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Public Employee Pensions and Investments

Abstract and Keywords

This article surveys the landscape of state and local retirement systems and assembles a long list of policy ideas and concerns. On average, public pension funds are in trouble, and the unfunded liabilities promise to strain tight public budgets. But not all systems are having difficulties. Overall, there are many dark clouds on the horizon. What are needed are more realistic actuarial assumptions, setting contribution floors, reducing the generosity of benefit structures, and sharing more costs with employees. States facing severe underfunding of pensions need dramatic reforms. Pensions are only part of the problem: other postretirement benefits (particularly those involving health care) exacerbate the financial trauma that lies ahead. The article notes that the states with severe funding problems face unsavory choices. They should assume a lower rate of return on investments.

Keywords: employee pension, local retirement system, pension funds, public budgets, return on investment, rate of return

Nineteen million public employees are covered by state and local retirement systems. Public pension funds exist at most jurisdiction levels, and they are tailored for teachers, safety workers, sanitation workers, judges, legislators, school janitors, and civil servants, among other occupations.1 These funds control a total of $3.2 trillion in assets, and they face up to $3 trillion in unfunded liabilities.2 Large public employee retirement systems are influential in corporate governance and management at many of the most important corporations in the country; at the same time, many funds are dealing with catastrophic financial losses after complex investment products went sour in the 2008 financial crisis. Many state and local governments are currently faced with rapidly increasing annual contributions to pension and health-care funds to pay for benefits promised years earlier.

In short, there are many reasons why the health of state and local public pension systems is a pressing financial, political, and policy issue. While the fall in asset values since 2007 has made pension finances a prominent public concern, the underlying forces affecting public pension funds at the turn of the decade have been fairly stable for two decades: changing demographics and fewer active employees compared to retirees along with stretched state and local budgets. In addition to these constants, recent changes in the accounting rules they observe have highlighted liabilities that are tied to retirement health-care benefits. As fiscal tensions and an aging population come to a head, plan beneficiaries, taxpayers, and credit markets will continue to assess the ability of the pension plans to efficiently fulfill their role. At the forefront are concerns that public pension funds will not be (p. 844) adequate to pay for promised benefits, and past administration of state and local retirement policies and funds have set up a potential budget time bomb.

While there is wide variation in the financial health of the 2,000 plans in the United States, there is no question that many jurisdictions face serious funding problems in their retirement systems. Even if investment returns jump to the previous decade's highs, many systems are underfunded; essentially, the funds are borrowing against the future, affecting taxpayers, public servants, and future public service. Strategies to address these gaps—which could include raising employee and employer contribution rates, adjusting benefits for future employees (and possibly current employees), shifting financial management, and changing the very structure of the systems—must be implemented soon.

This chapter provides an overview of US state and local public employee retirement systems. The data presented come from multiple sources, including the US 2008 Census, the Bureau of Labor Statistics, the Public FundSurvey, the Government Accountability Office, the National Center on State Legislatures, and the Pew Center on the States. The first section of the chapter describes the structure, finances, and history of state and local pension plans. This section introduces the fundamentals of state and local retirement systems, and it presents the current state of affairs in these systems following the financial market collapse of 2007–2008. The next section summarizes major areas of recent research concerning public pension plans, including health benefits and liabilities, actuarial methodology and assumptions, shifts into defined contribution plans, and governance and investment management. The final section outlines the effects of the recent financial and fiscal crises and examines steps taken to address the unfunded liabilities. It argues that reforms to date have been too incremental, and serious structural shifts must be undertaken to pay for the retirement and health benefits already promised to active employees while remaining competitive employers in the future.

Public Pension Plan Structure

Public employee retirement systems provide retirement income and other benefits to former state and local employees. While there is variation as to how employees in different occupations are clustered and the ways public pension systems are structured, the vast majority of the funds are set up as defined benefit (DB) plans: 84 percent of state and local government employees have access to DB plans.3 Defined benefit systems promise a specified retirement benefit to be collected in the future, generally with minimal years of service and age requirements. The specified benefits frequently include cost-of-living adjustments (COLAs). In contrast, (p. 845) defined contribution (DC) plans accumulate funds for an employee throughout his or her tenure; upon retirement, the employee draws on the invested assets and bears the risk as what their level will be. Only three states—Alaska, Michigan, and Nebraska—have mandatory DC plans for some or all employees (Nebraska's plan is cash-balance).4 In addition, most states have established voluntary supplemental DC plans that permit employees to take advantage of tax deferment of savings.5

Perhaps more than any other aspect of compensation, the structure of state and local pension funds has diverged greatly from private-sector retirement arrangements. Over the past two decades, the percentage of private-sector employees with DB retirement access declined from 32 percent to 21 percent. Many more employees are not offered retirement packages at all by their employers. In addition, state and local government employees receive a greater share of their compensation from benefits than private-sector workers. A 2010 employee compensation study from the Bureau of Labor Statistics showed that 8 percent of public employee annual compensation comes in the form of employer contributions to retirement benefits, with 0.8 percent of total compensation tied to defined contribution plans. For private industry employees, 3.5 percent of compensation is from retirement and savings, with 2 percent of total compensation tied to defined contribution plans.6

Public employee retirement systems frequently offer more than retirement income benefits. Retirement benefits generally consist of both pension payments and retiree health benefits.7 According to a 2006 Workforce Economics Inc. survey, all states but Nebraska offer supplemental health coverage to Medicare, and many states pay the employee premiums. All states provide health coverage to retirees that are not eligible for Medicare. While there is greater variability in access to other types of benefits, retirees are frequently offered prescription drug coverage, dental and vision insurance, and life and disability insurance.8

Table 30.1 offers an overview of state and local pension plans since 1995 by using data from the 2008 Census Bureau. There are 2,550 different plans covering nineteen million active and inactive members. In 2008, almost eight million beneficiaries received pension benefits from the plans. The major demographic and financial issues now facing the funds become clear when looking at rudimentary data about the systems. The ratio of active to inactive members (aggregated in the table) has declined from about 5:1 in 1995 to 3.3:1 in 2008. In addition, the annual expenditures of the funds on benefits have increased greatly, from $58 billion to $175 billion.

Public Pension Plan History

Pension benefits have been offered to selected groups of public employees since the mid-1800s. In fact, officers of the Continental Army threatened desertion in 1783 over the failure to honor salary and pension promises.9 Civilian pensions lagged behind military benefits, though cities and municipalities were leaders in (p. 846) offering benefits to police and fire workers (though many of the plans were self-funded).10 Massachusetts created the first state fund for general employees in 1911, and eventually state-sponsored teachers' funds became the norm due to the states' control over school spending in the local school districts. Public-sector coverage became more widespread after the passage of the Federal Employees Retirement Act in 1920.

