Government Pensions

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Government Pensions Up ThereLessons from
United States
INTERNATIONAL SEMINAR PENSION SCHEMES FOR CIVIL
SERVANTS AND PENSION FUNDS Itamaraty Palace,
Ministry of Foreign Affairs, Esplanada dos
Ministérios, Brasília, Brazil, 01-02 October 2003

• David LindemanConsultant to OECD

Some materials are taken from USDOL studies and
from Mitchell and Hustead, Pensions in the Public
Sector (2001)
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United States --some pension basics
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Overall pension structure in US

• About 96 percent of the workforce is covered by
  the national pension regime (old-age, survivors
  and disability insurance, OASDI)
• modest benefit level, actuarial adjustments after
  age 62, increasing normal retirement age,
• in OECD context, relatively good demographics
• Major exception to mandatory coverage is
  government workers but
• 60 plus percent of Federal workers now under
  OASDI
• 75 percent of state and local government workers
  under OASDI
• At any time, about half of the private sector
  workforce participates in a tax qualified plan
• Participation does not necessarily mean actively
  making contributions in a 401-k style plan
• Lifetime participation rates are much higher,
  probably on the order of 80 percent.

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United States private vs. public pension coverage

• Coverage for public sector workers are higher.
  According to USDOL studies, among wage and salary
  workers, as a percentage of the relevant labor
  force --

All wage and salary Private sector Public sector
Employer sponsors plan 58 91
Workers participate 43 77
Full-time wage and salary Private sector Public sector
Employer sponsors plan 63 94
Workers participate 50 85
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United States some pension basics 3

• Pensions are significant players in capital
  markets
• About 4.5 to 5.5 trillion USD in 2000 in private
  sector pension assets at the high point of the
  market.
• Another 2.3 trillion USD in state/local
  retirement plans.
• (Note GDP of about 10 trillion USD in 2000).
• But roughly 90 percent of all pension plans (less
  than 100 members) account for roughly 10 percent
  of participants, assets.

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Trends in Policy and Practice

• Development of CoDA or 401-k style plan
• Mostly depends on workers making contributions
  that employers then match.
• Workers almost always make their own portfolio
  decisions within a bounded range.
• (In public sector, 3 kinds of CODAs under
  sections 401-k, 403-b, 457 plans)
• Major shift from defined benefit (DB) schemes,
  which reflects
• underlying shifts in economy (e.g., decline in
  manufacturing)
• Academic, policy elite criticisms of portability
  losses tax benefits.
• interactions of regulation and macroeconomic
  environment
• Trend away from DB in public sector is less
  pronounced
• But in both sectors, even more so in the public
  sector, employers who sponsor a traditional
  (usually DB) pension also provide a CoDA.
• DB plans still hold 50 percent of the assets.

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United States --Federal Civil Service Pension
Reform
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Background

• Federal civil servants had separate pension
  scheme dating from early 1900s, a product of
  earlier civil service reform.
• Some state and local government pension schemes
  that survived Depression.
• By 1960s, comparability in total compensation
  vis-à-vis the private sector was the principle.
• 1935/1939 Old-Age, Survivors and Disability
  Insurance
• In general, Federal government not covered. But
  in early 1950s, military were covered
  prospectively
• Many state/local governments, but not all,
  voluntarily subscribed. About 75 percent of
  state and local workforce are covered.

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Problems with less-than-full coverage

• Gaps in disability and survivors coverage for
  mobile workers. Early-leaver losses
• Can lead to undesirable lock-in effects.
• Inadequate old-age benefits for some windfall
  benefits for others.
• OASDI is re-distributional.
• Unfair to exempt some relatively high paid (civil
  servants) from that policy.
• Especially elected political officials
• Until late 1970s, these were issues among
  experts. Public and political elites mostly
  unconcerned and uninterested.
• 1977/1983 Amendments changed landscape

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1977/1983 Amendments

• 1977 law rationalized OASDI dynamics and cut some
  short-term benefits for overall budget reasons.
• Also enacted two offsets to prevent unintended
  windfall benefits
• 1977 law also created Study Group on Universal
  Coverage. Study Group produced report in 1980.
• More famous 1983 law addressed loose ends from
  1977 law, and mandated coverage of new Federal
  workers
• Congress gave itself two years to design new
  pension regime for Federal workers
• Made easier by existence of study group report
  with concrete design options and, as a byproduct,
  some capacity in one of the congressional support
  agencies to staff the reform.

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Changing Pension Landscape

• 1977 Study Group used the principle of
  comparability and examined practices of large,
  good employers in service sector. Three tier
  approach
• Base OASDI coverage
• Usually some final pay defined benefit plan no
  more than 0.5 percent and 1.0 percent per year.
• A defined contribution thrift plan.
• About the same time, IRS regulations implementing
  IRC 401(k) and DOL regulations implementing
  ERISA 404(c) were making thrift plans more
  tax-efficient and feasible to operate.
• 401-k made allowed thrift plans to become fully
  EET
• 404-c allows employers to minimize fiduciary
  burden by letting worker make investment choices
  among at least three options.
• By early 1980s, 401-k plans were becoming very
  popular.

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Mid-80s Federal Civil Service Reform

• Generally followed the logic of the Study Group
  Report.
• Same overall replacement rate for long tenure
  workers but with workers (a) participating as
  other citizens in OASDI benefits and costs, and
  (b) paying higher explicit worker contributions.
  
