Thursday, April 25, 2013


On April 18, 2013, Congressman Devin Nunes (R-CA) introduced the newest version of his Public Employee Pension Transparency Act,” HR 1628, and its companion, S 779, was introduced in the Senate on April 23, 2013, by Senator Richard Burr (R-NC).  The bills are essentially the same as the previous versions from the last Congress, with a few significant exceptions.  Despite a “Dear Colleague” request made to other House members on February 25, 2013, Congressman Nunes only has two original cosponsors, as does Senator Burr.  NCTR, along with nine other national organizations, wrote to all House members on April 3, 2013, urging them not to cosponsor the Nunes legislation, and has recently joined with 20 other national groups representing public employers, public employees and public pension fund administrators in writing to former cosponsors of the legislation telling them PEPTA is unwise and unwarranted and asking for a meeting to discuss public pension plan reforms.  There are some signs that PEPTA may have lost some steam since the last Congress, but NCTR and other public sector organizations still view it as a major legislative threat.

In General
The new PEPTA legislation (HR 1628 and S 779) continues to require that, in order to retain Federal tax-exempt status for their bonds, sponsors of State and local pension plans (other than defined contribution plans) must file an annual report as well as potential supplementary reports with the Secretary of the Treasury related to their pension finances. These reports will be entered into a database that will be accessible to the public.

In effect, PEPTA would require every public pension plan to essentially keep two sets of books.  One would be the set that plans currently produce, which would reflect the reality of balanced investment portfolios -- including stocks and other sensible investment alternatives as well as bonds – that have, over the past 25 years, averaged 8.8 percent returns (based on median returns for periods ended 09/30/2012).  The other set would pretend that all public plan assets were invested in U.S. Treasury bonds (even though this is not the case for any public plan), which currently yield around 3 percent. 

The result would be two substantially different measurements of a plan’s unfunded liabilities maintained by the Treasury Department.  One set of numbers would be a substantially increased, artificial liability measurement that the use of the Treasury yield curve would produce, which, along with the unsmoothed valuation of assets, would significantly understate plan funding levels. This artificial set of numbers will differ substantially from those used to fund a plan or required for accounting and financial reporting purposes under GASB.  The reporting of these two sets of numbers will only serve to confuse the public, failing to provide clarity with regard to public pension accounting.
Specifically, PEPTA would require an annual report that would have to include the following:
  • A schedule of the funding status of the plan, including the net unfunded liability and the funding percentage of the plan;
  • A schedule of contributions by the plan sponsor for the plan year;
  • Alternative projections for each of the next 60 plan years of cash flows associated with the current liability, together with a statement of the assumptions used in connection with such projections;
  • A statement of the actuarial assumptions used for the plan year;
  • A statement of the number of plan participants who are retired or separated from service and are either receiving benefits or are entitled to future benefits and those who are active under the plan;
  • A statement of the plan's investment returns including the rate of return, for the plan year and the 5 preceding plan years;
  • A statement of the degree to which unfunded liabilities are expected to be eliminated;
  • A statement of the current cost of the plan for the plan year; and
  • A statement of the amount of pension obligation bonds outstanding.

The two significant changes from last year’s bill are the requirement for 60 years of plan projections of cash flow instead of 20 years, and the addition of the “current cost” of the plan.
In addition to the annual reports, supplementary reports will be required of plan sponsors in any case in which either the value of plan assets in the annual report is not determined using fair market value, or the interest rate or rates used to determine the value of liabilities or as the discount value for liabilities are not interest rates based on US Treasury obligation yield curve rates.

The supplementary report would be required to include certain information specified in the Annual Report -- specifically, a schedule of the funding status of the plan; a statement of plan investment returns; the degree and manner the plan sponsor expects to eliminate its current unfunded liability; and the plan’s current cost -- but determined by valuing plan assets at fair market value and by using the applicable daily Treasury obligation yield curve rate as the discount rate.  (This is also different from the previous legislation, in that it no longer would require the Treasury yield curve to be based on three different periods.) 

Finally, the legislation would continue to prohibit a Federal bail-out of public pensions.

Public Sector Reaction
On February 25th, Congressman Nunes circulated a “Dear Colleague” request to his fellow House members, asking them to join in cosponsoring his legislation.  NCTR immediately alerted its members, urging them to contact their Congressional delegations, particularly those Members who had cosponsored PEPTA in the last Congress, to ask them to call their public retirement systems before they considered cosponsoring the Nunes PEPTA legislation.   

Next, on April 3, NCTR, along with nine other national organizations, wrote to all House members, asking them not to cosponsor the Nunes legislation, and pointing out that PEPTA “paints an inaccurate and misleading picture of the state of public finance and pensions, and ignores the extensive efforts made at the state and local levels to close short-term budget deficits, as well as address longer-term obligations such as pensions.”  The letter went on to note that “Federal intrusion into areas that are the fiscal responsibility of state and local governments is unwarranted” and that it “makes no sense to impose disruptive and costly federal requirements that only serve to interfere with state and local government economic recovery and pension reform efforts.” 