Table 30.1 Overview of state and local pension plans





Number of Plans















Membership (in Millions)















Beneficiaries Receiving





Payments (in Millions)











Assets (in $ Billions)















Expenditures (in $ Billions)















Source: US Census Bureau (2008).

After 1920, the structure of public pension funds began to form into its modern shape. Employees and employers contributed, sometimes evenly, to a retirement fund. When Social Security was first created in 1935, the federal government was constitutionally blocked from taxing state and local governments, thus state and local employees were excluded from Social Security coverage. This was changed in 1950 when special coverage provisions for public employees were added to the Social Security Act (SSA) for those public employee systems that chose to join. 11 Not all plan sponsors voluntarily joined Social Security, resulting in divergent benefit and contribution schedules for the plans paying taxes to and covered by the SSA. About three quarters of state and local employees were covered by Social Security as of 1998, according to the House Ways and Means Committee. (p. 847)

Federal legislation continued to play a major role in state and local pension fund development following the Employee Retirement Income Security Act of 1974 (ERISA). ERISA applied only to private employee pension plans, and it outlined eligibility requirements and fiduciary responsibilities. Many public systems adopted ERISA's “prudent man” standard for management of the fund, and they then expanded their investment horizons outside of the state and Treasury debt instruments to include a broader range of investment securities. As greater portions of the funds' assets were invested in equities, the pension systems' financial health fluctuated with the stock market. This move to equities was beneficial through much of the 1980s to 2000s, though market downturns during these decades were increasingly problematic for fund finances. Nonetheless, as table 30.1 illustrates, public pension fund assets grew exponentially between 1995 and 2008 from $1.1 trillion to $3.2 trillion; assets in nongovernment securities, in particular, grew from $744 billion to $2.4 trillion.

Pension Plan Funding

Retirement benefits, particularly defined benefit systems, require managed funding to set aside sufficient assets to pay future promises for services provided today. Plan sponsors and (often) employees together contribute a portion of the employee compensation to a pension fund, ensuring proper funding of current and future obligations. The contributions are determined by actuarial calculations of the benefit liability, a discounted sum of future benefits given assumptions about retirement age, final salary levels, and longevity. The accumulated fund is invested, with the investment returns adding to the assets. Pension systems are considered fully funded if the fund assets on hand, given the multitude of assumptions regarding future performance, can cover the liability. There is no federal requirement for full funding by state and local government funds and these funds frequently fall below 100 percent funding ratios. In this case, some combination of higher future contributions and increased investment returns will be needed to cover the shortfall.

Pension systems provide audited reports with funding information. The Government Accounting Standards Board (GASB) established the financial accounting standards for pension funds, and over the past three decades they have issued statements updating the accepted reporting principles. Public employee retirement systems have standardized rules for reporting benefit liabilities. However, other critical aspects of the actuarial valuations are open to pension assumptions. In 1994, the GASB issued Statements 25 and 27, establishing more complete standards for reporting pension liabilities.12 The rate at which future liabilities are discounted, along with expected increases in salary and price levels vary between funds, can have a large influence on the actuarially determined contribution rates.13

The variation in the actuarial assumptions can make it difficult to evaluate the financial health of the different systems. Nonetheless, the funding ratio is typically used as a marker of plan finances and is frequently compared across funds. (p. 848) According to the Pew Center on the States, the states' systems were 84 percent funded in 2010, corresponding to $2.3 trillion in assets compared with $2.8 trillion in long-term liabilities. The Public Fund survey, which covers state and local plans, reported an average 80.9 percent actuarial funding ratio for fiscal year (FY) 2009. Other estimates place the funding ratio lower, at 78 percent.14 Table 30.2 includes data on funding ratios and displays other key elements of plan funding.

It is worth noting that public pension plans should not necessarily aim for full funding (100 percent) all of the time. Considering the risk profiles of plan sponsors and the amortization period that is available to fund benefits, there could be financial benefits to a lower funding ratio.15 Indeed, a 2008 GAO report found that many officials knowledgeable in and dealing with state and local government funds believed that 80 percent funding ratios are adequate.16

Eligibility and Rules

Public pension systems are frequently divided by occupation. This differentiation allows the pension funds to address the needs of different workers. For example, safety workers frequently retire early and are particularly interested in disability and survivor benefits. In addition, public employees make different contributions. Data from the Public Fund Survey, which includes 126 state (p. 849) and local plans with combined assets totaling $2.1 trillion covering 13.3 million members, show that public safety workers frequently have different eligibility requirements than other government employees. While it is difficult to average the rules for normal retirement ages and years of service across plans, police and fire employee retirement plans frequently have normal retirement ages of fifty after twenty years of service, significantly lower than other employees. In general employee plans, where public safety, general, and/or teacher employees are covered by the same systems, the retirement rules and benefit provisions may vary by occupation.

Table 30.2 Public pension plan funding, investments, and structure






Total Assets ($ Billions)












  Domestic Fixed Income






  International Fixed Income






  Real Estate
























Funding Ratio






Benefit Multiplier



















Source: Public Fund Survey; data generally dated from June 30, 2009, actuarial valuations.

In contrast to most private-sector DB plans, most public employees make contributions to the pension fund, often calculated as a percentage of current salary.17 It is notable that many state and local employee DB contributions are made to qualified funds and are not counted as taxable income.18 When the benefits are eventually paid to the retirees, these amounts plus interest are subject to federal taxes. According to the Public Fund Survey, employees contribute an average of 6.4 percent of salary. Safety workers typically contribute more, to compensate for their shorter service requirement. Plan sponsors are meant to contribute the amount necessary to cover new benefit obligations accrued over the period and a portion of any unfunded liability. In 2009, the public employer contribution to DB plans averaged 11.3 percent (see table 30.2).

