Report: Trustees Leading Public Pension Funds Astray

Unaligned incentives of board members are being blamed for state pension funds’ financial woes.

A new report blames public pensions’ financial woes in large part on their trustees, accusing many of them of being politically motivated, and lacking an incentive to protect their plans from major financial risks.

“Political appointees to pension boards are responsive to constituencies—such as local industry or the governor’s budget—that “steer them away from acting in the long-term interest of the pension fund’s fiscal integrity,” said the report, which was authored by Daniel DiSalvo, a senior fellow at the institute, and a professor of political science at the City College of New York. “But the representatives of public employees and their unions on these boards are also tempted to trade pension savings tomorrow for higher salaries today.”

According to consulting firm Milliman, the estimated funded status of the 100 largest US public pension plans is currently 71.2%, with a combined deficit of $1.448 trillion, the largest deficit in two years. Meanwhile, the funded ratio of the top 100 corporate defined benefit pension plans is 93.3%, with a combined deficit of $110 billion.

The incentive problem, says DiSalvo, is inherent in the structure of public pension fund boards, and the “only lasting solution” is to replace state-run defined benefit pensions with defined contribution plans. He argues that although defined contribution plans transfer risk to employees, they do not require boards to “make the kinds of decisions that imperil the funds of defined benefit pensions and the interests of taxpaying citizens.”

DiSalvo says that state pension boards should be making conservative investments and keep the discount rate lower, but that this is not happening. He says that politicians favor a high discount rate to keep short-run costs low, and because they make it appear as though the plan is fully funded because it assumes a high rate of return on existing assets.

DiSalvo cites research from political scientists Sarah Anzia and Terry Moe that found elected representatives of state pension boards did not seek to impose more realistic (lower) discount rates, and didn’t encourage government employers to consistently make the full annual required contribution.

“Rather, the opposite was the case,” wrote DiSalvo. “Pension systems with more plan participants on the board and strong public unions were associated with more fiscally irresponsible decisions. Discount rates were higher, and a lower percentage of the government’s required contributions were paid.”

Despite the DiSalvo’s support of a switch to defined contribution plans, reports from the National Institute on Retirement Security, and the Church Pension Group, a financial services organization that serves the Episcopal Church, argue that defined contribution plans are less efficient and cost more in the long run than defined benefit pension plans, while also providing lower benefits for workers. 

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