Solutions to the Public Pension Crisis

Public pensions at the state and municipal levels are unsustainable in their current form.  State Budget Solutions’ recent study by Andrew Biggs found that public pensions are underfunded by $4.6 trilion.  States and municipalities must achieve fundamental reform.  If reform does not happen, essential public services will have to be cut and dedicated government workers laid off, disrupting or eliminating public health, safety and education.

Switch to Defined Contribution System

The most effective reform is implementing a defined contribution pension plan. By putting all employees, both new and existing, into a defined contribution plan, which is similar to a 401(k) style plan found in the private sector.  Such a move means that existing defined benefit accruals for current employees would be frozen and employees would be moved to a defined contribution plan with the previously accrued amount placed in their new defined contribution account.

The best solution is moving all employees to a defined contribution system, but at a minimum, new employees should be enrolled in a defined contribution system.

Other Reform Options

Although implementing a defined contribution system for all employees is the most effective pension reform, other solutions are also available.

Primary Reforms to existing defined benefit plans

• Cap employer cost (i.e. state will pay no more than 10% of salary toward an employee benefit);
• Require the full ARC (or Normal Cost) of the plan to be paid each calendar year or legislative per diem will be canceled until full ARC is paid;
• Require that the ARC (or Normal Cost) be calculated using a realistic discount rate (either the treasury rate or the bond rate of the plan sponsor);
• Smooth pension wealth accrual making it a constant % of earnings(i.e. a cash balance or constant accrual plan).

Close Loopholes to Reform Pensions

• Eliminate double-dipping;
• Eliminate spiking;
• When calculating base pay, do not based the calculation of retirement pay on anything other than base salary;
• Require any purchase of service credit to be at full actuarial cost or prohibit the purchase of service credit;
• Eliminate cost-of-living adjustments or tie them to the CPI.

Secondary Reforms to existing defined benefit plans

• Increase employee contributions;
• Increase retirement age;
• Increase vesting period;
• Impose penalty on retire/rehire -new employer must pay pension;
• Increase the number of years used in final-average-salary calculation;
• Require that any purchase of service credit be at full actuarial cost (or prohibit the purchase of service credit);
• Cap retirement benefits at not more than 100% of final average salary;
• Eliminate pensions for employees who are convicted of work-related crimes;
• No pension benefit for voluntary service;
• Have tight review of disability claims.

Increase transparency

• Use generally accepted accounting practices;
• Discount rate for liabilities should either be the treasury rate or bond rate of sponsor;
• Eliminate smoothing of asset valuation in favor of market or fair value as of the actuarial reporting date;
• Same realistic discount rate should be used to calculate the ARC/Normal Cost;
• Require retirement system to annually report to Governor, Legislature and put on its public website:Committee and board meeting minutes online;
  The discount rate used to calculate pension liabilities and the value of those liabilities if a risk-free discount rate was used;
  Assumed rate of investment return for the purpose of projecting contributions and how the contributions would change if a lower assumed investment return was used;
  The period over which unfunded liabilities are amortized and how contributions would change if unfunded liabilities were amortized over a period equal to the estimated average remaining service periods of employees covered by the contributions;
  The period over which gains or losses are written on/off (smoothing): and also disclose the funded status on the basis of market value with no smoothing;
  The market value of assets and the difference between market value and the system’s actuarial value of those assets;
  Require the State Auditor or State Treasurer is to evaluate the report and submit an opinion of it to the legislatures.

When addressing the difficult topic of pension reform, it is worth keeping in mind the lessons Utah legislators learned as they enacted pension reform.  Those lessons include

• Ask the hard questions/demand data.
• Be hypothesis driven/avoid ideology.
• Involve all parties/build partnerships.
• Circulate reform proposal broadly.
• Be kind, polite and responsive.
• Keep moving forward.
• Demand comprehensive, long-term financial modeling from pension actuaries.
• Reality is NOT negotiable: let the data do the work.
• Future employees are not an effective lobbying force.
• Know the details and you will own the issue.