When Congressman Nunes introduced PEPTA on April 18th, NCTR issued a Press Statement that condemned the legislation as a Federal takeover of public pension accounting.  The statement quoted Meredith Williams, NCTR’s Executive Director, as saying that “I continue to be surprised that Congressman Nunes and his supporters believe that imposing unwarranted, unnecessary, and duplicative Federal regulation on state and local governments is the best way to solve any problem.”

The statement went on to note that when, as now, interest rates are very low, PEPTA will make pension plans appear very underfunded.  This could place pressure on State and local governments to put more monies into these funds than they really need based on their actual funding status.  “But when interest rates are high, it could make plans look even more funded than they actually are, which could exacerbate the underfunding of pensions,” the statement pointed out.

Finally, NCTR has joined with 20 other national groups representing public employers, public employees and public pension fund administrators in writing to former cosponsors of the legislation in both the House and Senate on April 24, 2013, telling them PEPTA is unwise and unwarranted and asking for a meeting to discuss public pension plan reforms.  The letter points out that the Government Accountability Office (GAO) (in a March 2012 report entitled “State and Local Government Pension Plans: Economic Downturn Spurs Efforts to Address Costs and Sustainability”) documented that the exhaustion dates cited in the PEPTA summary materials are “not realistic estimates” of the true financial condition of state and local retirement plans.   “Nevertheless,” the letter continues, “the legislation has been reintroduced in the 113th Congress, along with the same misleading information.”

As before, Congressman Nunes was joined in introducing the legislation by Congressman Paul Ryan (R-WI), the Chairman of the House Budget Committee, and Congressman Darrell Issa (R-CA), Chairman of the House Oversight and Government Reform Committee.  These two gentlemen continue to be very powerful members of the overall House Leadership.  However, unlike in the previous Congress, when Mr. Nunes had 36 additional original cosponsors when his bill was dropped and he added another 13 subsequently, he introduced PEPTA in this Congress with only these two additional original cosponsors. And, despite almost two months of seeking other cosponsors, he has only been able to add five more:  Cramer (R-ND); Duncan (R-SC); Jones (R-NC); McClintock (R-CA); and Westmoreland (R-GA). 

Similarly, in the Senate, Senator Burr had only two additional cosponsors when introducing his legislation on April 23rd – Senators Coburn (R-OK) and Thune (R-SD).  In the last Congress, when Burr introduced the Senate PEPTA bill, he had six original cosponsors,  Missing, at least for now, are Senators Grassley (R-IA) and Isakson (R-GA); Senators Ensign (R-NV) and Kyl (R-AZ) are no longer in the Senate.  Also, Senators Kirk (R-IL) and Chambliss (R-GA), who subsequently cosponsored the Burr legislation in the last Congress, are also missing from it so far.
While it is certainly likely that additional cosponsors will be added to both items of legislation, it does suggest that both Senator Burr and Congressman Nunes may have had some difficulty in obtaining comparable numbers for the introduction of this new version of their legislation.  This in turn suggests that the public sector message of unnecessary and unwarranted Federal intrusion is getting across.  Also, unlike the introduction of the PEPTA legislation in 2011, there are no signs of any coordinated media campaign this time around.  Congressman Nunes has not been seen on television talking about “smoking the rats out of their holes,” for example.

However, it is well to note that Congressman Nunes has a new trifold brochure supporting his legislation that includes a litany of supportive quotes and endorsements from newspapers across the country for his earlier bill.  Also, notwithstanding his new role as Chairman of the House Ways and Means Trade Subcommittee, and the demands it places on his time, he has once again championed this legislation.  In short, it cannot be safely assumed that this time he is any less serious about advancing PEPTA.  And as a more senior member and part of the leadership of the Ways and Means Committee, he is now in a much better position to help move it than he was in the last Congress.   

In summary, NCTR and the public pension community in Washington are taking the new PEPTA legislation as a very serious threat.  The risk is not that the legislation will be moved as a free-standing bill, but that it will be added to some other major piece of legislation, such as an extension of the debt ceiling, or tax reform, from which it will be difficult to strip out. 

Hopefully, the efforts of NCTR and its members to keep cosponsors off the bill this time around are working, and Members of Congress are not as quick to jump to blame public pensions for all of State and local governments’ fiscal problems as they have been in the past.  If you have not yet reached out to your Congressional delegation on this matter, please do so as soon as is possible.

