In September 2009, one year after the failure of Lehman Brothers Holdings, Meredith Williams left his office in Denver to travel around Colorado with the board of trustees of the state’s Public Employees’ Retirement Association, stopping in eight cities to meet with active and retired members. The pension plan had suffered monumental investment losses during the financial crisis — $11 billion, or 26 percent of its portfolio — and its funding ratio (based on the market value of assets) had tumbled to 52.7 percent. The pension had been fully funded at the start of the decade, prompting legislators to grant generous benefit increases and reduce contributions, but with the severe drop in asset values, “suddenly the plan was not sustainable for the long term,” says Williams, executive director of Colorado PERA.
He figured the eight-city “listening tour,” reaching out to the membership of 440,000, could start building the consensus essential to righting the plan. However, his most potent proposal — reducing the annual 3.5 percent cost-of-living allowance (COLA) for retirees — met with a lot of push-back.
“The loudest voices were from those in retirement, or about to be,” Williams recalls. “They said, ‘I’ve done my time and everything I was asked. Make the cuts to someone who is still working or to the new people.’”
Suggestions and objections in hand, Williams and the trustees returned to Denver and crafted proposals to present to the Colorado legislature. “We were fortunate to have the backing of the senate president, and he was joined by the minority leader, a Republican, so we had a lot of support right out of the gate,” Williams says. With the help of software from the plan’s actuarial consultant, legislators could input their own solutions and see firsthand the challenges of reshaping the plan. They quickly realized that without significantly reducing the COLA, the state would run out of money before any longer-term changes, such as granting new hires lower benefits, could make an impact. A nagging concern, however, was the likely legal challenge to rolling back benefits already promised, a move contrary to contracts clauses in both federal and state constitutions.
After the board’s legislative recommendations took shape, the Colorado PERA team made another trip around the state — 13 meetings in October and November 2009 — to a more receptive membership: 84 percent of attendees gave their support. “This time the reaction we heard was, ‘Now I understand why these steps are necessary. But what if a lawsuit prevails and you can’t reduce the COLA? What is your plan B?’” Williams remembers. “Our answer was, ‘There is no plan B. If the courts don’t allow our plan, you’re not going to like what will follow.’”
Then–Colorado governor Bill Ritter Jr., a Democrat, signed the bill into law on February 23, 2010. Less than three days later, retirees filed a class-action lawsuit contesting it.
Colorado PERA is not alone. State pension funds, facing a potential multitrillion-dollar shortfall, find themselves in the center of a four-way battle: Employees and retirees expect to be paid their promised benefits; the pension systems have clear obligations but may not have the resources to pay them; politicians are looking for ways to resolve the underfunding and balance the burden among retirees and workers; and state taxpayers, challenged to provide for their own retirements, resent the additional tax load.
Accordingly, over the past three years, most states have taken measures to shore up their defined benefit pension plans. A few, such as Colorado, Minnesota and South Dakota, have made the difficult choice of cutting benefits to current retirees, and all three are facing legal action on the grounds that they are not honoring their contracts. Other states are trimming their plans around the edges, adjusting benefits and contributions for the next generation but resolving to reach full funding over several decades. And following the current popularity of tea parties, smaller government and budget-cutting, a handful of states are even making noises about closing their traditional defined benefit plans and letting new employees fend for themselves with defined contribution plans. There’s even been talk in Washington about trying to pass legislation that would allow states to do the previously unthinkable — petition for bankruptcy — to get out from under their debt burdens. But while calls for state bankruptcies might play well with the Republican faithful, most observers doubt such a solution will ever become a reality. Instead, the real dramas are already playing out at the state level as officials and lawmakers desperately seek solutions to their pension crises.
