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Government Pensions “Up There” Lessons 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 Lindeman Consultant to OECD*.
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Government Pensions “Up There”Lessons 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)
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.
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 --
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.
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.
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.
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
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.
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.
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.
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.
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 OASDI’s 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.
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 one’s 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.
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.
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 OASDI’s 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
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.
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.
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.
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.
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 TSP’s 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.