In recent months, a handful of states have made big changes to their public retirement plans. The latest spate of pension reform is part of a broader trend among retirement plans following the financial crisis of 2008. The Center for Retirement Research at Boston College looked at reforms made at over 200 major state and local retirement plan between 2009 and 2014 and found that since the financial crisis, 74 percent of state plans and 57 percent of large local plans have cut benefits or raised employee contributions to curb rising costs.
A few states that have recently been in the news for their actions to address pension debt are reviewed below. Notably, most of these states have shifted the risk of future retiree benefits away from employers and onto public workers by designing plans that have more in common with a 401(k) than with traditional defined benefit plans. Despite dramatic changes in plan design, these states still struggle with how to pay off the existing unfunded liabilities. Further, the move away from defined benefit plan designs may exacerbate the problem rather than helping to solve it.
Michigan
In Michigan, legislation passed and signed by the governor in July is intended to increase incentives for teachers to join a defined contribution or a 401(k) type plan. The new law calls for the replacement of an existing hybrid retirement plan with a new hybrid option. The legislation does not change the pension or health care benefits for current retirees or employees who were hired before July 1, 2010; nor does it address the $29 billion unfunded liability of the older defined benefit plan.
Proponents of the legislation argue that it gives schools more predictable and contained pension costs.
Opponents, however, fear that the changes will cost taxpayers and lead to the closure of any hybrid retirement option, leaving teachers and other school employees with only a 401(k)-type plan. (If the new hybrid plan drops to a funding ratio of 85 percent or lower over two years, it will be closed to new members.) They also fear that it will make it more difficult to recruit new teachers and discourage existing teachers to remain in the profession long-term.
The final bill was a compromise from an earlier legislative proposal that would have closed the hybrid plan entirely to new hires and placed all teachers in 401(k)-style plans. That proposal was projected to cost $16 million in additional costs for 2018 and grow to as much as $813 million per year by 2048.
Moving school employees into a new hybrid plan does not pay down the debt of the legacy pension system that went from being fully funded in 1996 to a $29 billion deficit in 2017.
Pennsylvania
Pennsylvania legislators also passed pension reform legislation this summer that closes the existing defined benefit retirement plan to all school employees and most state workers beginning in 2019. Future workers will select from one of three plans that offer either a combination of some guaranteed benefit and a 401(k)-style option or a 401(k)-type option only. Current members of the retirement plan will have the choice to stay put or switch into one of the new plans, but once a choice has been made, it is final. Retirees will not see a change to their benefits under this new law.
Supporters of the legislation argued that the new retirement plan options reduce the burden on taxpayers who are on the hook for public-sector retirement benefits regardless of market performance and would avoid increases in contributions that schools and state government now face. It could also reduce fees paid to Wall Street and potentially save $10 billion, said Gov. Tom Wolf, who signed the bill into law on June 12, 2017.
The changes are not without critics, however, who argue that the transition to new retirement options does little to address the root cause of the pension crisis, which is the combined $70 billion unfunded liability of the state’s retirement plans for state employees and public schools.
Kentucky
In 2013, Kentucky lawmakers approved a pension reform plan that moved newly hired state workers to a 401(k)-style hybrid plan, generated an extra $100 million for the state pension system, and committed the state to making full recommended pension contributions every year.
After that plan was approved, a bipartisan group of Kentucky state legislators wrote of their fears that the new 401(k)-style hybrid plan would harm, rather than help, current and future workers by reducing benefits and increasing costs.
Since 2013, the unfunded liabilities of the pension system have continued to grow, totaling $33 billion at the end of June, 2017 – up $26 billion from about a decade earlier. Growth in the unfunded liability is attributed to everything from weak financial markets and plan performance to increases in cost of living adjustments and employer contributions below actuarially required levels, a “pattern of underfunding the system…from fiscal year 2004 to fiscal year 2014” that could leave the retirement system facing insolvency in just five years.
Kentucky Gov. Matt Bevin is preparing to call a special session to stabilize the state’s pension crisis, but has not yet released specific proposals for pension reforms or set a date for the special session.
Illinois
A pension reform plan for Chicago’s municipal and labor pensions was included in the Illinois state budget that was approved in July. The approved budget also included a hybrid plan for some new employees in the state pension system. Increased contributions from some employees and increased city contributions that were included in the measure are intended to improve the Chicago Municipal Employees retirement plan and the Chicago Laborers’ Annuity and Benefit fund funding ratios to 90 percent each by 2058.
Chicago is required to make contributions on an actuarial basis to both funds beginning in 2023. Participants hired after January 1, 2017, will face higher contribution rates but full eligibility for a benefit lowered to age 65 from 67. Those hired before 2017, but on or after January 1, 2011, will have the option to increase their contribution rate in exchange for lowering their retirement age to 65, while those hired before 2011 are not affected.
The pension changes for new hires at the Illinois Teachers Retirement System, the Illinois State Employees’ Retirement System, and the Illinois State Universities Retirement System include a hybrid retirement plan for new hires. The changes are not expected to dramatically reduce the state’s unfunded pension liabilities.
Lessons learned
The experiences of these public retirement plans might help to inform policymakers and stakeholders in Colorado who are working to ensure that public employees have a reliable and sustainable retirement plan, or at least provide a cautionary tale. Certainly considering how different plan designs treat risk and which parties bear risk is a critical part of the equation. Any changes will likely impact current, future, and retired public employees and should be a part of any discussion. In addition, any future changes should be evaluated in terms of how they address the current unfunded liability. As experienced by several states, efforts to shift risk and ignore the unfunded liabilities mean the plan is worse after reforms than before they were implemented.
In 2015, an independent, third-party analysis commissioned by the Colorado General Assembly and performed by GRS considered the cost and effectiveness of the PERA hybrid plan design compared to other types of retirement plans. PERA on the Issues readers may be familiar with this study that found the PERA plan design delivers the most benefit at the lowest cost. The GRS study also included information related to the cost associated with switching from the current hybrid defined benefit plan design to a cash balance-type plan. The “transition cost” of moving new hires to this type of plan structure over time would total between $9 billion and $16 billion.