The shortfall between state pension liabilities and the assets plans have gathered and invested to pay for them has been variously estimated at anywhere from $500 billion to $3 trillion. The figure at the lower end is an aggregation of fiscal year 2008 funded status taken from the states’ own reports by the Pew Center on the States and published in Pew’s comprehensive white paper on state pension and health care plans, “The Trillion Dollar Gap.” The larger figure, by professors Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester, is an estimate of underfunding as of June 2009, following the peak of the financial crisis; though pension funds’ assets were smaller at that time, the professors’ estimate sets much higher values on liabilities, borrowing methods from financial economics that differ from governmental accounting principles (see “Colored by Numbers,” below). Rauh and Novy-Marx grimly conclude that as of June 2009, state plans in the aggregate were funded at 41 to 56 percent, based on assets at market value and liabilities estimated using market discount rates.
The governmental pension community prefers the less-dire Pew report, naturally. The National Association of State Retirement Administrators, a research and lobbying group for state plan managers, quotes Pew’s study on its web site: “In aggregate, states’ systems were 84 percent funded — a relatively positive outcome, because most experts advise at least an 80 percent funding.” Pew has not updated its 2008 take on funding for the effects on portfolios of the financial crisis or the subsequent recovery.
A more timely assessment of state fund health by consulting firm Wilshire Associates, also based on states’ own financial reports, estimates that after hitting 95 percent in 2007, then staggering to 79 percent in 2008, funding of states’ pension obligations had fallen to 59 percent by June 2009. Wilshire calculates funding levels using market values of assets rather than smoothed actuarial values.
(In this article we report asset values and funding rates at market wherever possible, as of the latest available reporting dates.)
After the market shock of 2008, the heads of pension systems saw that their plans were in a bind that was not likely to be relieved by a few good years in the markets. One pension expert believes that without significant changes to benefits and contribution policies at many public funds, they could be out of money to pay benefits in as few as ten years.
At Colorado PERA, where funding fell to 52 percent in December 2008 and recovered to 58 percent a year later, Williams came to the same realization. “If you drop below 40 percent funding, No. 1, you have no ability to survive another market event like 2008,” he says. “Second, liquidity becomes a major concern. Your asset allocation has to become more conservative, and earning less on the portfolio just speeds up the process of hitting bottom.” Therein lies the motivation for Colorado’s drastic steps. In 2009, Williams persuaded the legislature to roll back the annual COLA to 2 percent. Other changes included small increases to contributions for both employers and employees, and a requirement that most members work longer before they retire. “What struck us was that reducing the cost of the plan through changes to new hires takes decades to have an impact on the funding status,” Williams adds. “We didn’t feel that we had decades.”
Most state legislatures, however, so far have taken less painful measures than Colorado has, such as pushing through contribution increases amounting to 1 or 2 percent of compensation, lengthening the time frame for calculating final average salary (to reduce the number on which retirement income benefits are based), and limiting changes to new employees.
Other states have been more determined to try to fix the problem. In California many employees will see the normal retirement age rise to 60 from 55 and will contribute 3 percent more of their pay starting this year, while the state’s contribution will rise to $3.9 billion from $3.3 billion. Missouri has bumped up its normal retirement age to 67, the highest in the nation, and new hires in 2011 and beyond will contribute 4 percent of pay to the plan, up from zero percent for current employees. Illinois, where funding in the State Employees’ Retirement System stood at 57.3 percent at market value in June 2009, has cut its COLA and raised its normal retirement age to 67. In Virginia new hires will contribute 5 percent of pay, versus none for past cohorts, and the state has deferred its contributions until 2013 as a budget-balancing measure.
The glacier analogy
During the first ten months of 2010, 18 states took action to reduce their pension liabilities, either through trimming benefits or increasing employee contributions, according to the Pew Center. In 2009, 11 states made similar changes, and eight did so in 2008 (some states made multiple changes). Over the three-year span, however, 20 states enacted no legislation. Of that group, a handful of states, such as Delaware, Florida, Idaho, North Carolina, Washington and Wisconsin, have been able to report high funding all through the crisis. The reason for their success is not complicated, but is very difficult to carry out year after year: They’ve all made contributions adequate to support the benefits they’ve promised.