Monday, April 1, 2013


A new “Backgrounder on Education” was released by the Heritage Foundation on March 25, 2013.   Entitled Official Education Spending Figures Do Not Incorporate Full Cost of Teacher Pensions, the new report claims that the Federal government “dramatically underestimates” teacher pension costs in its official education spending figures, and that correcting the problem could add tens of billions of dollars—about $1,000 per pupil—to official education spending estimates.
The report’s author, Jason Richwine, is the Heritage Foundation’s senior policy analyst in empirical studies, specializing in education policy, public-sector compensation and labor issues.  He also wrote another Heritage Foundation report, along with Andrew Biggs from the American Enterprise Institute (AEI), entitled Assessing the Compensation of Public-School Teachers.  (This report claimed that public-school-teachers’ total compensation (including benefits) was 52 percent greater than fair market levels indicate they should be, given the “relative lack of rigor of education courses” -- meaning that “many teachers have not faced as demanding a college curriculum as other graduates” -- and the “low cognitive ability compared to other college graduates” that active teachers exhibit.)

Richwine’s latest report asserts that the Federal government’s incorrect education spending estimates are due to the fact that the National Center for Education Statistics (NCES), a division of the U.S. Department of Education, permits states to define teacher pension costs as the amount school districts contribute to their pension funds each year. However, Richwine argues that since governments “frequently underfund their pensions,” the reported amount does not really reflect the “true” costs of these pensions, and that the “correct accounting” would measure pension costs based on the present value of future pension benefits that teachers have accrued. 
Of course, Richwine also insists that this “correct accounting” approach would also use a discount rate based on a virtually risk-free rate of return, such as the yield on U.S. Treasury bonds of around 3 percent currently, instead of the pension accounting method that he notes “detractors might call … an accounting trick” that bases the discount rate on the expected rate of return on plan investments.   This latter approach, Richwine say, is “roundly rejected by financial economists, private pension administrators, and public-sector pension regulators in other industrialized nations.” 

Consequently, Richwine argues, government actuaries discount future pension liabilities at a rate that is too high.  If the current numbers used by the NCES were replaced with both the risk-adjusted normal cost and the payments toward unfunded liabilities, the cost of overall benefits would go up by 78.8 percent, according to Richwine, and official total expenditures-per-pupil would rise from $12,309 to $14,054 during the 2009–2010 school year, which is the most recent year for which data are available.
Therefore, Richwine recommends that the NCES should begin measuring the cost of pensions with actual risk-adjusted pension liabilities rather than annual contributions.  He says that this would provide more accurate estimates of teacher pension costs and of education spending in general.

Richwine devotes much time to discussing how many economists agree that the only appropriate way to calculate the present value of a very-low-risk liability is to use a very-low-risk discount rate.  He says that this is a “basic principle of financial economics,” and that economists “practically unanimously support” this method. 
He goes so far as to point out that in a 2012 poll, 38 of 39 leading economists agreed with this statement: “By discounting pension liabilities at high interest rates under government accounting standards, many U.S. state and local governments understate their pension liabilities and the costs of providing pensions to public-sector workers.”  Richwine asserts that therefore, “defenders of public pension accounting methods, not their critics in mainstream economics, are the embattled contrarians.”

With all due respect to economists, they are not always right.  Indeed, Paul Krugman, an economist and winner of the 2008 Nobel Memorial Prize in Economic Science, has pointed out that economists can indeed make mistakes.  In a September 2, 2009 article in The New York Times entitled How Did Economists Get It So Wrong? Mr. Krugman discussed how so few economists saw the 2008 economic crisis coming.
Mr. Krugman noted that “During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right.”  “There was nothing in the prevailing models,” he observed, “suggesting the possibility of the kind of collapse that happened” in 2008.  The problem, he went on to say, was that the economics profession “went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”

So too, perhaps, with the discount rate controversy?  The financial economics model for the discount rate may work beautifully for critics of public sector defined benefit plans when, as now, there is a very long period of very low interest rates.  It can make it appear that plans are discounting future pension liabilities at too high a rate.  Consequently, critics argue, basing the discount rate on the expected return on plan investments systematically understates the costs of funding public pension plans. 
However, what happens when interest rates are very high?  Does the “truth” of Mr. Richwine’s assertions still hold?  For example, 30-year Treasury yields (as of the June valuation date) were almost at 14% in 1982 and 1984.  Between 1978 and 1985 they were consistently above 8%.  During such periods, would financial economists continue to insist that a discount rate based on expected rates of return understates the costs of funding plans?  Would 38 of 39 leading economists still agree that by discounting pension liabilities at the expected rates of return, many U.S. state and local governments were understating their pension liabilities and the costs of providing pensions to public-sector workers?

Basing the discount rate on the risk-free rate of return during periods of high interest rates could make plans look much better funded than they actually are.  Contribution rates could fall below those based on expected rates of return, and could exacerbate underfunding problems when interest rates drop.
I am not an economist, but it seems to me that for a theory to be useful -- in practice and not just in theory -- it should work regardless of whether a risk-free rate is at historic lows, as it has been now for several years, or in the double digits, as it may well be in the future depending upon inflation. 

Just consider me an “embattled contarian.”