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Pension Insurance for Public Employees?

posted by Adam Levitin

The New York Times' story about the insolvent pension plan of Pritchard, Alabama notes that while the Pension Benefit Guaranty Corporation (PBGC) partially insures private employers defined-benefit pension plans, it does not insure public employers' defined-benefit pension plans ("government plans" in ERISA-speak).  

This left me wondering why?

From an employee's perspective, such insurance is seems desirable--an employee with a defined-benefit pension plan has a large, undiversified risk in the plan itself.  I don't see any strong employee-side objections (yes, cost/benefit of premiums, but that's a factual question that can't be answered generically). 

Maybe there are insurance issues that explain the exclusion of public employer plans, but they don't leap out at me.  There are moral hazard concerns with any sort of insurance program, but are they substantially different with public employers? There could also be adverse selection problems if public pension insurance were optional.

Alternatively, maybe non-coverage of public plans was just a matter of historical circumstances.  In 1974, when ERISA was enacted, no one really thought that public pension plans needed insurance either because they were all doing well or because of the ability to replenish them via taxation.  

Or maybe there's a political story:  public employers didn't want to be regulated or pay insurance premiums and wanted the flexibility to underfund their plans if they found that convenient.  

I'm curious if anyone has any insight into either (1) the history of ERISA and the PBGC and the exclusion of public plans or (2) general policy arguments against insuring public defined-benefit plans.  Comments are open.  

Comments

Easy. Because public plans don't have the same funding requirements as ERISA plans. When you have a pension plan without strict funding requirements, there is no way to insure it. Think how much an insurance scheme will have to charge if the sponsor makes whatever promises it wants and never funds the plan.

That's why you hear about the unfunded pension liabilities. An ERISA plan is not allowed to go to that level of underfunding in the first place.

Conceptually, ERISA boils down to having the public back private pension plans.

Why should the public back other public pension plans?

I understand that I am not distinguishing between the federal public and the state or municipal public, but that begs the question: if local governments are in trouble, do we want that trouble to bring down (or at least weigh very heavily on) bigger governments?

I'm a bit fuzzy on the history of ERISA. Jim Wootton (SUNY-Buffalo Law) is the expert on this, AFAIK. But I do remember that one of the big problems addressed by ERISA was union-managed pensions, many of which were union-mismanaged pensions. I'm not sure that this happened in the public sector.

I tend to agree with the political story but consider also the possiblity that state and local government workforces were much smaller in 1974, the state and local governments' credit ratings much higher, and their pension obligations were such a drop in the bucket as opposed to the massive hole they now have grown to be.

Good background in Rose v LIRR, 828 F2d 910:

"The governmental plan exemption was included for several reasons. First, it was generally believed that public plans were more generous than private plans with respect to their vesting provisions. H.R.Rep. No. 533, 1974 U.S.Code Cong. & Ad.News at 4667. Second, it was believed that "the ability of the governmental entities to fulfill their obligations to employees through their taxing powers" was an adequate substitute for both minimum funding standards and plan termination insurance. S.Rep. No. 383, 93d Cong., 2d Sess., reprinted in, 1974 U.S.Code Cong. & Ad.News 4890, 4965; H.R.Rep. No. 807, 93d Cong., 2d Sess., reprinted in, 1974 U.S.Code Cong. & Ad.News 4670, 4756-57. Finally, there was concern that imposition of the minimum funding and other standards "would entail unacceptable cost implications to governmental entities." H.R.Rep. No. 807, 1974 U.S.Code Cong. & Ad.News at 4830. See also H.R.Rep. No. 533, 1974 U.S.Code Cong. & Ad.News at 4668."

Example: In Illinois, the Illinois Municipal Retirement Fund provides pension benefits for more than 2900 local governments. If the IMRF loses money on investments, which it did in 2008 (more than 20%), the municipalities are charged extra to make up the loss. And of course, the municipalities pass on that charge to the tax payers. If you ask the IMRF why, you get a bunch of doubletalk.

So, perhaps the bigger question is, why are government pensions allowed to make risky investments?

These comments have all been very helpful and informative. Thanks!

It would appear today that Congress's reasons for exempting government plans don't hold as strongly. If promised benefits are too large, taxation can't make up the difference. Clearly the temptation to underfund pensions today and put the cost on future politicians (by requiring future tax increases) is too tempting to many governmental bodies. Yes, there's a cost to mandating pension funding, but that's just reasonable fiscal responsibility. I wonder if this will be part of the inevitable wave of pension reform we see in the next decade.

@ Lima -- pension funds are - in theory - constrained by both common law fiduciary duty and by specific standards written into the pension plan and its supplements. The plan doc usually does have credit-ratings parameters, although we know from experience that a AAA rating didn't mean a whole hell of a lot.

Part of that disjunction between theory and reality is driven by the underfunding: when a plan's solvency assumes 5-8% returns (see Adam Levitin's comment above re: current promises and future liabilities), there's extraordinary political pressure to make risky investments.

For what its worth, the case of Prichard is the first I have heard of where a city or state is actually unable to pay benefits. Illinois, which has the worst funded state-run pension plans, is far from being in such bad shape as to be unable to pay benefits. Even Vallejo, CA, which is in bankruptcy proceedings, benefits are still being paid out (I believe). In other words, my understanding is that ERISA was designed to resolve the situation where a private firm went bankrupt and benefits didn't get paid; that situation was more or less unheard of in the public sector so ERISA didn't cover it.

This leads up to my question for the bankruptcy experts here: what, in your opinion, seems likely to happen to pension obligations when a city goes bankrupt? My understanding is that public pension benefits have very strong legal protections but I have no idea how those protections would be treated by a bankruptcy court. I know that the arguments the unions have made is that cities always have the capacity to tax and thus should be able to pay all obligations in full; is that an argument that courts will buy? Any insight would be greatly appreciated.

@jpe
Common law fiduciary duty was gutted about a decade ago by the ALI, which redefined the "prudent man" rule into something not much stronger than "honesty in fact". A fiduciary can now invest in Russian czarist railroad bonds, as long as it diversifies by also investing in--say--Nigerian 419 schemes.
I don't know about the genesis of this. It could have been political pressure, or maybe could have been simple lawneconomics ideology.

The problem is not the insuring of the plan or the enforcement of the funding. The problem is the ridiculous and nonsensical "assumptions" that are set by the unions for whom the plan is run. The only brake on nonsensical plan contribution requests is... bankruptcy for the private company involved. Public sector unions do not face such a constraint, and therefore have no problem making ludicrous requests. After all, "You're anti-education!" is the election statement if you don't support things such as a 12% annualized return forever.

I am absolutely shocked anyone at this blog is remotely considering having other citizens pay for the stupidity of any public-sector union.

No more bailouts.

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