Thursday, August 21, 2014

Tennessee forces Nashville and Memphis to fund their pensions

Two cities in Tennessee manage their own defined-benefit pensions, and it is no coincidence that both are majority Democratic, and both are underfunded.  We have discussed the reasons for this in past  blog posts.

Efforts at pension reform have been slow because voters in these cities do not seem to understand or care much about the future pension liabilities, which means that it is not a high priority for politicians.

For example when Nashville went to a more realistic discount rate, from 8.25% down to 7.5%, the city also changed the assumptions on pension growth so that the net effect was no additional savings.  So Nashville gave the appearance of change, without the substance.    

Also, for underfunded pensions, this kind of discounting creates an incentive for fund managers to go into riskier assets.  Indeed, Nashville's pension manager has adopted a riskier investment strategy.  Cross your fingers.   

And we still save nothing for medical pensions.  That is the elephant in the room.  

The obvious solution is a defined contribution schedule, like the Swedes, or  a more reasonable rate linked to the 30 year treasuries, adjusted for tax free status, e.g. 6.5%.

The latest development is a new state law, designed to force these cities to fully fund their pensions.  It does not force cities to make up for past underfunding.  


  1. Interesting. Also, interesting to note that 6.5% may even be optimistic, since it is based on the forecasted interest rate trends and may not account for medical cost inflation (5%) or other factors that could significantly vary. This number also relies upon the accuracy of retirement and mortality rates, which have been proven to be unreliable.

  2. I am of the opinion that government is never (perhaps almost never) able to be disciplined when a pile of money is lying around. Furthermore, a plan may start out like a good idea. Then it quickly becomes political (in particular when it comes to offering entitlements). The likelihood of a politician changing from DB to DC is low. For one, it goes against some in government’s paternalistic ideology. Second, it’s a political winner for liberals at least until calamity is immanent. The adjustments to the liability assumptions are a perfect example of government shuffling around numbers to make something look solvent. Any pragmatic observer knows its bullshit. There is a reason that Social Security & Medicare are considered the 3rd Rail of politics. I’m just concerned that we are at the point where the “tax consumer base” is larger than the “tax payer base”. That is a long-term structural issue.

    Another issue I’d like to hear from Dr. Froeb on is; why don’t state and local DB plans have to pay for PBGC insurance. I think about the teacher in Detroit. Potentially screwed six ways from Sunday. All decisions made by bad administrators. (The unions have a share in that blame, but that is a horrific loss for many of those families. I wonder on those in government with a paternalist ideology feel about that situation…..?)

  3. Good questions. The problems are easily analyzed using economics; the solutions are political. Perhaps we would make public pensions conform to the same rules as private ones.

  4. Luke, your last sentence is not technically correct. The law forces plans to begin fully funding to a concept called their ARC. Over time, in the calculation of the ARC any degree of underfunding due to a lack of prior funding the ARC, or due to missing the return target expectations will be incorporated into the estimated ARC requirements. So, over time, this law does force plans to make up for past under-funding.

  5. Nashville and Tennessee need to provide for pension reform addressing current liabilities and future liabilities. Current liabilities need to address the current weighted average cost of funding the pension fund in addition to addressing the future needs of the fund. As the current pension fund remains underfunded contributions in the future will need to be greater catching up with lost time and revenues. Additionally, Nashville and Tennessee need to consider pension benefit plans including self directed funds. The self directed funds would provide prescribed contribution, where participants would make choices on the investments. This change would shift the risk or liability of investing from the Nashville and Tennessee to individual employees (Brigham/Ehrhardt, 2014).

    Brigham/Ehrhardt. (2014). Financial Management Theory and Practice. Ohio: South-Western.