One observer, a municipal bond investor who incorporates the health of pension funding into his analyses of states’ creditworthiness, believes many states are taking the easy measures first, such as cutting benefits for new hires or curbing “spiking,” the abusive practice of inflating an employee’s last few years’ pay and thus the basis for benefit calculations. The investor says, “The political process will not go after the biggest bang first — cutting the benefits to retirees — because there is always the possibility that the stock market comes back and the problem starts to go away.”
A pension plan’s benefit obligations are something like a glacier. They start as a bare mountainside, but a little snow accumulates and freezes, then more ice builds up over many years in small layers. In the same way, each employee accrues a little more retirement benefit each year. There are two ways to make the glacier smaller. One is to reduce or stop the addition of new layers — in the case of a pension plan, perhaps reducing the benefits for new employees. But that tactic can only alter the glacier a little bit at a time. The second way, which can reduce the glacier rapidly, is to address the many accumulated layers frozen in the middle — the existing benefit obligations for today’s retirees and employees.
Last year professors Rauh and Novy-Marx authored a paper, “The Intergenerational Transfer of Public Pension Promises,” that compared the effectiveness of policy options available to state pension funds. The solution, they concluded, is confronting the obligations to the current base. A 1-percentage-point reduction in COLAs for retirees would reduce total liabilities by 9 to 11 percent; because many state plans provide for COLAs of 3 percent, cost-of-living increases make up about one third of their benefit obligations.
Reductions to COLAs work so well because they restrict the increases in benefits for everyone in the plan, whether retired or still working. That breadth also means that legislators wind up taking retirement income away from neighbors, family members and other constituents. “The measures that would actually have a substantial impact on unfunded liabilities are too strong to be politically acceptable,” says Rauh. “Unfortunately, attempts to reduce unfunded liabilities through the kinds of cuts legislators can pass easily are likely to fall short of what’s necessary to avert a crisis.” Therefore, lawmakers often resort to cutting benefits for people yet to be hired.
“The COLA is probably the most expensive feature, and plans that are legally and politically able to are considering getting rid of it,” says M. Barton Waring, who retired as global chief investment officer for investment policy and strategy at Barclays Global Investors and is an active pension scholar whose articles have appeared in many financial journals. “A lot of times they’ve been written into the plan in a hard way, and once they are granted it’s difficult to take them away. Protection of the COLAs is what ought to be unconstitutional.”
The other major lever at hand, increasing contributions, doesn’t reduce a plan’s liabilities but does improve funding. But it can also violate the existing social contract: Younger workers wind up subsidizing older ones who have made lower contributions all along. As a bargaining tactic, it presents a potential conflict of interest for labor unions, because they are supposed to represent all their members evenly, note Rauh and Novy-Marx.
Public employee unions are resisting reductions in benefits. Members of the American Federation of State, County and Municipal Employees, 1.6 million strong, earn just $45,000, on average, while working and retire with benefits of $19,000 or $20,000, says collective bargaining director Steven Kreisberg: “Should that be a problem in America — allowing public employees to retire with dignity?” He points out that most state employees make large contributions to their own defined benefit retirement and that about one quarter of state workers are outside the Social Security system.
"We simply need to put in more money”"
A 30-year veteran of organized labor who worked with the American Nurses Association and two federal employee unions before joining AFSCME, Kreisberg develops the union’s policies on pension and health benefits. He believes plans’ financial difficulties are being exaggerated by the media and calls on state sponsors to make greater contributions, especially those that have starved their plans, such as Illinois, New Jersey and Pennsylvania.
“We simply need to put in more money,” he says. “When tax revenues start to recover, states will only have to take a percentage point or less of their budgets to spend on pensions. That doesn’t seem onerous or challenging to the point that it can’t be done.”
DAVID BERGSTROM, executive director of the 87,000-member, $13 billion Minnesota State Retirement System (MSRS), has lived through several pension cycles. Minnesota born and bred, Bergstrom joined the Public Employees Retirement Association of Minnesota, which manages retirement plans for local government and school districts, in 1983 and moved to MSRS in 1992.
Like Colorado, Minnesota has taken the bull by the horns and reduced COLAs for current retirees. In Minnesota funding fell to 65.6 percent at market value of assets for June 2009 from a robust 93 percent in 2006. “Our actuaries told us that we had a significant contribution deficiency, about 6 percent of payroll, and that we would have needed multiple years of 15 percent returns in the investment portfolio to get to full funding,” says Bergstrom.