Generally, benefits are calculated using DB benefit formulas, which could include the number of years worked, a final average salary, and a multiplier. Again, it is difficult to compare multipliers across plans, but the Public Fund Survey shows that flat plans typically average between 1.6 percent to 2.5 percent of salary (many systems used a tiered multiplier). Final average salaries used as a basis of benefits are calculated considering the last one to five years of service. According to 2006 Census reports, a total of $151.7 billion in pension benefits were given to about seven million state and local government retirees and/or beneficiaries, or an average of $1,700 in monthly retirement benefits.19 As a rough comparison, the average monthly Social Security benefit is $1,070.20

In addition to monthly retirement benefits specified by formulas, most plans offer COLAs. These benefit augmentations can be automatic, based on a percentage of the Consumer Price Index or another inflation measure. COLAs can also be ad hoc, generally as approved by the sponsor's legislature. Less frequently, adjustments are flat, as in the case of the Arkansas Public Employee Retirement System, which has an automatic 3 percent compounded postretirement benefit increase provision.21

Given the difficulty in general labor markets and government budgeting following the financial crisis, there has been a fair amount of focus on comparing public and private compensation, with a particular examination of benefits.22 The Bureau of Labor Statistics (BLS) estimates average hourly total compensation in 2009 for state and local employees as $39.66, and retirement benefits contribute about $3.16 per hour to that figure. For private-sector employees, average hourly compensation is $27.42, with $0.94 per hour coming from retirement benefits. (p. 850) Other studies show that public-sector retirement benefits are nearly twice as high as private-sector DB retirement benefits. 23

However, figures like this can be misleading, and good comparisons are, in fact, not straightforward. For one thing, state and local employees are typically older and better educated than the general pool of private-sector workers, which naturally skews public-sector employee compensation higher.24 In addition, the Internal Revenue Code or other federal legislation does not treat plans comparably. Private plans are regulated by ERISA and their defined benefits are partly insured by the federal Pension Benefit Guaranty Corporation. Many public-sector systems, on the other hand, qualify under the 414(h) (2) section of the tax code, which allow the annual contributions to be pretax, before federal and municipal taxes are deducted. Because private pension plans do not qualify, private employees typically do not contribute comparable percentages of salary (as these contributions would come after tax).25 Benefits often make up a larger portion of total employee compensation among state and local workers, which may inflate the differences between public and private employees.26 Finally, some public-sector retirement benefits are higher in order to compensate for the lack of Social Security.

Another difference between public and private employees concerns the benefit protections afforded to public-sector retirees. Legal protections for promised public employee DB retirement income have ranged from constitutional provisions to legislated rules as to status of the pension trust fund and the benefit guarantee.27 Employees generally have legal rights to accrued benefits, and they have successfully defended these rights in court.28 In fact, it can be difficult to change benefit structures for current employees, even if they are not yet vested. For this reason, benefit changes are frequently applicable only to new hires. As will be discussed later in the chapter, a number of states are testing these legal protections by changing retirement benefits, COLAs, and service requirements for current employees, as a response to the financial and budget crises.

Pension Investments

With $3.2 trillion in assets, the state and local pension systems in the United States are among the largest institutional investors in the world. Asset growth has been pronounced in recent decades. In 1985, public pension system assets totaled about $400 billion. By 1993, pension system assets totaled about $1 trillion, and this amount has tripled over the following seventeen years. Much of this increase is due in part to a reallocation of asset investments into equities. As shown in table 30.2, about half of system assets were invested in equities in FY 2009, up from 22 percent in 1980. In addition to equities, investments in alternative investments, private equity, and hedge funds have also grown. Historically, the shift out of fixed-income securities into equities and various alternatives is associated with higher (p. 851) risks and returns. The best illustrations of this change are the effects of the 2008 financial crisis on pension fund assets, where a total of $1 trillion in equity asset value was lost between October 2007 and October 2008.29

The shift in asset allocation over the past two decades followed the effective end of “legal lists,” where states restricted the asset classes and geographic diversification of assets to limit risk and control investment strategies. Up through the 1990s, a number of states (Indiana, South Carolina, and West Virginia) had prohibited investment in equities, particularly international securities. Many states still limit the allocation of assets into equities to mitigate risk.30 As investment policy shifted and the assumed rate of return increased, the investment objectives grew more ambitious. Target portfolios now reflect high presumed investment returns with large equity asset allocation; the resulting rate assumptions have implications for pension accounting that are discussed in the next section.

Recent Research

There are a number of issues that have demanded particular attention from practitioners and academics regarding state and local government employee retirement systems. Having introduced the basic structure and current state of public pension funds, this section will expand key areas of research on issues affecting systems in the last decade. These include other postemployment benefits, variability of actuarial methods, pension governance, and defined contribution plans.

Other Postemployment Benefits

Many pension systems offer retirees benefits in addition to retirement income. The most substantial nonpension benefit in terms of cost is health-care benefits, but it can also include dental, life, disability, and long-term care insurance.31 Health-care benefits include pre-Medicare health insurance and Medicare-eligible health benefits. In 2004, the GASB approved GASB Statements 43 and 45, which established standards for measuring and reporting postemployment benefits other than pensions. The rules in the statements were phased in over two years from 2006 to 2008 for different-sized pension systems and were meant to augment the 1994 GASB statements that excluded health benefits. Public-sector employers are required to provide actuarial statements for other postemployment benefits (OPEB) that conform to Generally Accepted Accounting Principles (GAAP), reporting the unfunded liability and the required contribution necessary to achieve full funding with amortization.32 Importantly, the GASB standards do not require funding the (p. 852) liability; plans can (continue to) use pay-as-you-go financing, although governments that set up a trust fund to prefund obligations can use a higher discount rate for OPEB actuarial calculations.33

The actuarial statements conforming to the new standards reveal a total of $530 billion in unfunded OPEB liabilities for states and up to another $500 billion for local systems.34 Other studies estimate the total unfunded OPEB liability as substantially higher, up to $1.6 trillion.35 There are wide disparities in the relative sizes of the states' OPEB liabilities. For example, New Jersey, Hawaii, and Connecticut have OPEB-unfunded liabilities larger than their state budgets, while a number of states' liabilities are less than 2 percent of their annual state budgets. Typically, states that pay a greater portion of health-care insurance premiums have larger unfunded liabilities.36 In 2008, fourteen states required retirees to pay the full cost of their insurance premiums, while fourteen states paid the entire premium amounts.37 The rest required retirees to pay a portion of the premiums. At the same time, current annual OPEB payments are smaller than retirement benefits, even for states with large per capita obligations.

