issues in us public pension management © olivia s. mitchell the wharton school...
TRANSCRIPT
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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
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US Public Retirement System
National Social Security System: Defined Benefit, mostly unfunded
FederalCivilian Plans
FederalMilitary Plans
State & LocalPlans Private
Sector
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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.
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Social Security System (00)
• OASDI Payroll Taxes/yr: $493BWorkers w/ taxable earnings: ~153M
• OASDI Taxes/Worker: $3,200/year
OASDI revenues/yr: $568B
• OASDI Benefits/yr: $408BRecipients: ~45 M
• Av. Retiree Benefit: ~$9,100/year
OASDI expenditures/yr: $415Bwww.ssa.gov
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Problem: Current Rules Not Sustainable
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US public sector employees: 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
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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
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Federal DB plans
Assets Liabilities Funded %
CSRS $361B $962B 38%FERS $97B $191B 50%
Hustead (2000)
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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%
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5 Investment Options in TSP: 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
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TSP admin charges very low (00)
G fund: 0.05% of assetsC fund: 0.06% of assetsF fund: 0.07% of assets
Compare to retail mutual funds: 1-2% of assets
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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]
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TSP Investment Performance
-20
-10
0
10
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30
4019
91
1992
1993
1994
1995
1996
1997
1998
1999
2000
10-Y
ear
G Fund F Fund C Fund
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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 monthPayouts:
– Annuities, or– Cash refund
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Federal Military Pensions
~3M employees, high turnover even in peacetime (>1/2 have < 7 years tenure)
1st Pillar DB plan for 20+ years serviceBenefit = 1/3 of compensation
Most retire ~ age 42 28% funded: $150B assets, $529B
liabilities
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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
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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 planIncreasingly: CHOICE (DB or DC) –
Florida, for example
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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
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S&L Plan Investments: Now VS 25 years
ago: bonds the norm
Cash0%
Govt Bonds14%
Corp Bonds16%
Corp Stocks38%
RE1%
Other31%
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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.
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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)
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ETIs: Economically Targeted/Social Investments
“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
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How to enhance pension asset security?
Institutional Structure: Board size, composition, membership, authority
Set performance standards: fiduciary role, penalties: ERISA as a model
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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.
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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.
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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.
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Emerging public plan challenges::
Movement toward – DC plans– Hybrid plans
Concern over admin costs
Poor investment performance– DB– DC
Investor advice and education
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Conclusions
Public pension design and management not simple.
Usual pension issues PLUS political risk
Funding avoids retirement insecurity and later problems
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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