• Allowed vested workers to stay in the old Civil
  Service Retirement System (CSRS) or switch to
  Federal Employees Retirement System (FERS). New
  entrants and not-vested workers under FERS.
• Very few switched. One exception due to special
  efforts.
• FERS has three components (1) OASDI coverage, (2)
  moderate sized occupational DB tier, and (3)
  401-k style Federal Thrift Savings Plan (TSP).
• Most workers focus on TSP. Only if they become
  long tenure workers do they ever think about the
  DB piece.
• TSP also extended to CSRS workers but on less
  generous terms. Recently extended to military.

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Acquired Rights

• Acquired rights was not a large issue in Federal
  civil service reform debate.
• Old CSRS formula, while generous, was not
  excessive relative to pension packages among
  comparable employers
• For switchers, it is easy to calculate hybrid
  formula of CSRS and FERS rights.
• 1977 social security law had already taken away
  windfalls.
• Under Federal US law, legal protection of
  acquired rights rarely extends to system rights
  vs. past accruals and then only on the basis of
  current wage or salary.
• But state workers may have greater protection --
  see later discussion.

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Why Did the Reform Happen?

• Financing problems in OASDI in 1977/1983 made an
  experts issue a fiscal and political issue.
• Covering relatively high paid Federal workers
  makes OASDIs 75 year balance look better.
• Of course taxpayers and/or workers pay for this
  improvement but that is hidden in the civil
  service account in the overall budget.
• Congressmen became vulnerable to charges of
  unjust enrichment.
• Precedent of military coverage
• Advantages of non-coverage (windfalls) had been
  removed in 1977 OASDI amendments. Otherwise CSRS
  workers were left alone.
• 401-k type pensions had become extremely
  fashionable.

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Thrift Savings Plan

• Choice among (1) equity index C fund, (2)
  corporate bond F fund, and (3) Federal government
  bond G fund. Recently a (4) small cap index fund
  and (5) international index fund have added.
  Discussions to add a lifecycle option.
• Decisions to change ones portfolio have time
  lags that most private 401-k plans do not have.
• For post-reform workers, automatic 1 percent, 1-1
  match for next 3 percent, and 0.5-1 match for
  next 2 percent.
• For CSRS, allowed to put in 5 percent without
  matching.

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Thrift Savings Plan

• While the funds are technically outside the
  government (CBO and GAO ruling), the G fund is
  used by US Treasury to meet the Debt Limit when
  the ceiling becomes constraining.
• On the other hand, the G fund has blended and
  less volatile rates of return that are hard to
  replicate in the private sector. Ideal
  risk-less investment medium maybe better than
  I-bonds and TIPS options for private sector
  households.
• ERISA fiduciary rules apply to TSP governance.

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United States state and local plans
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Unresolved Issue of State and Local Government
Workers in OASDI

• Uncovered state/local workers about one-quarter
  of that workforce.
• Disproportionately police and fire workers plans.
• Windfall limits remain a constant (and
  complicated) irritant to those affected by them.
  Except for an effect on OASDIs long-term
  balance, Congress might repeal them.
• Three barriers
• Current privatization debate about OASDI makes
  it hard to rationally discuss further state/local
  coverage.
• Recent trend in opinions from the Supreme Court.
• Fiscal

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Constitutional cloud

• Supreme Court has gone through three phases on
  constitutional issue
• Until the late 1930s, Court had a comity
  doctrine that made it to any Federal impositions
  on state and local governments, even in their
  capacities as employers.
• Increasingly accommodating 1940 to mid-1980s.
• In last 10-15 years increasingly negative again
  (impair sovereign powers test)
• But did uphold Medicare coverage and law
  prohibiting withdrawal from OASDI.

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Fiscal Federalism Realities

• Congress probably (but not 100 percent) could
  find constitutionally permissible way to cover
  state/locals, but any such attempt would
• impose severe burdens on states/locals with PAYG
  schemes (e.g., Massachusetts) and force good
  states to subsidize bad states.
• not be popular even among those who have funded
  schemes (e.g., California)
• If ever tackled, probably on a new entrant basis
  and without any fiscal relief to affected
  entities.

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State/local pension landscape

• Some 261 systems and 378 plans
• Systems apply to more than narrow employment
  group
• Benefit provisions in schemes not integrated with
  OASDI are more generous, but combined
  OASDI-supplementary scheme benefits are generally
  higher in total.
• As of 1996, median financing ratio of state/local
  plans was estimated at 91 percent (average 87).
• But serious under-funding (book reserve or PAYG
  financing) in some jurisdictions, and
• In some jurisdictions, liabilities are evolving
  at an ever higher rate.

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Beneficiary rights state/local government plans

• State and local plans are not covered by the
  labor law provisions of ERISA, but they are
  covered (via workers) by tax law provisions.
• But ironically court decisions under common law
  and using the contract clause of the US
  constitution often provide rights that are equal
  or superior to those under ERISA
• In addition, some states have their own
  constitutional provisions outlining pension
  rights for state and local government workers.
  But state constitutions are more like
  super-laws than hard-to-amend national
  constitutions.

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Governance state/local government plans

• In general, governance of public sector pension
  schemes is similar to private sector.
• Selection of trustees not without problems in
  terms of competence, political patronage and ties
  to fund management.
• Auditing and oversight could be improved in some
  jurisdictions.
• DC plans that rely on transparent contracting-out
  to private service providers and letting workers
  make their own portfolio choices have fewer
  obvious problems, but
• controversy over management of TSPs new IT
  system
• Public sector (and non-profit) schemes are under
  much greater pressure to exercise corporate
  governance than are large private sector schemes
• Private sector pension plan trustees are not
  inclined to tell other private firms how to
  manage their businesses.