Future payments, however, may not be as manageable. According to the GAO, public-sector employers have not prefunded OPEBs because health-care costs were less expensive when the benefits were first offered and the health-care inflation rate is less predictable.38 In addition to fundamental budgeting concerns, this liability can affect credit ratings. To date, the governments' plan of action to deal with the OPEB obligations appears more important than the actual size of the liability for ratings. The three major rating agencies issued public statements in 2007 indicating that they will consider a “government's approach to addressing its OPEB liability, as well as the magnitude of the liability itself, into its analysis of the main credit factors.”39

Pay-as-you-go financing will eventually become a significant annual expense for many jurisdictions. As the actuarially determined unfunded liability is now required on accounting statements, governments may consider prefunding their OPEB obligations. There are a number of options for prefunding the liability and reducing the future obligations. First, it is important to note that most OPEB benefits do not have the same legal protections as retirement pension benefits; employers can change the level of health-care benefits and the premiums required by beneficiaries. Changing the nature of the OPEBs is not mutually exclusive to considering ways to prefund the obligations. Much like retirement benefits, paying for unfunded liabilities would entail establishing a fund and contributing payments to cover current annual payments and the amortized future costs. Eleven states already had OPEB trust funds in 2001; many more states were planning to or had already created funds following the new GASB rules.40 The trust funds can be separate from a pension fund, or pooled together for administration. Like pension funds, OPEB funds will enable employers to issue OPEB bonds, which offer the same benefits and costs as pension obligation bonds. There are a number of types of OPEB trusts that qualify under different sections of the Internal Revenue Code. (p. 853)

Actuarial Assumptions

As the preceding sections make clear, much of the discussion about public pension funds regards their funding status. The method of calculating a system's liability and the value of its assets is therefore a critical dimension of pension funds. Plans generally project future service and calculate contribution rates as a percentage of salary. Plan assets are smoothed for investment gains and losses over a period of time to avoid sharp changes in funding levels. In addition, state and local plans specify their discount rates for liabilities in the actuarial reports, and most state plans use a rate between 7 percent and 8.5 percent. This practice has generated a lot of criticism, and federal legislation prevents private DB pension plans from using such high discount rates.41 In practice, however, GASB Statement 25 proposes that the discount rate “should be based on an estimated long-term investment yield for the plan, with consideration given to the nature and mix of current and expected plan investment.”42 According to a study by Callan Associates, public pension plans had a median annual return of 9.3 percent over the past twenty-five years, but over the past ten years the return has dropped to 3.9 percent.43 The long-term return on investment corresponds to the plans' high discount rates, and, based on historical performance, the return on investment follows the GASB guidelines.

However, there appears to be a divide between academics and practitioners regarding the appropriate standards for discount rates.44 Generally, economists consider the riskiness of the liabilities when determining the rate, rather than the expected growth of the dedicated asset funds.45 Considering the protections that many promised retirement benefits enjoy and the relative safety of future earned benefits, the pension fund liabilities themselves will not likely experience significant variation. The appropriate discount rate is akin to the risk-free interest rate. Because this rate is considerably lower than the investment rate returns of 8 percent or so, the newly calculated liability is significantly higher than financial statements would suggest. Recent studies estimate the unfunded liabilities of state-sponsored plans at $3.23 trillion when using Treasury bills and bond yields.46 Furthermore, linking liability discount rates with investment yields encourages risky investment strategies that have a higher average return but greater risk.

There are practical reasons why the actuarial discount rate tends to be considerably higher than the risk-free interest rate. As outlined by Peskin, a higher discount rate can reduce costs and risks for plan sponsors and taxpayers.47 Because lower rates would raise the actuarially required contribution (ARC), the plan's assets would rise; surplus assets (over 100 percent of funding) tend to be used to increase benefits. Given the “stickiness” of budgets, the relative bargaining positions of plan members and the temporal disconnect between those officials promising higher benefits and those in office when the expense is due, it may be in sponsors' best interests to underfund liabilities. Of course, there are also the immediate benefits to employers: using a higher discount rate, or increasing the riskiness of investment assets, decreases the required contribution as a percentage of salary. (p. 854)

Using the projected investment return as the discount rate has other, more legitimate benefits. A study comparing conventional actuarial methods to “market-value liability” methods suggests that using risk-free bond yields would result in erratic contribution levels.48 Given the reality of the budgeting process, these fluctuations are less practical than the smoothed contribution rates as a percentage of payroll.

There have been recent efforts to standardize the discount rates that different public pension funds have used to calculate their liabilities. In the fall and winter of 2010, the GASB solicited comments to a proposal that has been considered for about four years. The GASB had thought about standardizing rules for the discount rate assumptions. One possibility for the discount rate included a blend of the presumed investment returns and the risk-free rate, where only the unfunded liability would need to be discounted at the lower rate. In February 2011, Republican congressmen introduced legislation that would require state and local pension funds to use only the risk-free rate when discounting liabilities.

There are a number of other important economic assumptions required for valuation, including the future rate of inflation (especially important for plans that have automatic COLAs) and the health-care inflation rate. In addition, demographic assumptions are not all standardized across programs; these include retirement ages, mortality and disability rates, and terminations. There are also different actuarial cost methods that are approved by the GASB; these include normal entry age, projected unit credit, aggregate cost, and frozen entry age.49 According to the Public Fund Survey, in FY 2008 the vast majority of plans were using the normal entry age cost method (65 percent of plans), followed by the projected unit credit method (13 percent). The normal entry age method uses an individual participant's age when he or she becomes a member, then calculates pension benefits based on future expected salary. The benefit costs are calculated as a dollar amount or percentage of the individual's salary from entry through retirement. In contrast, the projected unit cost uses the individual's projected final salary to estimate benefits and adjusts for the number of service years credited. The major difference between the two methods is the rate at which liabilities accrue; normal costs are considerably higher in early years when using the normal entry age cost method.

Contribution Rate Volatility

Given the range of actuarial methods and assumptions, combined with the volatility in market forces and rates of inflation, it is perhaps not surprising that plan sponsors have experienced a fair amount of instability in their annual contributions (employee contributions are generally more steady). This volatility can be difficult for state and local governments' budget planning. The problem is exacerbated when plan sponsors do not contribute the full actuarially required contribution or when they take a “pension holiday” by not making any contributions; this (p. 855) not only increases the unfunded liability, but also ensures that contribution rates will vary even more in future years.