Plan trustees considered limiting changes to benefits and contributions for new hires, but realized the impact was too small and far-off. Next on the list was raising contribution rates for current employees; the board ruled that out too, because increases from the previous four years were just being phased in. Other, smaller changes in vesting and interest paid on refunds were proposed, but all were entirely prospective and did not take away credits already earned. “We took the COLA reduction and other cuts to our stakeholders — the unions and retirees — and all of them supported the change,” Bergstrom says.
The Minnesota legislature passed the Omnibus Pension Bill by overwhelming margins, and then-governor Tim Pawlenty signed it on May 15, 2010. A new approach shifts some of the funding risk to participants by reducing benefit increases until the plan’s funding, based on market valuation, is restored to 90 percent (compared with 75 percent for the large general employee plan in June 2009). In the general state plan, the COLA has been cut to 2 percent from 2.5 percent. Retired teachers receive no raise this year or next, with 2 percent annual increases to follow until 90 percent funding is attained. The measures reduce the estimated June 2009 underfunding of $3.6 billion by $800 million.
“Our law says that as fiduciaries we have to rely on reason rather than hoping for strong markets,” Bergstrom notes. “We had the opportunity to start saving $52 million a year, so if the market recovery was slow or the market simply did not recover, the delay would have set us back further.”
Complicating the efforts to repair state pension plans are legal challenges brought by pensioners who object to having their cost-of-living increases taken away. There’s real money at stake — in the case of Colorado, the class-action complaint estimates that the cut in the COLA will cost the average retiree more than $165,000 over 20 years.
“The public employees have contracts with the states for benefits, and those contracts should be treated the same as any other, such as the interest states pay to their bondholders,” contends Stephen Pincus, a partner with Stember Feinstein Doyle & Payne, a plaintiffs’ rights law firm in Pittsburgh that is representing pensioners in Colorado, Minnesota and South Dakota.
Pincus asserts that civil-servant retirees are protected by general clauses in the state and federal constitutions about governments breaking contracts, as well as by specific provisions in the three states’ pension laws that prohibit reduction of workers’ benefits once they’re retired. No additional actions are being contemplated against other states, he says, but the 2011 legislative sessions have just begun. Because legal actions are under way, the three states facing class actions can provide little direct comment, but in each case, pension managers forged a consensus with state employees and legislators.
“We assumed from the beginning” that the state would be sued, says Colorado PERA’s Williams. “At the same time we had actuaries crunching numbers, we had lawyers doing legal searches. The board would not have proceeded if it did not feel secure that it was on solid legal ground.”
Bay state picture
THE STATE RETIREMENT system of Massachusetts dates back 100 years. The second generation of its enabling legislation was formulated in the 1940s, when life expectancies were shorter and career tenure was long. For most workers, benefits are modest but come at a high cost: In the general state plan, payments to retirees today average just $25,000, and Massachusetts public workers are not covered by Social Security. Cost-of-living allowances are paid on just the first $12,000 of a retiree’s benefit. Contribution rates on employees hired since 1996 are above 9 percent, among the highest in the U.S.
The plan was a pay-as-you-go arrangement until the late 1980s and had an unfunded liability of $23.8 billion at market value as of January 2010, mostly attributable to the 70 years that the state wasn’t funding it. The antique design, covering more than 100 state and local employers and 510,000 workers and retirees, places a great burden on the plan today: Only a quarter of the state’s contributions — projected at $1.4 billion for 2011 — are allocated to paying benefits, while the remainder goes to reduce the unfunded liability.
In 2009, after embarrassing media coverage, the legislature closed several egregious loopholes in benefit policies, such as one that granted an additional year’s benefits for one additional day of service. Next, Governor Deval Patrick appointed a 17-member commission for a second phase of pension reform, made up of legislators, pension executives and, as co-chairmen, two prominent academics: Alicia Munnell, director of the Center for Retirement Research at Boston College, and Nobel Prize–winning economist Peter Diamond of the Massachusetts Institute of Technology. The commission met nine times between March and September 2009, when it offered 32 recommendations covering benefit design, retirement security and plan funding.
