Report: State Pension Plan Among Worst-Funded

April 23, 2010

Investigative Reports

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The NerveThe South Carolina Retirement System is among the worst-funded pension plans for teachers in the nation, according to a study released last week by the Manhattan Institute and the Foundation for Educational Choice.

Titled “Underfunded Teacher Pension Plans: It’s Worse Than You Think,” the study estimates that only 41 percent of the Palmetto State’s public retirement system is funded, eighth-worst in the nation.

Only West Virginia, Illinois, Oklahoma, Indiana, Kansas, Rhode Island and New Jersey fared worse, according to the report.

The S.C. Retirement System is different from some other teacher pension plans in that it administers retirement benefits for all retirees of South Carolina’s public work force, not just teachers.

In plans such as South Carolina’s, where it covers teachers and other non-education public employees, the funding gap calculated in the report was pro-rated based on the share of teacher participation.

The report says the Dow Jones Industrial Average “would have to nearly double overnight” to make up for the underfunding of 59 pension funds that cover most of America’s teachers.

“Although it is generally acknowledged that education is the foundation of every modern society’s future prosperity, schools unfortunately will have to compete with retirees for scarce dollars,” according to the report’s authors. “This competition is uneven, because retirees have a legal claim on promised pension benefits that supersedes schools’ budgetary needs.”

However, Keith Brainard, research director for the National Association of State Retirement Administrators, said he has three major issues with the study:

  • It is based on calculations and methods that do not comply with standards set forth by professional accounting and actuarial standards-setting boards;
  • It is based on assumptions of future investment returns that are unreasonably pessimistic, ignoring a long history of capital market performance and returns from diversified portfolios that typify public pension fund investments; and
  • It focuses solely on investment risk while ignoring other risks that public sector policymakers must consider.

In Brainard’s view, the critical factor is whether the funding of the plan is causing fiscal stress on the state’s budget.”This past fiscal year saw a significant decline in the stock market, but one of the things we try to do in public pension plans, because we have the ability to pool the risk and spread it over a long period of time, is to try and spread out the volatility,” said Peggy Boykin, S.C. Retirement System director. “The perpetuity of government – the fact that government isn’t going to cease to exist – gives us the flexibility of planning for the long term.”

In fiscal year 2008-09, the state retirement system’s rate of return was negative 19 percent, according to the entity’s 2009 annual report. However, in the first six months of the current fiscal year, the system was showing a positive return of 16 percent, Boykin said.

There has been talk of increasing contributions to the plan by one-quarter to one-half percent as a result of the stock market’s decline in recent years, but the system’s actuary has recommended delaying a decision on that until 2012, when the full impact of the recent upturn can be assessed, Boykin said.

Since 1974 the S.C. Retirement System’s average annual return has been 7.75 percent. If the first half of this fiscal year are included, that figure jumps to 8.25 percent, she added.

The report said U.S. taxpayers owe $932.5 billion to teacher pension accounts, nearly three times the amount stated by the retirement plans.

“The insufficiency of assets in state teacher pension funds is massive and unsustainable,” the report said. “States can start by accounting honestly for the current costs of future benefits. If they did so, they would reduce the temptation of their elected officials to be overly generous in awarding benefits.”

The authors said states should consider shifting to 401(k) plans used in the private sector, especially for new and younger employees.

Officially, the S.C. retirement system has a stated funding gap of nearly $4.9 billion, according to the report. That would mean it was 69 percent funded. But after adjusting for market value, the funding gap was nearly $12.2 billion, leaving it only 41 percent funded.

“What they’re using is not public pension-funding methodology,” Boykin said. “They’re valuing us as though we were a corporate pension plan, and there are big differences between how a public pension plan is operated and a corporate pension plan is operated.”

The funding gap cited in the study is the result of aggressive “discounting” of the cost of paying benefits in the future because fund operators assume that the value of stocks held in fund portfolios will be much higher by the time the funds have to pay out those benefits.

This assumption permits public officials to contribute fewer dollars toward satisfying these plans’ obligations, and thus to avoid taking the cautious but unpopular step of raising taxes or cutting services.

The Manhattan Institute is a New York-based think tank that promotes economic choice and responsibility while the Foundation for Educational Choice is a pro-school choice organization.

Reach Dietrich at (803) 779-5022, ext. 110, or kevin@scpolicycouncil.com.