Figure 30.1 shows the average contribution rates that state and local governments paid between 1997 and 2008, with data compiled from the Pew Center on the States and the Public Fund Survey. Contributions decreased between 1997 and 2002, despite declining investment returns and the 2001 recession, which resulted in negative returns. Contribution rates then increased through FY 2004, at one point going up by almost 30 percent in one year. Since then, employer contribution rates have cycled up and down. In many cases, the changes in rates have reflected the (lagged) movements of the equity markets. Pension holidays, however, have taken place in both fiscally flush and tight years. For example, New Jersey reduced state and local contributions to the state system by $1.5 billion in the mid-1990s while the fund earned high returns from its increasingly equity-based investments. Following the financial collapse in 2008, the state legislated a “pension holiday,” allowing sponsors to skip contributions in 2009 to ease other budget pressures.50 While New Jersey is a prominent case, it is estimated that only half of the state pension plans contributed the full ARC in 2006.51 The average percentage of ARC actually paid by state plans since 1997 is shown in figure 30.1.

 Public Employee Pensions and Investments

Figure 30.1 Average contribution rates and average percentage of ARC paid

Source: 1997–2000 Pew Center on the States; 2001-2008 Public Fund Survey.

There are a number of strategies available to smooth contribution rates. First, plans can control the growth of fundamental aspects of retirement liabilities, (p. 856) notably benefit increases. This would address an underlying source of growth that contributes to volatility in employer contribution rates. On the actuarial side, plans can examine methods to smooth the ARC. Investment returns can be smoothed over a five-year period to absorb both losses and rapid gains to the fund assets. Indeed, some systems had contribution rates equal to zero during the high-return years of the 1990s.52 The smoothing period can be extended, though this will likewise understate funding problems during bear markets. More substantially, systems can shift the distribution of fund assets to less volatile asset classes, and away from equities and alternative investments. While this would result in lower average returns, thereby increasing the overall employer contribution rate, it would make the ARC more regular and create less budgeting havoc. Funds can set contribution rate floors or mandate a fixed rate, thereby trading off flexibility for continuity—and possibly creating other funding issues.53 Of course, these strategies are less meaningful if plan sponsors do not regularly pay the ARC and, instead, budget what is fiscally available.

Defined Contribution

As mentioned earlier in the chapter, the DB structure of most public-sector retirement plans is markedly different than in the private sector, which increasingly offers DC plans if a retirement benefit is available at all. While the implications of shifting more state and local government retirement plans to a DC structure will be discussed along with other reforms later in the chapter, this section focuses primarily on the structural elements and current status of public-sector DC plans.

DC plans eliminate much funding risk. Because DB plans promise specific benefits to retirees, plan sponsors must appropriately value their future benefit obligations and assets used to fund those liabilities. Depending on the strength of the retirement promise—and typically in state and local governments, the promised benefits are on par with general obligation debt, or risk-free for beneficiaries—state and local governments must set aside funds for beneficiary benefits through contributions, investment returns, or debt. The temporal issues inherent in any retirement plan predisposes DB plans to increase benefits that will accrue in the future, frequently in place of more straightforward salary increases. The DC structure alleviates these issues for the plan sponsor by shifting the focus from benefits to be paid in the future to current contributions. Once the specified contributions are made every year, there is no unfunded liability and the risk of future performance of the fund is borne by the beneficiaries.

While plan sponsors obviate their funding risk with DC plans, beneficiaries bear greater risk in their retirement income. DC plan members do not have specified retirement benefits, but rather they must live off of the assets accumulated during employment. Because assets can grow at variable rates, and there is uncertainty as to how long retirees will require income, beneficiaries in DC plans carry (p. 857) much of the risks that are pooled up to the plan sponsor in comparable DB plans. In addition, the smaller asset pools belonging to plan members do not benefit from some economies of scale in investment opportunities and administration costs. One of the few benefits of DC plans to plan members is the portability of benefits to other state programs or beyond the systems altogether.54

It is not surprising, therefore, that public-sector employees have largely resisted shifting from DB to DC plans. While a number of states offer DC plans as supplements to DB plans, only Alaska, Nebraska, and Michigan have mandatory DC plans for general state employees hired after a certain date; Utah will offer a choice between a DC and hybrid plan for new employees beginning in 2011.55 Six other states offer optional DC plans for general employees and teachers, and many states offer DC plans to higher education faculty. In 2002, the governor of California proposed shifting new California public employees into a DC plan. The resulting protests and considerable political backlash ended this possibility. Five other states have hybrid plans, which combine elements of DC and DB plans; generally, employee contributions go to DC accounts while employer contributions go to a DB fund.

Pension Fund Governance and Activism

In many respects, public pension fund administration is a subset of normal human resource management that occurs in every jurisdiction. The unique nature of the retirement system fund, however, creates political and economic elements unlike any other program involving public employee compensation and taxpayer funds. Legislatures and public employee retirement system administrators, typically led by a governing board, have a responsibility to plan beneficiaries expecting to receive retirement benefits while mitigating risk to the general taxpaying population through prudent management of benefit promises, contributions, and asset investment. While these populations are not necessarily at odds, governing boards frequently correspond to a mix of constituents in order to ensure competing interests are represented. Trustees on the governing board are elected by plan members (active and retired), appointed by the employer, or serve ex officio; the latter members are frequently elected to their positions in a general election. According to a 2006 National Education Association survey, the median governing board has nine trustees, and plan members elect half of the trustees.56

How much governance influences key aspects of the retirement plans is a matter for debate. In a series of papers, Hsin and Mitchell found that the number of trustees elected by plan members is correlated with high employer contribution rates and lower funding levels.57 Other papers have shown mixed effects.58 The expected correlation is unclear. On one hand, elected trustees may be interested in expanding benefits and COLAs, which increases liabilities, and may not be particularly knowledgeable about investment strategies. On the other hand, beneficiary (p. 858) representatives have a vested stake in the financial health of the funds, have a strong incumbency rate, and are less interested in special interest-group politics involved in a general election.

From a practical standpoint, more important than the quantitative analysis of pension fund governance influence is the recent attention paid to the economic and political connections of legislators, ex officio trustees, unions, and funding policies. The New York Times has run over three dozen articles—many placed on the front page—that deal specifically with retirement benefits and/or pension funds and political relationships over the past five years (this count does not include articles dealing primarily with pension fund finances). A 2009 study similarly indicated that “prior to the 1980s, state and local pensions were not on the radar screen of interest groups,” but the visibility of special interest group activity has grown since then.59 While the governance structure has remained constant in a number of the pension plans in recent decades, the political economy surrounding the plans is shifting, with public employee unions gaining strength relative to private unions and the discrepancy between public and private compensation growing.

