Funding Discipline for U.S. Public Pension Plans: An Empirical Analysis of Institutional Design

• Author: Natalya Shnitser
• Position: David and Pamela Donohue Assistant Professor, Boston College Law School
• Pages: 663-714

Funding Discipline for U.S. Public Pension Plans: An Empirical Analysis of Institutional Design Natalya Shnitser  ABSTRACT: Using newly collected data on over 100 state-administered pension plans, this Article shows that previously overlooked differences in institutional design are associated with the striking variation in funding discipline across U.S. public pension plans. As state and local governments grapple with unfunded pension obligations, this Article presents a timely examination of public plan governance across two key dimensions: the allocation of control over funding decisions and the transparency with respect to funding liabilities. It shows empirically that greater constraints on legislative control over funding decisions—typically through the delegation of control to pension-system boards—have been associated with better funding discipline. Conversely, liability-pooling arrangements that have shrouded individual employer responsibility for underfunding have been associated with worse funding discipline. These findings should inform current reform efforts to address the multi-trillion dollar shortfall in pension funding. To date, such state and local government efforts have focused primarily on scaling back benefits for public employees but have overlooked the role of institutions in explaining why some public employers have consistently contributed to the pension funds while others have failed to set adequate contribution rates or have withheld promised funds.  David and Pamela Donohue Assistant Professor, Boston College Law School. I would like to thank Rick Antle, Ian Ayres, Shuky Ehrenberg, Yan Epelboym, Henry Hansmann, John Langbein, Amy Monahan, John Morley, James Naughton, Joshua Rauh, Roberta Romano, Maxim Pinkovskiy, Brick Susko and the participants of the Federal Reserve Bank of Cleveland 2013 Conference on Public Pension Underfunding, the 2013 American Law & Economics Association Annual Meeting, the 2013 Netspar International Pension Workshop, the 2013 American Law & Economics Association Annual Meeting, and the Brandeis University 2013 Municipal Finance Conference for helpful comments on earlier drafts. All errors are my own. 664 IOWA LAW REVIEW [Vol. 100:663 I. INTRODUCTION ............................................................................. 665 II. FUNDING DISCIPLINE .................................................................... 667 A. O VERVIEW OF P UBLIC P ENSIONS ............................................... 667 B. V ARIATION IN F UNDING D ISCIPLINE .......................................... 669 C. P RIOR S CHOLARSHIP ............................................................... 674 III. INSTITUTIONAL VARIATION .......................................................... 677 A. V ARIATION IN THE A LLOCATION OF C ONTROL OVER F UNDING D ECISIONS ............................................................................... 677 1. Local Employers vs. State Employers ........................... 677 2. Pension System Trustees vs. State Legislatures ........... 678 3. Delinquent Employers vs. Pension System Trustees ... 685 4. State Legislatures and Pension System Trustees vs. Constitutional Amendments ........................................ 687 B. T RANSPARENCY R EGARDING U NFUNDED L IABILITIES ................. 688 1. Liability Sharing Arrangements ................................... 688 2. Disclosure Requirements .............................................. 689 IV. EMPIRICAL DESIGN ........................................................................ 691 A. D ATA ...................................................................................... 691 B. A NALYTICAL A PPROACH .......................................................... 692 V. RESULTS AND DISCUSSION ............................................................ 695 A. R ESULTS ................................................................................. 695 B. C ONTROLS AND R OBUSTNESS C HECKS ...................................... 700 VI. POLICY IMPLICATIONS ................................................................... 704 A. 2012 GASB R EFORMS ............................................................. 704 B. S TATE -L EVEL S OLUTIONS ......................................................... 706 C. S TATE A DMINISTRATION OF M UNICIPAL P LANS ........................ 707 VII. CONCLUSION ................................................................................ 708 APPENDIX A .................................................................................. 710 APPENDIX B ................................................................................... 711 2015] FUNDING DISCIPLINE FOR U.S. PUBLIC PENSION PLANS 665 I. INTRODUCTION In recent years, the underfunding of public pension plans across the United States—totaling between $1 and $3 trillion dollars in the aggregate 1 — has contributed to ballooning budget deficits, municipal bankruptcies, 2 and increasingly dramatic calls for public pension reform. 