts. It’s a state plan and the collective information is available. I’ll buy you dinner each year their returns are greater, adjusted for annuity costs, than the Oklahoma Teachers Retirement System’s, if you’ll buy me dinner each year they are not. Real research is on my side.
And out of the exercise might come a meaningful idea that I first heard from James Wilbanks years ago, namely that Oklahoma could have a very efficient, high performing, low cost retirement system for public employees that is operated as a Defined Contribution plan, but retains the significant benefits of a large, collective plan. Maybe even ordinary, private sector citizens could participate. Oh, but that wouldn’t serve the interests of the “investment advisers” who populate our legislature or members of the OCPA board who fear large, efficient public entities making investment decisions.
Unless Shelton corrects his more recent article Don’t ignore teacher retirement benefits soon, next time I’ll be forced to provide another lesson in Normal Cost demonstrating more clearly how the Limited Thinkers at the OCPA continue to fall short of a reasonable standard of competence.
As always lunch is on me for the first to ID the photo location or the subject of the “half picture” displayed.