A related issue involves public pension fund activism. As investors, public pension plans are among the most active institutional investors in terms of proxy proposals, long-term ownership, and public attempts to influence corporate strategy.60 The increase in ownership activism could be in part a consequence of the political factors in pension governance mentioned above; it is also a natural effect of the rising pension assets invested in corporate equities. As large, long-term shareholders, public pension plans can monitor corporate management to maximize investment return. Retirement systems may also be interested in social causes that are not necessarily related to maximizing long-term return, though these desires can be concurrent.61

Public pension plan activism has occurred in the form of shareholder proposals, director nominations, and informal communications with management.62 A particularly prominent example is the California Public Employee Retirement System's (CALPERS) “Double Bottom Line” initiative that began in 2000. The initiative made investment decisions based on social, rather than financial, decisions by excluding firms in certain industries and those with poor labor rights records. In September 2010, the SEC passed a proposal granting proxy access to institutional investors with ownership profiles similar to public pension plans. The National Association of State Retirement Administrators (NASRA) and the major public pension plans supported wider proxy access in order to increase the shareholders' ability to nominate directors to corporate boards.

Pension fund activism can improve investment returns by restraining corporate management rent extraction from shareholders. However, limiting the investment portfolio or focusing on nonfinancial elements of securities can reduce the overall returns, in contrast to the prudent man standards governing most public pension fund boards. While it is hard to estimate whether public pension fund activism improves the fund value, there have been a few studies that investigate (p. 859) the effect of activism on equity values, which indirectly measures financial impact for the funds. The evidence is mixed. A study on the CALPERS “Double Bottom Line” program found that activism had a positive effect on share prices for targeted firms.63 Other studies considering a broader sample of public pension fund ownership found an insignificant or negative effect of public pension fund activism on equity value.64

State and local government pension plans' interactions with corporations and the equity market go far beyond their influence on equity values. As substantial investors, public pension plans are very much affected by the markets. Given the financial downturns of the 2000s, there is additional scrutiny as to the degree of investment risk taken by funds run by trustees without substantial investment experience. Investment risk should vary with retirement horizons, the ratio of active to retired employees, and return assumptions. A look at the data, however, reveals that there is relatively little variation in the share of assets invested in risky securities (that is, in assets other than US government debt), and it is not correlated as expected to the variables mentioned.65 Almost all state funds have 50–70 percent of their assets in equity; an average of 7.4 percent is invested in private placement equity. Wilshire Associates reported allocations into private placement equity as high as 21 percent. The financial crisis also highlighted fund investments in over-the-counter derivatives, exemplified by a local multidistrict Wisconsin teacher's fund that lost $200 million in collateralized debt obligations.66 The cumulative impact of the financial crisis on pension fund assets is discussed in more detail in the next section.

The Impact of the Financial Crisis and Paths to Reform

As this chapter has made clear, a number of policy issues are facing state and local pension funds. There is no greater issue than the financial outlook of the DB plans; this matter is even more urgent following the financial crisis in 2007–2008 and the subsequent declines in equity values and in state and local governments' fiscal outlooks. The full extent of the crisis will be felt over the next few years as funds that smooth investment returns realize the decline in their assets. In addition, tight state and local budgets are squeezing annual contributions to the funds, exasperating the funding problems and threatening the ability to bridge the funding gap in the future. The sharp declines in assets and funding status have sparked reactions from plan sponsors, spurring some to attempt changes to promised benefits, shifts in investment allocation, and other reforms. It is worth noting, however, that many plans had structural underfunding issues before the crisis. (p. 860)

According to Census data, the largest one hundred public funds lost $835 billion of value in the recent recession, and as a result FY 2010 benefit payouts amounted to almost 8 percent of total fund assets. Through 2009, 58 percent of funds had funding ratios below 80 percent, a distribution not seen for fifteen years.67 Optimistic economic scenarios estimate that the 2013 funding ratio to average 76 percent, assuming contribution rates remain steady.

Plan sponsors are responding to the financial crisis in a number of ways. States have enacted and proposed legislation to deal with their funding issues in 2010 and 2011.68 According to the National Conference on State Legislatures, the proposals offered by state legislatures and governors in 2011 regarding state pension and health-care benefits are extensive. They include increasing employee contributions (fifteen states), reducing benefits or raising the retirement age for new employees (eleven states), and limiting pension “spiking” or artificial increases to final years' salary (six states). More radically, five states (Illinois, Kansas, Massachusetts, New Hampshire, and New Jersey) have proposals that would reduce benefits or increase the retirement age for existing employees. Proposals, of course, are not equivalent to legislation, but the activity in 2010 suggests that more legislatures are taking real steps toward reform. According to the National Conference on State Legislatures, nineteen states have enacted major changes to their plans since January 2010. Table 30.3 details some of the changes proposed in response to the financial crisis as well as general funding problems between 2009 and 2010. The actions can be grouped in three categories: changes to lower the future funding requirement, changes to increase the funding ratio, and changes to relieve current (p. 861) funding requirements. A number of states have made benefits less generous, by either increasing service requirements or extending the final pay average period. Nine states (Vermont, Michigan, Colorado, Utah, Virginia, Illinois, Missouri, Mississippi, and Arizona) increased the retirement age and service requirements in 2010, and four states (New Jersey, Minnesota, Iowa, and Missouri) increased vesting requirements for 2011. Louisiana was the only state to lower requirements by decreasing the vesting period. Nine states have reduced benefits for early retirement outright; in Colorado, this change extends to active employees.

Table 30.3 Public pension responses to the financial crisis, FY 2009–2010



Benefits Reduction


Employee Contribution Increase


  Employee Contribution Increase for Active Employees


Increasing Service/Retirement Age Requirement


Increase in Final Average Salary Period


Reduced COLAs


  Reduced COLAs for Current Retirees


Changes Away from DB Plans


Source: 2009 and 2010 NCSL Annual Report on State Pension Legislation.

In the second category of legislative changes, ten states increased employee contributions in 2010—four of these states (Missouri, Utah, Virginia, and Wyoming) introduced employee contributions for the first time for current employees and future hires. Perhaps the most radical changes include reducing postretirement benefit increases (generally through COLAs). Eight states changed COLAs; in Minnesota, South Dakota, and Colorado these changes apply to current employees and retirees. Given the protections afforded to benefits, many of these decisions are being challenged in court.

