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Issues in US Public Pension Management © Olivia S. Mitchell The Wharton School Pension plans are long-term financial contracts: Objective: to deliver affordable, reliable retirement benefits Key: A long term financial promise Nature of promise How long?

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issues in us public pension management

Issues in US Public Pension Management

©Olivia S. Mitchell

The Wharton School

pension plans are long term financial contracts
Pension plans are long-term financial contracts:
  • Objective: to deliver affordable, reliable retirement benefits
  • Key: A long term financial promise
    • Nature of promise
    • How long?
  • US public pension environment complex
us public retirement system
US Public Retirement System


Military Plans

State & Local



Civilian Plans



National Social Security System: Defined Benefit, mostly unfunded

us social security
US Social Security:
  • Mandatory retirement system, defined benefit (DB)
  • Payroll-tax financed, mostly PAYGO
  • Single largest government program
  • Payroll tax: 15.3% tax on covered earnings (split)
    • OASI: 5.26% of pay to cap ($80,400 in ‘01,indexed)
    • DI: 0.94% “ “ “
    • HI: 1.45% on all earnings
    • ==>Most HH in US pay more to SS than to IRS.
social security system 00
OASDI Payroll Taxes/yr: $493B

Workers w/ taxable earnings: ~153M

OASDI Taxes/Worker: $3,200/year

OASDI revenues/yr: $568B

OASDI Benefits/yr: $408B

Recipients: ~45 M

Av. Retiree Benefit: ~$9,100/year

OASDI expenditures/yr: $415B

Social Security System (00)

us public sector employees
Who’s included?

Federal govt civilian,


State and local gov’t workers (eg teachers & legislators, police/fire, municipal)

75% covered by Social Security as 1st pillar plan

Most have 2nd pillar DB pension too

Lately DC growing

US public sector employees:
federal civilian pensions
Federal Civilian Pensions
  • 3M employees, including Congress and Postal Service
  • 1st pillar DB plan with old and new vintages:
    • CSRS set up before Social Security (1920)

Benefit = 2% Pay * Service

    • FRS (1983) when federal workers into SS

Benefit = 1% Pay * Service

  • Plus TSP plan: defined contribution
    • CSRS: 5% ee, no employer match
    • FRS: up to 10% ee, +5% employer match

1.5% to 5, 1.75% next 5, 2% thereafter; FAP=Hi3

federal db plans
Federal DB plans
  • Assets Liabilities Funded %
  • CSRS $361B $962B 38%
  • FERS $97B $191B 50%

Hustead (2000)

federal thrift saving plan tsp
Federal Thrift Saving Plan (TSP)
  • 2nd pillar defined contribution plan for federal employees (1984).
  • ~$93B assets, 2.5 M participants (3/01)
  • Average account balance ~$37,000
  • Employer contributes 1% of pay for all; then employees elect 0-10% and have employer match* to total of 15%

*100% to 3%, 30% to 5%

5 investment options in tsp
G fund: Special issue Treasury Securities

C fund: Stock index fund (S&P500)

F fund: Fixed Income index fund (Lehman Bros Aggr. Index)

2 New Additions: 2001

S fund: Small Cap Stock Index fund (Wilshire 4500 Index)

I fund: Int’l Stock Index Fund (EAFE Index)

Money Manager is Barclays

5 Investment Options in TSP:
tsp admin charges very low 00
G fund: 0.05% of assets

C fund: 0.06% of assets

F fund: 0.07% of assets

Compare to retail mutual funds: 1-2% of assets

TSP admin charges very low (00)
tsp asset allocation patterns 3 01
TSP Asset Allocation Patterns(3/01)
  • G fund (Govt sec’s): 38% ($35.5B )
  • C fund (equities): 56% ($52.4B)
  • F fund (fixed income): 6% ($5.4B)

[Private pensions: 55-60% equities, too]

other tsp design issues
Other TSP design issues:
  • Transfers:
    • 1x per month, Web or by mail
    • Transfer effective by end of month, if in by 15th, otherwise end of next month
  • Payouts:
    • Annuities, or
    • Cash refund
federal military pensions
Federal Military Pensions
  • ~3M employees, high turnover even in peacetime (>1/2 have < 7 years tenure)
  • 1st Pillar DB plan for 20+ years service

Benefit = 1/3 of compensation

Most retire ~ age 42

  • 28% funded: $150B assets, $529B liabilities
from 2001 military can join tsp
From 2001: Military can join TSP
  • Voluntary contribution:
    • Up to 7% of base pay
    • To $11K indexed, $15K by 2006 (sec 402(g))

state and local pensions s l
State and Local Pensions (S&L)
  • 2200 systems, 13M employees, 5M beneficiaries
  • Generally 1st pillar DB plan:

Benefit = 2% Pay * Service

  • Some also have 2nd pillar DC plan
  • Increasingly: CHOICE (DB or DC) – Florida, for example
s l plan performance
S&L Plan Performance

All Systems (’99)

  • Assets ~$2Trillion
  • Contributions $62B
  • Benefits paid $82B

Funding Status: 98%

5-yr ROR($wtd to 98): 14% and PENDAT 1998

keys to a well run public pension system
Keys to a well-run public pension system:
  • Good governance: contributions, recordkeeping, money management, benefit payments.
  • Shielded asset management.
  • Performance standards, reviews, penalties for noncompliance.
  • Transparent reporting/disclosure.
governance concerns include
Governance concerns include:
  • Ignorance/Fraud: Pension invests in junk bonds (Orange County).
  • Asset valuation: Japanese pensions hold large interest in insolvent banks.
  • Shareholder activism: Fund managers tell companies what to do (e.g. Penn fund divests insurers; TIAA-CREF proxy votes on social fund)
etis economically targeted social investments
“When pension assets must be invested according to political/social criteria; ignore risk/return”

Malaysian Provident funds had to help insurers.

Korean pensions loaned 2/3 of assets to MOF for “social” purposes

African and Mexican public funds must invest in mortgages.

Alaska Ret System lost ~$80M in local home mortgages when oil prices fell

ETIs: Economically Targeted/Social Investments
how to enhance pension asset security
How to enhance pension asset security?
  • Institutional Structure: Board size, composition, membership, authority
  • Set performance standards: fiduciary role, penalties: ERISA as a model
the prudent person rule
The Prudent Person Rule:
  • Requires managers to be “prudent” and manage in best interest of participants;
  • Show diversification;
  • Investments part of risk/return portfolio;
  • Held personally liable if found imprudent.
  • Operational Controls: liability insurance.
  • Investment Authority: Competitive bids for outsourced investment
  • Reporting/Disclosure: Frequency/form of asset /liability valuation, common assumptions, reporting format for expenses, returns, risk.
governance affects s l investment outcomes
Governance affects S&L investment outcomes:
  • Retirees on boards cuts returns slightly (more bonds).
  • In-house vs external money managers have similar investment patterns (but competition critical)
  • Requirement to invest in own-state projects can reduce returns.
  • Requiring fiduciary insurance can help.
emerging public plan challenges
Movement toward

DC plans

Hybrid plans

Concern over admin costs

Poor investment performance



Investor advice and education

Emerging public plan challenges:
  • Public pension design and management not simple.
  • Usual pension issues PLUS political risk
  • Funding avoids retirement insecurity and later problems
benefits of stronger public pensions in developing countries
Benefits of stronger public pensions in developing countries:
  • Primary: More reliable old-age support for aging population, less uncertain tax environment
  • Secondary: better-run real sector (reporting/disclosure stronger), capital market broader/deeper, robust insurance market, possibly higher national saving