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March 15, 2010

The Largest Loophole

In an effort to close loopholes and bring a public retirement system rife with abuse and calculated manipulation into line with the state’s present economic priorities, Deval Patrick and the state legislature last year tightened the rules governing state pensions.

But a Pew Center on the States report published last month included Massachusetts on a list of 19 states whose pension systems are “cause for serious concern.”

And the problems highlighted in the Pew report have little to do with public employees scamming the system. In fact, the system is barely worth scamming because the government can’t manage to fund it fully.

Now, the governor has set his sights on making the state’s ever weakening pension system financially solvent, and we hope he brings leadership of a more uncompromising variety to that problem than he did to tightening the system’s loopholes last year.

Closing loopholes, while necessary, was largely a political exercise. Unfortunately, many large loopholes remain, as detailed by recent Boston Globe reports on the Bristol County Sheriff’s office.

Aging

We’re encouraged that in his latest bid for reform, Patrick seems to be on the right track. He’s proposed raising the state retirement age from 65 to 67 and capping pensions at $85,000 per year. He also wants to base pensions on average employee earnings over the last five years on the job, rather than the last three.

And even though the current economic hard times could and should lead to greater state employee union flexibility on reform, the governor and the legislature must also focus on how the pension fund is supported.

The Pew study found that Massachusetts was one of eight states to leave more than one-third of its total pension liability unfunded in the 2008 fiscal year.

The Pew report highlighted that the state’s pension liability was equal to 207 percent of state payroll, and over five years, it had contributed 93 percent of the amount it was required to contribute for benefits to be fully funded.

And at last check, the state assumed an 8.25 percent return on investment for its pension fund — clearly an aggressive assumption. States with high performing pension funds generally assume a return closer to 7 percent, according to Pew, and there are knowledgeable investors who advocate for making that assumption even more conservative.

Sunshine State

It’s not impossible to get the funding right. New York’s pension system is 107 percent funded. In December, New York’s legislature raised the state’s minimum retirement age from 55 to 62. Florida, Wisconsin and Washington all fund their pension systems at or above 100 percent.

The defined benefit pension is a dinosaur. It can be incredibly expensive, difficult to manage, and hard to predict. All but the biggest and oldest firms in the United States have abandoned it for the defined contribution 401(k) or similar plans.

States seemingly stick with their pension systems because selling public sector employees on a 401(k)-style retirement system would inevitably produce a massive squabble with employee unions committed to at least preserving the status quo. The fixed pension system is a better deal for employees, and in the public sectors where pay is not high, it seems a reasonable benefit.

But Massachusetts, like other states that have chronically underfunded their pension systems, is finding it owes more annually as a result. Unchecked or unchanged, the debt will increase exponentially and lawmakers will be forced to make stark choices between funding pensions or funding education, or health care, etc.

States know, or can ascertain with reasonable accuracy, how much they should be putting away each year to cover current and future public sector retirees. We hope Patrick can give even more attention than he gave to closing public pension loopholes to requiring the state to fully fund and intelligently manage its retirement system.

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