3 The lack of funding discipline on the part of some public employers, as measured by the failure of such employers to meet the annual contribution benchmarks recommended by the Governmental Accounting Standards Board (“GASB”), has been a significant culprit. 4 Despite the widespread consensus that meeting these benchmark contribution targets is essential for the responsible management of long-term pension liabilities, U.S. public employers have exhibited tremendous variation in funding discipline, with some consistently making the recommended pension payments but others habitually skipping or underpaying the target contributions. Using newly collected data on 110 state-administered public pension plans, this Article shows that previously overlooked differences in plan-level 1. Joshua Rauh, The Pension Bomb , MILKEN INST. REV., Jan. 2011, at 28, 32, available at http://assets1c.milkeninstitute.org/assets/Publication/MIReview/PDF/26-37.mr49.pdf. See generally ALICIA H. MUNNELL ET AL., CTR. FOR RET. RESEARCH AT BOS. COLL., THE FUNDING OF STATE AND LOCAL PENSIONS: 2012–2016 (2013), available at http://crr.bc.edu/wp-content/uploads/2013/07/slp_32-508.pdf. 2. In recent years, a number of municipalities, including Vallejo, California, in 2008, Central Falls, Rhode Island, in 2011, Stockton, California, and Mammoth Lakes, California, in 2012, and Detroit, Michigan, in 2013, have filed for bankruptcy in part due to the burden of pension obligations. See, e.g. , Monica Davey & Mary Williams Walsh, Billions in Debt, Detroit Tumbles into Insolvency , N.Y. TIMES (July 18, 2013), http://www.nytimes.com/2013/07/19/us/detroit-files-for-bankruptcy.html; Elizabeth Trotta , Stockton Teeters on Bankruptcy Edge, but City’s Not Alone, THE EXCHANGE (June 27, 2012, 3:00 PM), http://finance.yahoo.com/blogs/the-exchange/ stockton-teeters-bankruptcy-edge-city-not-alone-190026487.html. 3. In the same period, most states scaled back pensions for new employees, and a number of states reduced pension obligations to current employees and retirees. See U.S. GOV’T ACCOUNTABILITY OFFICE, STATE AND LOCAL GOVERNMENT PENSION PLANS: ECONOMIC DOWNTURN SPURS EFFORTS TO ADDRESS COSTS AND SUSTAINABILITY 21 (2012), available at http://www.gao. gov/assets/590/589043.pdf; see also John W. Schoen, Pandemic of Pension Woes Is Plaguing the Nation , CNBC (Nov. 19, 2013, 6:00 AM), http://www.cnbc.com/id/100929269; Christine Williamson, Motor City as a Motivator: Detroit’s Woes Seen Likely to Push Others to Resolve Their Pension Underfunding , PENSIONS & INVS. (Aug. 5, 2013), http://www.pionline.com/article/20130805/ PRINT/130809965/motor-city-as-a-motivator. In July of 2013, Senator Hatch proposed “a way for states and cities to exit the pension business.” Mary Williams Walsh, Pension Proposal Aims to Ease Burden on States and Cities , N.Y. TIMES (July 9, 2013, 12:01 AM), http://dealbook.nytimes.com/ 2013/07/09/pension-proposal-aims-to-ease-burden-on-states-and-cities. Under the proposal, local governments would hold annual auctions to purchase annuity contracts for their employees. In the course of the working years, an employee would collect a series of annuity contracts that, in the aggregate, would substitute for a pension. The public employer’s liability would consist only of the upfront payment to the insurer. Id. 4. The GASB is a private, not-for-profit entity that sets standards for accounting and financial reporting by state and local governments. Facts About GASB , GOV’T ACCT. STANDARDS BOARD, http:// www.gasb.org/jsp/GASB/Document_C/GASBDocumentPage&cid=1176163065939 (last visited Oct. 29, 2014). 666 IOWA LAW REVIEW [Vol. 100:663 institutional design are associated with the variation in funding discipline. The analysis exploits the lack of federal regulation for public plans, which has left the governance of such plans to highly variable, plan-specific rules. Across the plans examined in this Article, there are significant differences in the employees and employers covered, the composition of the governing system boards, the control afforded to the state legislatures, the allocation and disclosure of liabilities, and even the statutory and constitutional constraints on pension funding. Such variation presents a unique opportunity to study how different public employers have managed long-term liabilities and how legal institutions have been used to constrain the inherent principle–agent problems and the tendency of political actors “to prefer the present to the future.” 5 The focus of the analysis in this Article is on institutional variation across two key dimensions: the allocation of control over funding decisions and the transparency with respect to funding liabilities. The results of the empirical analysis indicate that greater delegation of control over funding decisions to pension system boards has been associated with better funding discipline. Conversely, the widely adopted “cost-sharing” arrangements...