In Some States, Pension Pain Yields Budget Gains

By: - May 20, 2010 12:00 am

Photo by Jim Urquhart, The Salt Lake Tribune

Utah public employees protested changes that state made to its pension system.

This is turning out to be a pivotal year in public pension policy, as states move to bring down escalating retirement costs that threaten their governments’ stability.

Since the Wall Street meltdown in 2008, nearly every state has taken some steps to curb rising pension costs. But many of those steps have been minor ones.

This year, however, a dozen states have enacted reforms more substantial than those in the past: Illinois raised its retirement age to 67 from 62 for new hires, the highest retirement age in the country.  Wyoming started asking current state workers to contribute to their retirement; up to now, the state paid the cost. Utah closed its defined benefit plan to new workers, one of a handful of states to move away from traditional pension systems that have been in place for decades.

All this has happened against the backdrop of the pension crisis in Europe, and of global fears that unsustainably generous pension commitments in American states could cause the same disastrous consequences as they have already caused in Greece. The events in Europe brought into focus growing worries about public pension costs as large numbers of baby boom workers near retirement. It also magnified a change in the tone and visibility of the public pension issue that had already been gathering momentum.

Several governors have elevated pension reform to the same level of urgency as Medicaid, corrections and education spending. New Jersey Governor Chris Christie said the public retirement system is “bankrupting our state” as he pushed through a package of benefit limits. Unions representing New Jersey police, firefighters and teachers filed lawsuits challenging Christie’s changes, which affect newly hired employees. Hundreds of current and retired Utah employees rallied at the state capitol in a losing effort to persuade lawmakers to reject a proposal to institute a non-guaranteed retirement plan similar to a 401(k) for new hires. New Hampshire’s local governments and schools mounted a court challenge to the state legislature’s vote to effectively increase pension contributions from municipalities. 

The tone is coarser this year because states are facing a third year of cutting services and programs and are raising taxes to cover budget shortfalls that have topped $230 billion since 2008. Elected officials are targeting state retirement plans because contributions and investment gains are not keeping up with the cost of benefits. A  report released in February by the Pew Center on the States ( Stateline ‘s parent organization) said states are $1 trillion short of the money they need to pay their public pension and retiree health care benefits.

The disappearing guarantee

The long-term sustainability of Utah’s public pension plan was the issue that led state lawmakers to push through a major overhaul. Current workers will remain in the defined (guaranteed) benefit plan, in which retirees receive a monthly pension based on age and service for life. But new workers will choose between a non-guaranteed 401(k) style defined contribution plan or a hybrid of the two. Neither option is as generous as the current plan, and both are riskier because employees choose their investments, which can fall in value. But states are moving in this direction because of the savings; Utah would have to pay $400 million a year to fully fund its current retirement system.

“The number one goal … is to ensure the state can meet 100 percent of the pension obligations it has made to current employees,” state Senator Dan Liljenquist, who sponsored the Utah legislation, said after the Senate vote. “There is only one thing that could bankrupt this state, and that is an unfunded liability that comes from our pension program.”

Michigan and Alaska are the only states that have moved to a defined contribution plan for state workers; several others are offering hybrid plans similar to Utah’s. A coalition of Alaska lawmakers, retirees and labor and education groups tried to repeal the revisions to the pension plan this year, saying the savings were not clearly demonstrated while the retirement benefits were less generous. Supporters said the 401(k) type plan is needed to address a projected shortfall nearing $10 billion in retirement system funding.

Usually state lawmakers aim reforms at future employees because pension obligations made to current employees must be honored under state law. But in this year of aggressive approaches, some states are going after current employees — keeping their promises to pay benefits but asking workers to contribute more money.  Colorado, Iowa, Minnesota, Mississippi, Vermont and Wyoming hiked contributions from some or all current employees, according to a tally by the National Conference of State Legislatures. Governor Tim Pawlenty signed the Minnesota legislation on May 15. It lowered annual cost of living increases and raised vesting requirements.

Colorado made large-scale changes in its public retirement system after years of failing to meet its required contributions. The legislature, with Gov. Bill Ritter’s approval , enacted bipartisan legislation shoring up the pension fund for nearly 438,000 state and local employees and retirees. 

Instead of paying Social Security, most Colorado state and local employees and teachers contribute to pension plans administered by the state Public Employee Retirement Association (PERA). Local police and firefighters and county employees in 54 of 64 counties are covered by a separate statewide pension system.

The latter system is funded at a level higher than 100 percent. The reform legislation this year was aimed at PERA, which had an unfunded liability of $30 billion and was projected to be broke within 20 years if no action were taken. Investment losses experienced during the recession contributed to the funding gap, but a 1999 decision by the Legislature and the PERA board to increase benefits and lower contributions was the main cause. The board at that time was dominated by public employees who stood to gain as beneficiaries of the benefit improvements.

The 2010 bill approved by Colorado lawmakers and signed by Ritter increased employer and employee contributions, raised the minimum retirement age for new employees from 55 to 60, capped cost of living adjustments for current and future retirees at 2 percent instead of 3.5 percent, and froze them for a year. A group of retirees has filed a lawsuit challenging the cost-of-living reduction, saying it violates U.S. and state constitutional protections against reducing benefits to existing pension plans.

When he signed the legislation, Ritter couched the rationale for the changes in purely fiscal terms. “We are all confronting the harsh economic realities of the worst recession since the Great Depression,” he said. “This is a fiscally responsible bill, and it represents another difficult but necessary decision that will require shared sacrifice and shared solutions from public employers and employees alike without imposing an unfair or undue burden on either group.”

New approaches

Neighboring Vermont and New Hampshire came up with novel approaches to addressing their pension gaps.

Vermont preserved its defined benefit plan for teachers, thus avoiding a fight with its largest public employee union. But teachers will be required to work additional years and make higher contributions to their pension fund in exchange for a larger pension check on retirement. The state will initially save $15 million per year, or about 10 percent of Vermont’s current budget shortfall.

New Hampshire set an example for states struggling with how to pay the bill for retiree health care, which accounts for more than half of the $1 trillion pension-related gap that states face. Under the New Hampshire plan, government workers will have the chance to make tax-free contributions from their paychecks to pooled investment accounts managed by their unions. Those accounts will cover retiree health care costs and will save state and local governments $60 million per year in health care subsidies currently paid to retirees.

Despite the increasing mood of pension realism in state capitols, more than a few states still face enormous challenges that they are struggling to deal with. Illinois is considering borrowing $4 billion to make its public pension payment. Michigan’s legislature approved a plan last week to lure 30,000 school employees into retirement.   

“This is a long- term problem that will require a long- term solution,” says Susan Urahn, managing director of the Pew Center on the States. “States won’t be able to invest their way out their shortfalls. They need to responsibly make the necessary contributions, in good times and bad, and look for ways to better manage costs.”

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Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.