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NEW YORK Billionaire philanthropist and former heavyweight natural gas trader John Arnold became aware of the ailing U.S. public pension system years ago, before unprecedented municipal bankruptcies highlighted the gravity of the situation.
Houston-based Arnold, 40, retired from hedge fund management in 2012 after trading in energy for more than a decade at Enron Corp and then at his own fund, Centaurus Energy.
As well as running The Laura and John Arnold Foundation, Arnold is a member of The Giving Pledge, which asks the world's wealthy to commit to allocating the bulk of their fortunes to philanthropy.
Through the foundation he has focused on issues that can't be solved through free markets, including public pensions and the political gridlock that has stymied reform.
"The political discourse has changed considerably since we started working on the issue," Arnold told the Thomson Reuters Global Markets Forum in an exclusive interview on Tuesday.
"The risk is that politicians make a minor reform to the system and call that success and move on to the next thing. That is what we're seeing in Illinois right now."
The Illinois legislature last year passed a pension reform law, only to see it stalled in court as unions and retirees challenged its constitutionality.
Arnold said the main cause of the pension funding gap was "the structure and funding policies of pensions."
"In public pensions, these market failures include diffused costs, concentrated benefits (and) political expediency by politicians who want to push expenses to the future," he said.
Ratings agencies have been sounding alarms on underfunded pension funds from New Jersey to California. Last week, the U.S. Securities and Exchange Commission questioned whether the funds will be able to pay retirees, something municipal securities investors need to know.
Public pensions are following a path similar to corporate defined benefit pensions, withdrawn during the 1990s when they became too costly to guarantee. This led to a move to put the onus to save for retirement onto employees.
So-called defined contribution plans such as a 401(k), where employers match employee savings, "can be designed so that plan members do not have to be savvy investors," Arnold said.
The key issue remains one of systems being allowed to roll current costs ahead for years.
The largest fund, California Public Employees' Retirement System, with nearly $300 billion in investments, extended its assumption of how long workers will need benefits by two years, Arnold noted.
"The policy response was very telling. They did not increase city contributions to the plan immediately; instead, they are phasing it in over a number of years starting in (I believe) 2017. In other words, we'll pay for it in the future."
Arnold hopes to guide states and cities to enact policies that create sustainable systems.
"(Defined contribution) plans can be part of the solution, but are not a silver bullet," he said. "Everyone knows their system needs reform. The debate is whether to make minor reforms or structurally fix the system."
(Editing by Walden Siew and Eric Walsh)