States have also taken action to provide themselves with funding relief, through new pension obligation bonds (POBs), temporarily reducing employer contributions, and extending the amortization period in order to lower the ARC. Other states are changing demographic and economic assumptions. Washington delayed the adoption of new mortality tables and reduced the projected salary growth. New York State is lowering its discount rate from 8 percent to 7.5 percent; Utah and Pennsylvania made similar moves in 2008 and 2009, respectively. The use of POBs was attractive for states that legally could not put off contributions or borrow from the fund, or POBs were considered a prudent financial strategy to arbitrage future equity performance and provide spending relief. As with all arbitrage opportunities, timing and specifics of the issuers will have significant effects on the overall performance of POBs.69

Less formally, some states and local plan sponsors have deferred or reduced contribution payments for a temporary period. For example, Virginia delayed paying $620 million to its state retirement system for FY 2010. Governor Rell in Connecticut had also deferred payments to the pension plan and had proposed eliminating the pension benefit guarantee for future employees. California had seriously considered borrowing $2 billion from CALPERS, while the New York legislature agreed to allow the state and municipalities to borrow $6 billion from the pension fund in order to pay the required annual contributions.70

These latter moves represent short-term fixes. The legislative changes that reduce the growth of future funding needs and increase contributions from both plan sponsors and employees are more sustainable and address the structural funding problems. It is perhaps surprising that the recession and subsequent unfunded liability has not led to more proposals for fundamental changes to public pension structure. Only two states have enacted major changes to parts of their retirement systems. Utah will begin requiring employees to choose between a DC and a hybrid plan, and Michigan created a new hybrid plan for newly hired state teachers. (p. 862) Substantially more states have committees looking into switching to DC plans, but to date there is no reform wave in pension structure. In part, this may be due to political realities. Many legislatures are cutting pay, jobs, and services; state representatives may not have the political appetite to tackle major changes in the public employee retirement structure. Surely, many elected officials observed the political fallout from the failed DC proposal in California in the early 2000s. Less radical structural changes, such as opening eligibility for Social Security in the 23 percent of systems that currently do not qualify for SSA, have similarly been absent in the recent two years.

In addition to dealing with retirement benefit liabilities, state and local governments are going to have to deal with the OPEB liabilities revealed since the passage of GASB Statements 43 and 45. Many states have shifted from pay-as-you-go plans to more strategic planning to pay for the estimated costs. Plan sponsors have issued OPEB bonds, borrowing to prefund the obligation. While this entails exchanging flexible liabilities for rigid interest debt, the new GASB standards include accounting rules that makes this option favorable. In addition, a number of states are proposing changes to their retiree health insurance plans over the next five years.71 More than half of the states have increased cost sharing, in some cases requiring employee contributions for the first time. Five states have diminished health benefits for future retirees since 2004, and more retirees will probably face higher deductibles and co-pays. Because OPEB liabilities are so dependent on the rate of health-care inflation, sponsors will need to prefund growing costs; unfortunately, it appears that most state actuarial reports use a long-term medical inflation rate of about 5 percent, down from the 10–14 percent levels that have been the norm recently.72 Even a 1 percent difference in the inflation assumptions can change the amount of the unfunded liability by 20 percent.

Looking Ahead

Surveying the landscape of issues facing state and local government employee retirement systems illuminates a number of policy ideas and concerns. On average, public pension funds are in trouble, and the unfunded liability will strain already tight public budgets as benefit obligations become due. Not all systems, however, are having difficulty. Any description of public pension fund reform must distinguish between those state and local government funds facing severe funding problems and those that have been responsibly managing their retirement systems. At the same time, it is wrong to claim that there is not a funding crisis in public pension funds or that there wasn't a crisis before the recent market declines.

For the plan sponsors with actuarial funding ratios over 90 percent following the decline in equity values in 2008, the current obligations require modest, but not inconsequential, adjustments to contributions, investments, and assumptions. Reforms could include a mix of the legislative moves taken in 2010 to improve the funding picture described above: using more realistic actuarial assumptions, setting (p. 863) contribution floors, reducing the generosity of benefit structures, and sharing costs with employees. Even these steps may not be sufficient in states that appear well funded at first glance. Utah offers a good example of a state that had responsibly funded its state plan, yet it faced looming increases in required contributions following the financial crisis. In 2008, Utah had a funding ratio of 96.5 percent but projected a 70.5 percent funding ratio by 2013. This was partly due to the 22 percent decline in the plan's asset value in 2008. When the state considered what the ARC would need to be, when given a discount rate of 7 percent, it found that contributions would have to rise by 75 percent. Eventually, Utah made the radical decision to close its DB plan to new employees and it offered a DC or hybrid plan choice.73

In those states facing severe underfunding—the list of such states varies over time, but it typically includes Connecticut, Illinois, Kansas, Kentucky, Massachusetts, New Jersey, Oklahoma, Rhode Island, and West Virginia—more dramatic reforms are necessary. Increasing employee contributions or extending the service requirement will not be sufficient to fill the unfunded gap, which reaches over 30 percent. State and local governments have relied heavily on investment returns to fund liabilities, and they did not pay the ARC in full; in New Jersey, strong equity performance in the late 1990s left the state system 106 percent funded, and in the following eight years, state contributions averaged less than half of the ARC.74 States that are now in trouble have generally also offered more generous benefit terms in the 1990s through the early 2000s. Though there is less aggregate data available on increases in unconventional benefit costs, many states are concerned about the rate of retirees returning to work (double-dipping) and artificially high final salaries that increase the benefit base.75

What should reforms look like in states that have severe pension funding problems? First, governments must commit to assessing their pension obligations realistically, regardless of the GASB actuarial requirements that may result from new accounting rules or federal legislation. This means using a lower rate of return on investments to realistic levels to discount future benefits and realistic salary growth expectations. Plan sponsors do not have to choose between rates of 3 or 8 percent. Rather, there is a middle ground that reflects the expected return on a portfolio conservatively—and passively—invested in equities and alternative investments. For example, corporations use a discount rate of about 6 percent, reflecting the risk that corporations may go out of business. Governments will need to find an enforcement mechanism for paying the required pension contributions every year, in all market conditions. Laws or constitutional requirements can enforce this practice. In states with the legal room to increase employee contribution rates, employee rates must rise. Employee contribution rates can be set at a fraction of the sponsor's rate, raising employees' stakes in any change in benefits or asset management. Finally, governments should contain future benefit increases by tying them to higher employee contributions and/or requiring taxpayer approval, as has been implemented in San Francisco, for example.

