Thursday, July 7, 2011

Amazing Article on Employee Benefits

Must read.

The problem is that public workers get too little of their pay while they work and too much when they retire. According to a new paper by Maria Fitzpatrick of Stanford University: “Schools and other public sector employers contribute nearly three times as much per hour worked to the pension benefits of their employees as their counterparts in the private sector.”

Many public workers would vastly prefer to get more money today in exchange for lower pension payments, Fitzpatrick finds in the study, “How Much Do Public School Teachers Value Their Retirement Benefits?
In 1998, Illinois upgraded the pensions that teachers would get on future earnings and gave these employees an opportunity to increase their pension payout based on past earnings. Teachers had the option of making a one-time payment equal to 1 percent of their salary per year of service prior to 1998, up to a maximum of 20 percent.

Upgrade Offer

The returns of taking the deal were quite high, Fitzpatrick wrote. “The average price of the upgrade offered to employees with 25 years of experience in 1998 was $15,245 while the expected costs of providing them with the extra retirement benefits if they all purchased would have been $94,166.”

Yet even given those extremely generous terms, plenty of teachers preferred to have more money immediately: “More than 20 percent of these employees do not purchase more retirement benefits even when offered them at just 16 cents on the dollar.” Using a sophisticated statistical procedure, she determines that “averaging along the entire demand curve, employees in [Illinois Public Schools] are willing to trade just 30 cents for a dollar’s worth of future benefits.”

This work suggests that we should offer cash to public workers in exchange for giving up some of their future benefits. If public workers really only value their pensions at 30 cents on the dollar, then a deal where we paid workers 65 cents today to reduce the net present value of their benefits by a dollar, would essentially make both public workers and taxpayers 35 cents richer.

Home-Firm Bias

Our defined-benefit system also means that undercompensated state-appointed investment officials are managing multibillion- dollar portfolios. Unsurprisingly, they make mistakes, sometimes for very understandable political reasons. Rauh co-wrote a study with Yael Hochberg that examines the private-equity investments of public pensions and finds that they display a substantial home bias. On average, state pensions invest more than 12 percent of their private-equity funds with in-state firms.

Twenty-three percent of Tennessee’s public pension investments in private equity go to in-state firms. Out-of-state public pensions place less than 0.2 percent of their funds in Tennessee. These in-state investments seem to reflect politics rather than economics. The net internal rate of return for out- of-state private-equity investments is 4 percent; the return for in-state investments is 0.4 percent.

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