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Taking the Field: Tension on pensions 

By Paul Meyer, NCLM Executive Director

Earlier this year, a prominent Raleigh think tank cited a highly suspect and agenda-driven study to infer that North Carolina’s state and local government pension systems had huge unfunded liabilities. In this case, the think tank was not doing much thinking. The study it cited came to its conclusions by using a presumed annual rate of return of 2.734 percent on the $89 billion (that’s right, billion with a B) in pension system assets invested in the stock market and elsewhere.

Let’s put that figure in perspective. The pension fund’s actual annualized rate of return over the last five years has been 8.5 percent. Its rate of return over the last 10 years has been 6.5 percent, a period that covers the single worst year of stock market performance since the Great Depression. The Standard & Poor’s 500, over the course of its existence since 1928, has had what is known as a geometric average rate of return – a conservative calculation that more accurately looks at the real effects of market losses – of 9.6 percent annually. North Carolina’s state and local pension systems, meanwhile, use a presumed rate of return of 7.25 percent in determining funding levels and any unfunded liabilities. It’s the fourth lowest presumed rate of return in the country, and one that independent investment research firms like Morningstar consider sound.

In other words, no one would utilize a 2.734 percent presumed rate of return except as a scare tactic. These figures and what they mean are worth considering because North Carolina legislators have been discussing major changes in the pension system. Those discussions are likely to continue into next year.

The most significant change would be a shift from a defined benefit plan, in which government retirees receive fixed payments until death, to a defined contribution plan, in which benefits are accrued in individual accounts. Some other states have moved from defined benefit plans to defined contribution plans like the 401(K) plans often seen in the private sector. Those states typically took that step because their plans had become significantly underfunded due to years of inadequate funding, as well as set cost-of-living increases that helped to strip away fund principal.   

North Carolina does not face the dire circumstances found in those other states. Since the Great Depression, the Tar Heel state – at the state and local level -- has been among the most fiscally prudent states in the country. The public pension system here consistently ranks among the best, most financially sound in the country.

When discussed publicly, the state and local government pension systems are often lumped together. That’s understandable. The funds are invested together by the State Treasurer’s Office and the fund managers whom she hires. The Local Government Employee Retirement System, though, is overseen by a separate board, its cost-of-living adjustments are considered separately, and its funds are accounted for separately.

When accounted for separately, the local government pension system is 100 percent funded, meaning local governments and local taxpayers face no unfunded liabilities. That’s not my assessment. It’s the assessment of independent financial experts like Morningstar.    

As more debate about the pension system looms, it is important to keep in mind why state and local governments have made benefits like a defined benefit pension plan available to workers. Dependent on taxpayers, state and local governments have traditionally paid workers less than in the private sector. But as large employers, and with local governments having the ability to join together to form benefit pools, they have been able to utilize economies of scale to provide better benefits at reasonable costs. These benefits are a vital tool to attract and retain everyone from police officers and firefighters , who face on-the-job dangers every day, to engineers, who can receive significantly higher salaries in the private sector.

Limiting the ability of local governments to decide how best to compensate their employees would be a mistake, damaging their capacity to hire the qualified workers who are key to carrying out the services that municipal residents rely on. It’s not a path that North Carolina should or needs to go down.