All of the above reforms only concern the benefits promised to current employees and retirees. Future employees have no guarantees, and they are not an effective (p. 864) special-interest group. If the above reforms cannot be implemented in full, governments must admit that they cannot commit to acting as responsible stewards of employees' retirement security; these states should shift to hybrid or DC plans for new employees. While this change could affect future recruitment and retention, and is not necessary in all state and local governments, it is the fiscally responsible action. In addition, the 23 percent of plans that are currently not eligible for Social Security should apply for qualification.

In its recent 2010 report, the Pew Center on the States contended that part of the $1 trillion funding gap counts as “good news”: the size of the unfunded liability has spurred calls for reform from policymakers across the country. Certainly, high-profile legislation in Wisconsin and Michigan regarding employee contributions to retirement pension and health funds in 2011 has increased public awareness about the issue and spurred new energy from both ends of the political spectrum to close the funding gaps. However, looking across the state and local pension plans in this country that are in the most serious financial trouble, there does not appear to be gathering momentum for the package of fundamental reforms highlighted above, and the most frequently invoked fix involves cutting benefits for future employees. In the midst of tight state and local budgets, legislatures must fund the steep losses in pension assets following the recession. At the same time, they must consider that their true natures, for better and worse, have in many cases led to generous and unfunded benefit increases, risky investments, and sloppy accounting. While raising funding ratios in the near-term, policymakers need to commit themselves in the long term to state and local governments' financial well-being.


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                                                                                                      (1) US Census Bureau (2008).

                                                                                                      (2) Novy-Marx and Rauh (2009), 3: 2; US Census Bureau (2008).

                                                                                                      (3) Wiatrowski (2009), 1.

                                                                                                      (4) Snell (2010), 1–3. Cash balance plans are similar to DB plans, in that employers bear the investment risk, but balances are expressed as a lump sum rather than a periodic payment.

                                                                                                      (5) GAO (2008), 5.

                                                                                                      (6) Bureau of Labor Statistics (2010).

                                                                                                      (7) GAO (2008), 5.

                                                                                                      (8) Ibid.

                                                                                                      (9) Stewart (2005), 85.

                                                                                                      (10) Clark, Craig, and Wilson (2003), 167. Self-funded plans are based on employee, not employer, contributions.

                                                                                                      (11) Clark, Craig, and Ahmed (2009), 239–271.

                                                                                                      (12) GAO (2007), 62.

                                                                                                      (13) Munnell, Haverstick, and Aubry (2008), 1–12.

                                                                                                      (14) Munnell, Aubry, and Quinby (2010), 4.

                                                                                                      (16) GAO (2008), 2.

                                                                                                      (17) Munnell and Soto (2007), 1.

                                                                                                      (18) GAO (2008), 10.

                                                                                                      (19) Ibid., 1.

                                                                                                      (20) Social Security Administration (2010), 1.

                                                                                                      (21) Peng (2008), 40.

                                                                                                      (22) Edwards (2010); Bender and Heywood (2010). Following a delayed budget vote in Wisconsin pertaining to public employee benefits in early 2011, there were numerous articles written about this issue.

                                                                                                      (23) The Pew Center on the States (2007), 12–14.

                                                                                                      (24) Bender and Heywood (2010).

                                                                                                      (25) GAO (2007), 8.

                                                                                                      (26) Bender and Heywood (2010).

                                                                                                      (27) GAO (2007), 19.

                                                                                                      (28) Brown and Wilcox (2009), 538–542.

                                                                                                      (29) Munnell, Aubry, and Muldoon (2008), 1.

                                                                                                      (30) Peng (2008).

                                                                                                      (32) Clark (2009), 5.

                                                                                                      (33) Peng (2008).

                                                                                                      (34) Clark (2009), 1.

                                                                                                      (35) Edwards and Gokhale (2006); Zion and Varshney (2007).

                                                                                                      (36) Clark (2009), 3.

                                                                                                      (37) Robinson et al. (2008), 3–11.

                                                                                                      (38) GAO (2008), 21.

                                                                                                      (39) Moran (2007), 13.

                                                                                                      (40) Wisniewski (2005).

                                                                                                      (41) Waring (2009), 32.

                                                                                                      (42) Brown and Wilcox (2009), 540.

                                                                                                      (43) Reilly (2010).

                                                                                                      (44) Brown and Wilcox (2009), 538.

                                                                                                      (45) Novy-Marx and Rauh (2009), 1.

                                                                                                      (47) Peskin (2001).

                                                                                                      (48) Jones, Murphy, and Zorn (2009), 1.

                                                                                                      (49) Peng (2008).

                                                                                                      (50) Benner (2009).

                                                                                                      (51) Barrett and Greene (2007), 1.

                                                                                                      (52) Young (2009), 75–85.

                                                                                                      (54) Fore (2001).

                                                                                                      (55) Snell (2010a).

                                                                                                      (56) Peng (2008).

                                                                                                      (57) Hsin and Mitchell (2010).

                                                                                                      (58) Munnell, Haverstick, and Aubry (2008).

                                                                                                      (59) Almeida, Kenneally, and Madland (2009).

                                                                                                      (60) Johnson and Greening (1999); Qui (2003); Romano (1993).

                                                                                                      (61) Barber (2009), 271–294.

                                                                                                      (62) David, Bloom, and Hillman (2007), 1.

                                                                                                      (63) Barber (2009).

                                                                                                      (64) Woidtke (2002).

                                                                                                      (65) Lucas and Zeldes (2009), 16.

                                                                                                      (66) Duhigg and Dougherty (2008).

                                                                                                      (67) Munnell, Aubry, and Quinby (2010).

                                                                                                      (68) Snell (2010b, 2011).

                                                                                                      (69) Munnell et al. (2010), 3.

                                                                                                      (70) Hakim (2010).

                                                                                                      (71) Kearney et al. (2009).

                                                                                                      (72) Clark (2009), 8.

                                                                                                      (73) Liljenquist (2010).

                                                                                                      (74) It is worth noting that New Jersey is also involved in what could be a harbinger of future pension issues with the Securities and Exchange Commission (SEC). In August, New Jersey reached a settlement with the SEC over a charge that the state had fraudulently marketed municipal bonds by misrepresenting their pension liability. The fraud charge was filed following the creation of an SEC unit dedicated to investigating pension funds and municipal securities.

                                                                                                      (75) A number of pension systems allow retirees earning pension income to return to work, thus earning a salary and retirement income at the same time (“double-dipping”). Because retirement benefits are based on the employee's salary during the final years of employment, it is possible to increase the pension benefit by “spiking” salaries during the final years of work.