1 / 30

Issues in US Public Pension Management

Issues in US Public Pension Management . © Olivia S. Mitchell The Wharton School mitchelo@wharton.upenn.edu. Pension plans are long-term financial contracts:. Objective: to deliver affordable, reliable retirement benefits Key: A long term financial promise Nature of promise How long?

finna
Download Presentation

Issues in US Public Pension Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Issues in US Public Pension Management ©Olivia S. Mitchell The Wharton School mitchelo@wharton.upenn.edu

  2. Pension plans are long-term financial contracts: • Objective: to deliver affordable, reliable retirement benefits • Key: A long term financial promise • Nature of promise • How long? • US public pension environment complex

  3. US Public Retirement System Federal Military Plans State & Local Plans Federal Civilian Plans Private Sector National Social Security System: Defined Benefit, mostly unfunded

  4. US Social Security: • Mandatory retirement system, defined benefit (DB) • Payroll-tax financed, mostly PAYGO • Single largest government program • Payroll tax: 15.3% tax on covered earnings (split) • OASI: 5.26% of pay to cap ($80,400 in ‘01,indexed) • DI: 0.94% “ “ “ • HI: 1.45% on all earnings • ==>Most HH in US pay more to SS than to IRS.

  5. OASDI Payroll Taxes/yr: $493B Workers w/ taxable earnings: ~153M OASDI Taxes/Worker: $3,200/year OASDI revenues/yr: $568B OASDI Benefits/yr: $408B Recipients: ~45 M Av. Retiree Benefit: ~$9,100/year OASDI expenditures/yr: $415B Social Security System (00) www.ssa.gov

  6. Problem: Current Rules Not Sustainable

  7. Who’s included? Federal govt civilian, Military; State and local gov’t workers (eg teachers & legislators, police/fire, municipal) 75% covered by Social Security as 1st pillar plan Most have 2nd pillar DB pension too Lately DC growing US public sector employees:

  8. Federal Civilian Pensions • 3M employees, including Congress and Postal Service • 1st pillar DB plan with old and new vintages: • CSRS set up before Social Security (1920) Benefit = 2% Pay * Service • FRS (1983) when federal workers into SS Benefit = 1% Pay * Service • Plus TSP plan: defined contribution • CSRS: 5% ee, no employer match • FRS: up to 10% ee, +5% employer match 1.5% to 5, 1.75% next 5, 2% thereafter; FAP=Hi3

  9. Federal DB plans • Assets Liabilities Funded % • CSRS $361B $962B 38% • FERS $97B $191B 50% Hustead (2000)

  10. Federal Thrift Saving Plan (TSP) • 2nd pillar defined contribution plan for federal employees (1984). • ~$93B assets, 2.5 M participants (3/01) • Average account balance ~$37,000 • Employer contributes 1% of pay for all; then employees elect 0-10% and have employer match* to total of 15% www.tsp.gov *100% to 3%, 30% to 5%

  11. G fund: Special issue Treasury Securities C fund: Stock index fund (S&P500) F fund: Fixed Income index fund (Lehman Bros Aggr. Index) 2 New Additions: 2001 S fund: Small Cap Stock Index fund (Wilshire 4500 Index) I fund: Int’l Stock Index Fund (EAFE Index) Money Manager is Barclays 5 Investment Options in TSP:

  12. G fund: 0.05% of assets C fund: 0.06% of assets F fund: 0.07% of assets Compare to retail mutual funds: 1-2% of assets TSP admin charges very low (00)

  13. TSP Asset Allocation Patterns(3/01) • G fund (Govt sec’s): 38% ($35.5B ) • C fund (equities): 56% ($52.4B) • F fund (fixed income): 6% ($5.4B) [Private pensions: 55-60% equities, too]

  14. TSP Investment Performance

  15. Other TSP design issues: • Transfers: • 1x per month, Web or by mail • Transfer effective by end of month, if in by 15th, otherwise end of next month • Payouts: • Annuities, or • Cash refund

  16. Federal Military Pensions • ~3M employees, high turnover even in peacetime (>1/2 have < 7 years tenure) • 1st Pillar DB plan for 20+ years service Benefit = 1/3 of compensation Most retire ~ age 42 • 28% funded: $150B assets, $529B liabilities

  17. From 2001: Military can join TSP • Voluntary contribution: • Up to 7% of base pay • To $11K indexed, $15K by 2006 (sec 402(g)) www.tsp.gov/uniserv/forms.tspbk-u-08.pdf

  18. State and Local Pensions (S&L) • 2200 systems, 13M employees, 5M beneficiaries • Generally 1st pillar DB plan: Benefit = 2% Pay * Service • Some also have 2nd pillar DC plan • Increasingly: CHOICE (DB or DC) – Florida, for example

  19. S&L Plan Performance All Systems (’99) • Assets ~$2Trillion • Contributions $62B • Benefits paid $82B Funding Status: 98% 5-yr ROR($wtd to 98): 14% www.census.gov and PENDAT 1998

  20. S&L Plan Investments: Now VS 25 years ago: bonds the norm

  21. Keys to a well-run public pension system: • Good governance: contributions, recordkeeping, money management, benefit payments. • Shielded asset management. • Performance standards, reviews, penalties for noncompliance. • Transparent reporting/disclosure.

  22. Governance concerns include: • Ignorance/Fraud: Pension invests in junk bonds (Orange County). • Asset valuation: Japanese pensions hold large interest in insolvent banks. • Shareholder activism: Fund managers tell companies what to do (e.g. Penn fund divests insurers; TIAA-CREF proxy votes on social fund)

  23. “When pension assets must be invested according to political/social criteria; ignore risk/return” Malaysian Provident funds had to help insurers. Korean pensions loaned 2/3 of assets to MOF for “social” purposes African and Mexican public funds must invest in mortgages. Alaska Ret System lost ~$80M in local home mortgages when oil prices fell ETIs: Economically Targeted/Social Investments

  24. How to enhance pension asset security? • Institutional Structure: Board size, composition, membership, authority • Set performance standards: fiduciary role, penalties: ERISA as a model

  25. The Prudent Person Rule: • Requires managers to be “prudent” and manage in best interest of participants; • Show diversification; • Investments part of risk/return portfolio; • Held personally liable if found imprudent.

  26. Related: • Operational Controls: liability insurance. • Investment Authority: Competitive bids for outsourced investment • Reporting/Disclosure: Frequency/form of asset /liability valuation, common assumptions, reporting format for expenses, returns, risk.

  27. Governance affects S&L investment outcomes: • Retirees on boards cuts returns slightly (more bonds). • In-house vs external money managers have similar investment patterns (but competition critical) • Requirement to invest in own-state projects can reduce returns. • Requiring fiduciary insurance can help.

  28. Movement toward DC plans Hybrid plans Concern over admin costs Poor investment performance DB DC Investor advice and education Emerging public plan challenges:

  29. Conclusions • Public pension design and management not simple. • Usual pension issues PLUS political risk • Funding avoids retirement insecurity and later problems

  30. Benefits of stronger public pensions in developing countries: • Primary: More reliable old-age support for aging population, less uncertain tax environment • Secondary: better-run real sector (reporting/disclosure stronger), capital market broader/deeper, robust insurance market, possibly higher national saving

More Related