“There were two lights — the co-chairs,” recalls Michael Widmer, president of the 80-year-old Massachusetts Taxpayers Foundation, who attended two of the sessions. “But the meetings were in another universe. The debate was supposed to be over reducing the underfunding for the pension plan, but some of the conversation was over how we would expand benefits. In theory, they would spearhead phase-two reform, but because there were so many advocates for pension recipients on the committee, its promise was ended the day it was appointed.” No real progress was made during the 2010 election year, he adds.
But Patrick won reelection, and Widmer has proposed more-aggressive measures with the 2012 budget, including extending the amortization period through 2040. “These proposals kick the can down the road by extending amortization of the unfunded liability to 2040, but they’re the minimum of what’s necessary,” Widmer says.
Savings from the governor’s early-2011 proposals are estimated at $5 billion over 30 years. If the amount seems small in comparison to the $20 billion-plus underfunding, it is, but the state is facing a deficit for 2011 estimated by the Massachusetts Taxpayers Foundation at $2 billion, so near-term resources are scarce. Moreover, Patrick’s proposals cite the need to honor contracts with employees and retirees and specifically rule out the tough measures of cutting existing benefits. “The outside world may see a liberal patina on Massachusetts, but we have a very entrenched political culture here and tend to be slow on reforms like this,” observes Widmer. “We’ll see how much the legislature can handle.”
Another state that is slowly working to right its public pensions is Pennsylvania, where the general and teachers’ plans claim combined membership of 670,000 and assets of $67 billion. After investment windfalls pushed funding rates over 100 percent in the late 1990s, legislators increased benefits and granted employers several years of contribution holidays. The free spending eroded funding ratios nearly every year of the past decade, even before the financial crisis — to 69 percent for the general plan and 56 percent for the teachers’ plan (both at market value of assets as of December 2009 and June 2010, respectively).
"“We shouldn’t be asking taxpayers who earn $50,000 themselves to be guaranteeing the lifetime income of a university chancellor who makes $150,000.”"
State senator Glen Grell, a Republican who has represented the 87th district in south-central Pennsylvania since 2004 and who served in the administration of former governor Tom Ridge from 1995 to 2000, proposed in 2010 that the state’s general and teachers’ schemes be reorganized into arrangements that combined elements of defined benefit and defined contribution plans — guaranteeing small lifetime benefits to be supplemented by personal accounts funded 3 percent by contributions from employees and 2 percent from the state. “I was out talking about the proposals for six months, and while the teachers’ union never warmed to them, there were individual teachers and school boards that appreciated we were proposing a middle-of-the-road change compared to our prior plan,” Grell says.
In a lame-duck legislative session, Grell’s hybrid idea was ruled out, but nine significant reforms were made to the defined benefit plans, including benefit reductions for new employees and higher retirement ages and employer contributions. The bill also prohibited Pennsylvania from issuing bonds to fund its liabilities. It passed the Pennsylvania house in November by a vote of 165 to 31.
The benefits of current retirees were left untouched because, as Grell notes, “no one wanted to put together a plan that would immediately wind up in court.” As with other plans that have affected only future benefits, the net present value of savings is small and achieved only in the long run: a reduction in benefits of $24.7 billion over the next 30 years, offset by $23.3 billion
of actuarial and funding changes to amortize the unfunded liability, for a net savings of $1.4 billion.
“Of course there are some that don’t think we went far enough, who would like to see us close out the plan and start all new employees under a DC plan,” says Grell. “And there may be an effort in that direction, depending on how aggressive the new governor [Tom Corbett, a Republican] wants to be.”
CLOSING PENSION PLANS TO new state employees is a drastic step. Before 2010 only two states had done it, shunting new hires to defined contribution plans: Alaska in 2006, and Michigan in 1997 (for general state employees). West Virginia ended its defined benefit plan in 1991 in favor of a defined contribution arrangement but returned to a pension plan in 2008.
