From the November 2011 issue of Investment Advisor • Subscribe!

Answering the Public Pension Question

There’s no easy answer to public pensions, but remaining objective is key to finding a workable solution

Funding gaps. Benefit cuts. Fiscal reform. Budget repair. No matter where you live today, it’s hard to ignore the challenges that many state and municipal pension systems are facing. As a registered investment advisor, you are faced with myriad questions on the topic from clients who are seeing the headlines everywhere.

Some reports have called it a crisis, a tsunami and even a sinkhole. However you view public sector pension (defined-benefit) programs, one thing is certain—never before have they received so much attention. Volatile market conditions in recent years have only amplified the situation.

According to the U.S. Census Bureau, some 20 million employees and seven million retirees and beneficiaries are covered by 2,500 state and local pension plans. Given the sheer impact these obligations have on budgets, tax burdens and workers’ expectations, it’s no wonder the issue often creates intense and polarized debate. Policy makers and government managers have undoubtedly given some thought to their own situations: How long can their pension program continue to pay promised benefits? Is it time for a change? If so, what are the options?

These are complex questions, with no easy answers. Each situation is unique and each outcome different. However, what may be the same for every public sector employer with a retirement program is the need to do a comprehensive assessment and evaluation. Your clients rely on you as a resource for answers on how best to proceed. Having a sound understanding of the different options available to your clients can put them at ease and demonstrates your value as a trusted investment advisor.

Turning to the tools and guidance available in the industry can help you gain a better understanding of the process to counsel your clients in developing a systematic and analytical process for decision making. The key to this process is remaining objective, “solution-neutral” and considering the various stages of the decision-making approach:

Pre-planning. No large undertaking should begin without proper planning. Preparation helps employers lay the groundwork for a retirement program analysis. This phase starts with helping your clients identify relevant stakeholders and important information about the role they play in developing a workable solution. Typically, these groups will encompass members of the community, current employees, retirees receiving benefits, taxpayers, unions and management.

It’s important that your clients understand the perspectives of each group and the potential conflicts among them. This will help identify who among the various stakeholders should become part of an analytical and decision-making body.

Another key to pre-planning is agreeing on the priorities and values of the organization. This provides a benchmark to measure the current retirement program against any future alternative. The organization’s priorities should be weighted and documented to establish a framework for ongoing analysis. This will also help settle conflicts in the event of budget issues, cost reductions or when reviewing the interests of certain employee groups.

Analysis and Solution. Once a pre-planning document is established, the next step is to determine whether the existing retirement program aligns with priorities and meets the stated goals. If there are gaps, it is important to understand their causes. Likewise, it is necessary to identify the demographics of the work force and determine whether the system is sustainable in the short and long term. Part of this will require mapping out scenarios that not only contemplate reasonably predictable circumstances, but also more dramatic market upswings and downturns. Once this process is complete, your clients can better visualize what solution would work best in the face of change.

In some cases, your analysis may confirm the existing plan is meeting its goals and does not require significant change. For others, it will be obvious that more adjustments must take place. Such a redesign should consider a number of factors, including program features and options, such as costs, benefits and risks; the ability to meet stated organizational goals; the impact to stakeholders; and the ability to overcome obstacles (past employee benefit commitments, contractual agreements, state statutes and constitutions, and local laws and charters).

The good news is that decision makers today have a range of options. These include retaining the standing plan for current employees and establishing a defined-contribution plan for newer employees, or introducing a new plan across the organization and giving employees the option to select the new plan or remain with the old.

Implementation. A benefits change of any scale requires careful planning and due diligence. It is imperative to help your clients build a comprehensive transition and implementation plan that clearly identifies team members and responsibilities; key dates and events; contractual, legislative and legal factors; service providers for various aspects of the program; communications planning and elements; and performance metrics and feedback mechanisms.

There is no question that traditional pension plans are an important, highly visible and—in today’s environment—highly emotional benefit for public sector workers. Yet they have also become vulnerable as many of these state and municipal employers wrestle with budget issues. The focus on these programs creates an opportunity for plan decision makers to assess their own situation, no matter what their status is. Each situation is unique and there is no one-size-fits-all solution. However, applying a thorough and process-driven approach is key to reaching the right outcome.

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