Public pensions have gotten a huge amount of attention ever since the city of Detroit declared bankruptcy last month. Concerns have focused on whether pension funds can generate adequate returns to support their long-term payouts while maintaining their promised benefits, especially in light of the many recipients who aren’t eligible for other forms of financial assistance, most notably Social Security.
Some analysts, including Fool contributor Morgan Housel just last week, don’t think the pension crisis is a crisis at all. They argue the pension crisis has gotten blown out of proportion, with investors and workers all overreacting to the financial stresses that the 2008 recession and market meltdown put on the pension system. As those stresses have lessened, the argument goes, pension funds will see their conditions improve.
One study from the Center for Retirement Research strongly supports the non-alarmist point of view, with hard evidence that the measures that state and local pension funds have taken to shore up their finances will ensure their survival. But the way in which those conditions will improve will itself have big ramifications for employees, potentially causing a retirement crisis among workers who were led to expect much more from their pensions.
When the cure is worse than the disease
The CRR study took a look at 32 pension plans across 15 different states to see exactly what responses the plans made during the financial crisis. Far from concluding that all pension plans themselves shared the views of CalPERS CIO Joseph Dear that “there is a reasonable basis to be confident” about the poor performance of its pensions, all but three of the 32 plans have made at least some reforms.
The most popular reform, made by three-quarters of the plans, was to adjust age and tenure requirements. Most of the plans did so on a new-hire basis only, but four plans made adjustments for all employees. Similar changes to the average salary period used to measure pension benefits and reductions in the benefit accrual factor were largely targeted at new hires, although some existing workers were also affected.
Solving one problem, creating another
From the perspective of the plans, these reforms have been wildly successful. The CRR now estimates that pension costs as a percentage of state and local government budgets will actually fall over the long run, as reform efforts have an increasingly large impact over the next 15 to 35 years. One big question remains whether future returns will live up to expectations, especially as public pensions have followed the moves in past years by private companies United Parcel Service, Inc. (NYSE:UPS), Ford Motor Company (NYSE:F), and Lockheed Martin Corporation (NYSE:LMT) by increasingly raising allocations to bonds in their respective pension portfolios. But despite some sensitivity to return assumptions, the CRR study found that governments would likely be able to absorb some deviation from expected returns.
But the more important issue is how, for workers, falling benefits and increased contributions add up to increased economic pressure now. Even the CRR study acknowledges that plans won’t necessarily stick with reforms in the long run, instead bowing to increasing public pressure to expand benefits once again after the economy begins to improve more strongly.
As a result, the true crisis over public pensions might well come not from the financial condition of the plans themselves but rather from the shock that future retirees face when they realize that the benefits they had hoped would sustain them prove inadequate to the task. For workers with enough time before they retire, personal financial planning of their own can help them overcome their new challenge. But no one should dismiss the cost that employees are increasingly bearing in efforts to shore up pension-fund finances — even if public pensions eventually do get a clean bill of health as recent stock market gains take hold.
Tune in every Monday and Wednesday for Dan’s columns on retirement, investing, and personal finance.You can follow him on Twitter @DanCaplinger.
The article The True Crisis Over Public Pensions originally appeared on Fool.com.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Ford and United Parcel Service (NYSE:UPS). The Motley Fool owns shares of Ford and Lockheed Martin.
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