This October 2011 Pension Research Council paper titled, Public Pension Pressures in the United States, discusses why public pensions have warranted so much interest of late, focusing on their financing status and reform options. One reason is that some in the private sector are experiencing “pension envy” on learning that public pension benefits are often more generous than those paid to private sector employees. For instance, benefits on average replace 56% of pay for employees with 30 years of work in the public sector (66% if they are not covered by Social Security), versus 46% for private defined benefit-covered workers. Another reason is that financial markets – investors, rating agencies, and insurers – are devoting much more attention than ever before to the financing demands of public sector pensions plans when considering whether a state may be able to sustain, and surely to increase, efforts to borrow as a means of smoothing the deleterious impact of the financial crisis. This chapter discusses why public pensions have warranted so much interest of late, devoting particular attention to their financing, funding status, recent developments, and reform options.

This study shows that many state pension plans will be able to pay promised benefits for some time, but there is enormous cross-state heterogeneity. Several states will surely require substantial new revenue soon or they will need to institute benefit cuts if they are to return their plans to long-term solvency. What remains to be seen is how the burden of returning the plans to financial health will be borne, and how key stakeholders will implement reforms in these systems, if they are to once again become viable before time runs out.

Public sector pensions in the United States cover approximately 20 million public sector (non-federal) employees and around seven million retirees. The vast majority of U.S. public pension plans are of the defined benefit (DB) variety, where retiree payments are specified as a stream of periodic payments for life with the amounts based on retirees’ salary and years of service. In contrast, most private-sector employees with pensions have defined contribution (DC) plans; in these, contributions are specified as a percent of pay, but no particular benefit payout is specified.

Labor market analysts are in agreement that pensions are one of many forms of deferred compensation offered to enhance employers’ ability to recruit, incentivize, and eventually retire employees. The U.S. has had a rich tradition of offering pensions to public employees, beginning with disability pensions for the militia during the Colonial period. Thereafter, the U.S. Continental Congress established disability programs for members of the armed services during the Revolutionary era, which were later converted to old-age pension programs for veterans. In the mid-19th century, many U.S. cities provided benefits for their superannuated teachers, firefighters, police officers, and other public personnel, as part of a broad effort to reform civil service jobs and move them into a merit-based system rather than one based on patronage. Most federal employees were covered by retirement pensions by 1930, though the federal approach to retirement provision has also evolved over time.

The first U.S. state credited with establishing a statewide retirement plan is Massachusetts, which in 1922 began to cover general public employees. Thereafter, several states moved to implement pensions (mostly defined benefit plans) in response to the passage of the national Social Security Act in 1935, which explicitly excluded public sector employees. In 1950, an amendment to that Act permitted governmental units to enter Social Security; currently, public employees in seven states are still not included in the U.S. Social Security system. In brief overview, this study argues that the recent financial and economic crises have exacerbated the breadth and depth of pension financing challenges by undermining state revenue collections, wounding pension investment performance, and spiking pension liabilities. Fewer active workers remain to support retirees than ever before, and even if equity returns did rise strongly and persistently, it is unlikely that this will happen soon enough to cure the most seriously challenged plans. Yet it is worth remembering that many state pension problems arose for deeper reasons including the lack of public pension transparency, overreliance on risky asset returns to measure pension liabilities, and inability to meet contribution requirements on a regular basis. As a result, too many U.S. state pension systems have become underfunded, and several face enormous challenges in the not-too-distant future if they are to return to solvency.

As a result of the recent ‘perfect storm,’ what was once seen as a safe defined benefit promise has now been transformed into a much riskier retirement offering. U.S. state pensions are not guaranteed by federal backing, so it is possible that a public plan might even be unable to continue paying promised benefits. Though modern U.S. history offers no examples of state bankruptcies to date, some municipalities have had to renegotiate their obligations in recent decades. This in turn raises questions about how public pensions are governed, and whether the existing structures are capable of ensuring managerial oversight of operations and accountability. Pension trustees are the designated ‘holders of the pension purse strings,’ faced with the difficult challenge of balancing the often-conflicting interests of public sector active and retired workers, taxpayers, and consumers.

Those seeking to remake and strengthen public pensions will need to return the plans to affordability, while making them more resilient to financial, economic, demographic, and political pressures.

The full study is most interesting and be found at www.pensionresearchcouncil.org/publications/document.php?file=991