A study examining funding policy, benefit design, and economic assumptions of six US public funds, which managed to endure the economic turmoil, shows some consistent features that could be emulated for fund persistence.
The National Institute on Retirement Security (NIRS) study, conducted by Jun Peng, a University of Arizona academic who specialises in state and local government financial management, and Ilana Boivie, director of programs for the NIRS, found the funding policies of these funds were strong and so worthy of examination by other pension systems.
The six funds it looked at (listed below) all had varying asset allocation, discount rates and funding policies, but there was sufficient consistency in certain behaviours and practices that could provide guidance for public pension reform in the US, with the basic tenet of sagacious design.
“The existence of such well-funded pension plans illustrates that public pensions can be designed to be affordable and sustainable, even through one of the most substantial economic downturns,” the paper says.
The paper “Lessons from well-funded public pensions: an analysis of six plans that weathered the financial storm”, identified specific design lessons for other public pension plans.
- The most fundamental principle in ensuring a plan achieves a 100 per cent funding ratio is ensuring the plan sponsors pay the entire amount of the annual required contribution rate each year.
- If a plan is considering increasing employee contributions, it may consider structuring the employee rate so that any cost volatility is shared between the employees and employers. This can be done by implementing an adjustable employee contribution rate, or have a relatively fixed employee rate that pays for a specific portion of the long-term expected pension cost.
- A prudent COLA structure. Ad hoc COLAs can be granted in a sensible and responsible way (for example when the plan is well-funded, and amortise it straight away); and automatic COLAs can be provided at a modest level, eg half of CPI.
- All the pension plans had measures to prevent pension spiking. Spiking can be minimised in three ways: the final average salary (FAS) that determines the pension benefit cannot include a one-time payment at the time of termination; the growth rate in total salary in the final year or two, cannot exceed a certain percentage; the FAS can be capped.
- Economic assumptions – including the overall discount rate, the inflation rate and the real rate of return – are appropriate and achievable over the long term. Four of the six plans examined had a real return expectation close to or well below 4 per cent.
The six funds were:
Delaware Public Employees Retirement Systems’ State Employees Pension Plan
Idaho Public Employee Retirement Systems’ Public Employee Retirement Fund Base Plan
Illinois Municipal Retirement Fund
New York State Teachers’ Retirement System
North Carolina’s Teachers and State Employees’ Retirement System
Teacher Retirement System of Texas
The full study can be accessed here