State Pension Plans Scramble to Avoid Bankruptcy
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.”