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

663

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. OVERVIEW OF PUBLIC PENSIONS ............................................... 667

B. VARIATION IN FUNDING DISCIPLINE .......................................... 669

C. PRIOR SCHOLARSHIP ............................................................... 674

III. INSTITUTIONAL VARIATION .......................................................... 677

A. VARIATION IN THE ALLOCATION OF CONTROL OVER FUNDING

DECISIONS ............................................................................... 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. TRANSPARENCY REGARDING UNFUNDED LIABILITIES ................. 688

1. Liability Sharing Arrangements ................................... 688

2. Disclosure Requirements .............................................. 689

IV. EMPIRICAL DESIGN ........................................................................ 691

A. DATA ...................................................................................... 691

B. ANALYTICAL APPROACH .......................................................... 692

V. RESULTS AND DISCUSSION ............................................................ 695

A. RESULTS ................................................................................. 695

B. CONTROLS AND ROBUSTNESS CHECKS ...................................... 700

VI. POLICY IMPLICATIONS ................................................................... 704

A. 2012 GASB REFORMS ............................................................. 704

B. STATE-LEVEL SOLUTIONS ......................................................... 706

C. STATE ADMINISTRATION OF MUNICIPAL PLANS ........................ 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 aggregate1—

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 scal ed 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 & INV S. (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).