It’s true that, at a glance, defined contribution plans appear much less expensive to employers than defined benefit plans. States don’t have to kick in much more than the current year’s contributions, and the risks of generating investment returns and providing lifetime incomes, and the liabilities that come with them, are handed over to the employee. But a sponsor does not simply walk away from a defined benefit plan.
The defined benefit/defined contribution decision goes far beyond the cost of the retirement benefit — it can change the very nature of employment in the public sector. The prospect of a pension is an important factor in people’s decisions to take what are often lower salaries in the public sector.The long-term result for those states that end their public employee pensions could be a workforce that demands higher pay and won’t have an incentive to stay in jobs as long.
The idea of preserving the obligation to pay lifetime benefits may not resonate with taxpayers in times of fiscal austerity, but as a retirement vehicle, the defined contribution plan simply is inferior, says pension scholar Waring. “The most stingy defined benefit plan gives a better benefit than the most generous defined contribution plan,” he explains. “A benefit set at just 1 percent of final salary per year of service gives you a real retirement payment, whereas the median balance in defined contribution plans for people retiring now is under $100,000, because people don’t save enough. It’s not that in principle a DC plan couldn’t be as generous, but in practice they’re just not.”
Paternalism aside, the costs of an underfunded defined benefit plan don’t stop when it’s closed to new employees. “The biggest issue is that closing your DB plan does not eliminate the liabilities — you will be working down those obligations for 40 more years,” observes David Stella, secretary of the Wisconsin Department of Employee Trust Funds. Younger employees, an important source of defined benefit contributions, are no longer in the plan, but benefits still have to be paid to retirees, and the obligations to current employees keep growing. “Where does the difference come from?” Stella asks. “You have to increase the contributions from the people still in the plan or from employers, or both, or you have to earn greater investment returns.”
Alaska’s case illustrates his point. The defined benefit plan’s funded ratio, measured at market value of assets, dropped to 52.4 percent for fiscal 2009 from 81.1 percent in June 2006, just before the plan was closed. The markets were a factor, of course: Assets dropped to $5.1 billion from $6.6 billion. But despite Alaska’s closing the plan to new entrants, liabilities rose by about 20 percent over the four years, to $9.7 billion from $8.1 billion.
Republicans’ good fortune in the recent elections, combined with the current fervor over budget-cutting, is pushing a number of states to consider shutting plan doors. In addition to Corbett in Pennsylvania, the new GOP governors of Alabama, Nevada, Tennessee and Wisconsin all back defined contribution plans for new hires, and Republican lawmakers in Oklahoma are making similar noises.
Alaska’s experience is too brief to allow conclusions to be drawn about the adequacy of benefits or cost differentials, but Michigan, which closed its defined benefit plan for general state employees in 1997, offers a benchmark. “When we made the change, the predictability of cost was important from the employer standpoint,” explains Phillip Stoddard, director of Michigan’s Office of Retirement Services since 2004 and a 23-year veteran of the Michigan retirement system. “For the employees, there was a lot of talk about portability, and the investments were doing so well. It was innovative on the part of our executives at the time, who had been looking at private enterprise moving to DC plans.”
Thirteen years on, 29,000 active participants, or more than half of the system’s employees, are in the defined contribution plan. The average balance is about $50,000, but for employees close to retirement — age 60 or higher — the average account is about $123,000. Michigan’s actuaries reckon that a defined contribution balance that size can provide retirement income of about $9,000 per year. Meanwhile, in the defined benefit program, the average benefit for people currently retiring is closer to $30,000 annually. The defined contribution plan saves the state about $25 million a year over the defined benefit plan, on a total cost of $429 million in fiscal 2009.
Stoddard concedes that the defined benefit plan is providing a more robust benefit: “I’m pleased that our plan is in the mainstream in that it includes an employer contribution and employer match” — 4 percent and 3 percent, respectively, the latter contingent on the employee contributing at least 3 percent. “But,” he adds, “the $50,000 and the $123,000 average balances — those clearly need to grow.”
