LEGISLATIVE OPTIONS TO REFORM PUBLIC PENSION PLANS
By Girard Miller
Following the stock market swoon of 2008-09 that decimated pension fund investment portfolios and doubled the unfunded liabilities of most public plans, the funding problems of public retirement plans have attracted national attention. With public pension plans now underfunded by about $800 billion using conventional actuarial methods applied to 2010 yearend market values, and public retiree medical benefit plans suffering even deeper deficits of $1.5 to $2 trillion, concerns are mounting over the ability of public employers to meet their obligations. Pension reform has become a rallying cry in many state legislatures, and many states have revised their plans in an effort to address the financial hemorrhages.
The challenge states and localities now face is that many of those revisions and reforms are insufficient to align long-term liabilities and costs with the capacity of public employers to pay for these benefits. For a public employees’ retirement plan or system to operate in the best interests of all stakeholders, including taxpayer/voters as well as the affected employees, it must be affordable, sustainable, sufficient and competitive. This often requires changes in the plan that will affect current employees as well as new hires—although many states will struggle with legal, labor relations and sometimes even constitutional issues in making legislative changes for vested employees. In this context, here are several reforms legislatures most likely will consider in an effort to provide authority for public employers to change benefits formulas prospectively for incumbent employees:
1. Raise employee contributions. This is generally the least controversial as a matter of law. Benefits may enjoy protections, but employees’ contributions are usually fair game. A strong argument can be made that employees are more responsible in their views of the benefits when they share in the costs and do not view the retirement benefits as “free money.” For retiree medical benefits plans, known as OPEB, the concept of an employee contribution is relatively new, but will become inevitable in many states because these plans are quite deeply and unsustainably underfunded.
2. Reduce pension multipliers prospectively. The idea is that future service will be rewarded with a lower benefit formula. For example, a state may limit the maximum multiplier for future service to 1.7 percent for general employees and 2.3 percent for public safety employees in the Social Security system, and 2.5 percent for those outside of Social Security. Such benefit levels would be consistent with “sufficient” pension benefits for new hires, and would put senior employees on an equal footing with new employees with respect to their future service. Such reductions, where they apply, will also have a significant impact in reducing employer costs.
3. Raise the retirement age for younger workers. It is not fair to raise retirement ages for workers over age 50 by more than a month or two for each year prior to their planned retirement, but for younger workers, it may be both appropriate and necessary to invoke higher ages ranging from 62 to 67 for civilians and 57 for public safety. Legislatures can consider a variety of transition provisions to provide equitable treatment to in-service employees. A prudent provision for changes of retirement ages would ensure that any employee whose retirement date has been increased prospectively should not suffer a reduction in the accrued actuarial value of previously earned vested benefits; this adjustment can be made on an individual basis and would optimize the plan transition by giving the plans and the employers the greatest latitude for making changes while still protecting individual rights.
4. Prohibit retroactive pension increases. History has shown that benefits increases awarded retroactively have produced no value to taxpayers, windfalls to the senior incumbents and huge liabilities for the employers.
5. Raise retiree medical benefits (OPEB) eligibility ages. For new hires, age 65 will likely become the new norm for employer-paid retiree medical benefits. For incumbent employees, age 60 for civilians and age 57 for public safety are appropriate and reasonable levels with appropriate transition provisions to protect vested accrued rights. For example, a transition formula could cap the benefits of incumbent employees by a ratio of years served, divided by either 25 or 30 years as a normal full service career. Again, the rule that accrued vested benefits should not be reduced may apply here if the plan documents and enabling legislation have provided legal claims to full benefits at an early age.
6. Limit retiree medical benefits to a fixed dollar per month per year of service. A formula allowing $10 or $15 per month per year of service toward retiree medical expenses will still be highly competitive in the private labor markets. A Consumer Price Index inflation escalator can be provided, but this will be far less costly than medical inflation.
7. Require employers to make full actuarial contributions by a certain date. In the interim, those presently underfunding must ramp up their contributions. For OPEB plans, this may take five years.
8. Place a dollar cap on pension benefits or pensionable compensation at a level not to exceed two times the state's median household income, currently $50,000 nationally. This would essentially limit public pensions for new hires to five figures on average, and compel those seeking higher retirement income to also participate in a defined contribution—401a, 403b or 457—plan.
9. Require hybrid defined contribution and defined benefit plan for new hires similar to the federal employees’ retirement system, which provides a pension multiplier of 1 percent and a matched employee savings plan up to 5 percent of salary.
10. Limit total compensation to competitive market standards. Some states will likely consider establishing statutory limits on total compensation for public employees to prohibit awarding retirement benefits that would exceed private labor market standards when combined with salaries, wages and other benefits. Such a standard would still permit retirement benefits to exceed private sector standards but would reduce other compensation.
11. Other miscellaneous reforms should also be considered, such as “anti-spiking” provisions that eliminate overtime from pension calculations; requirement for a longer average final compensation calculation; elimination of deferred retirement option plans that have rewarded employees for unsustainable early retirements; and governance of the retirement plans to include more, or a majority of, independent directors.
A key issue in some states will be whether these limits supersede collective bargaining or supplant it. It would seem reasonable for the legislature to set limits by statute that cannot be exceeded in a labor agreement, and permit bargaining within that envelope of restrictions. This assures retirement reform on a universal statewide basis to discourage piecemeal reform efforts, wide and noncompetitive disparities in benefits among public employees, and divide-and-conquer tactics by multiple employee bargaining units.