Perils Facing PERA and Other Pension Plans

I did an interview about Colorado's public employees pension plan (known as PERA) with Brad Jones of Face The State, a news site that covers political events in Colorado.

PERA's administrators are doing a statewide "Listening Tour" to get input and feedback from Coloradoans about what should be done to close PERA's $17 billion gap in unfunded liabilities. As I researched the topic, talked about it with Brad, and thought about possible solutions; there are really no easy answers.

In theory, PERA's investment portfolio is supposed to grow at a large enough rate in order to cover the obligations for current and soon-to-be-retired public employees. That theory was blown to smithereens last year, as the net asset value of PERA took a 26% haircut in 2008 from the stock market crash. The ugly financial results are on page 17.

It's structurally flawed, because PERA is paying out $1.89 in benefits for every $1 paid into the plan. In 2008, the contribution/benefits deficit was about $1.3 billion, this year it's on pace to hit $1.47 billion.

So what are the possible solutions to "save" PERA? They're similar to what will probably happen with Social Security, with the exception of means testing:

1) Increase in the minimum retirement age. This is a no-brainer, as the current formula allows some employees to retire in their 50s, and could have 20-40 years of paid pensions. Nice gig if you can get it, but its not financially sound policy.

2) Freeze and/or reduction in annual Cost of Living Adjustments (COLA) and defined benefits. This won't be popular, but I don't see any way around it. At the minimum, PERA should implement a "COLA Holiday" for at least 2-3 years. It won't close the gap entirely, however, it would be a good start. Benefits promised to new employees under 40 will have to be reduced.

The myth of the Industrial Age, defined-benefit pension plan is being exploded. That's the reason why 401(k) and IRA plans came into vogue in the 70s and 80s, because big companies knew they couldn't afford these pension liabilities and still stay in business. State employees who still have this entitlement mentality that they deserve to be taken care of in their golden years because they were a loyal public servant... well, they need (and will be getting) a serious reality check soon.

3) Change how the investment portfolio is managed. The "buy and hope" theory of investing doesn't work anymore. The administrators should hire a team of great investors and/or traders, pay them a small fee and base most of their compensation on performance. In other words, if they don't make the plan money, they won't get paid. The idea of paying a financial planner or money manager a flat fee, regardless of how your portfolio performs is a joke.

The only chance that PERA has of staying solvent in the next decade or two is generating significant investment income. The administrators should (at the minimum) reduce exposure to US stocks, and increase it for well-selected, well-managed stocks of foreign companies.

They should also look at investing in FOREX and options markets, and increase the asset allocation of precious metals. Changing market conditons require a different investment strategy - and what's worked the last 10-20 years probably won't work the next decade or two.

My interview is towards the end of the weekend podcast at www.FaceTheState.com. Thanks to Brad Jones for the opportunity to talk about this important issue; and if you live in Colorado, make your voices be heard by filling out this PERA survey.