Michigan just moved its new public school employees to a hybrid plan that provides a base guaranteed benefit plus a defined contribution component. “We’re excited about the hybrid plan because predictability is an important component of retirement income,” Stoddard says.
West Virginia’s teachers have made a round-trip from the world of defined benefits to defined contributions and back. The traditional plan was closed in 1991 because of very poor funding, bottoming out at just 17 percent in June 2003. State employees were not satisfied with the defined contribution plan that replaced it, however: Compared with an average annual benefit under the old defined benefit plan of about $30,000, teachers approaching retirement held just $23,000 — that’s total assets, not annual income — in their individual defined contribution accounts.
“Under the new plan, people had less to retire on for a lifetime than they would have received every year, so you can see why there was pressure to return to the old plan,” notes Terasa Miller, acting executive director of the West Virginia Consolidated Public Retirement Board, which oversees two major plans, for state employees and teachers, with 56,000 and 63,000 members, respectively, and seven smaller plans.
Not only did benefits turn out to be inferior, plan managers were not convinced that the new arrangement was saving the state and employers in terms of “normal cost” (the annual expense of providing for each year’s pension benefit), prompting several years of studies on the costs of restoring the defined benefit plan. Aside from amortization of the past liability, normal cost has since turned out to be about 4.3 percent of payroll — roughly 40 percent lower than the 7.5 percent employer contribution that was going into the defined contribution plan.
“We realized there could be immediate savings on what was being put in to fund each year’s future benefits, and any additional amount could have gone toward paying down the unfunded liability,” explains Miller. Legislation was passed to return all employees to the defined benefit plan in 2005, but some resisted having to leave the defined contribution plan, delaying the change until 2008.
The West Virginia legislature also has actively dealt with the defined benefit plan’s previous underfunding. Lawmakers confronted the amortization of past liabilities in 1994, when they developed a 40-year plan, “and they have firmly stuck to that,” says Miller. Moreover, she adds, the state has dedicated a large part of the money it receives from tobacco liability settlements to replenishing the pension plans. Another part of the legislation prohibits benefits being increased until the plan is fully funded, scheduled for 2034. Funding of the teachers’ plan had improved to 43 percent at market value of assets by June 2009 — still low, but feasibly on the way to full funding.
“Our legislature thought this was the best plan for our teacher members, to give them a guaranteed benefit so that they wouldn’t need other state services in retirement when their defined contribution monies were exhausted,” Miller says. “From a policy standpoint, I think it was the right decision.”
In New Jersey, Governor Chris Christie has proposed a package of pension reforms resembling those of other states: raising retirement ages for younger workers, increasing employees’ contributions to a uniform 8.5 percent and the controversial COLA reduction. According to the governor’s web site, the changes “will reduce total pension underfunding from $181 billion in 2041 without reform to $23 billion in 2041 and increase the aggregate funded ratio from the present level of 66 percent to more than 90 percent in 30 years.”
Presidential hopeful Newt Gingrich fears that the public pension crisis will result in a march to Washington by the leaders of troubled states looking for federal bailouts. He urges Congress to change federal statutes to allow states to petition for bankruptcy and force a renegotiation of pension benefits in the federal courts. He asks for new laws that would prohibit states from raising taxes to pay for the revised arrangements.
What’s needed is a national consensus that will give states more control over public plans, says Munnell of the Center for Retirement Research. “There needs to be leadership, perhaps from the National Governors Association, to recognize that these protections to employees’ benefits are in fact harmful,” she says. “The protections for public DB plans should be scaled back to what they are in the private sector. The idea that you can’t adjust anything for the current workers just doesn’t make sense.”
Munnell also sees a greater role for hybrid plans. “DB and DC plans can be stacked,” she explains. “States could provide defined benefits on the first $50,000 of a worker’s salary, and on amounts over with a DC plan. That would reduce some of the cost, but it would keep so much risk from falling on taxpayers. We shouldn’t be asking taxpayers who earn $50,000 themselves to be guaranteeing the lifetime income of a university chancellor who makes $150,000.”