Public pensions

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Public pensions are an arrangement to provide people with an income when they are no longer earning a regular income from employment.^[1] The amount of tax dollars that go to pension funds is determined by legislators and included in each state's budget.

Plans

See Types of pension plans

There are two main kinds of public pensions, defined benefit plans and defined contribution plans.

Defined benefit plans

Defined benefit plans provide a guaranteed life-time retirement benefit based on an employee's years of service and salary, the amount of which is calculated differently by different states. Although most statewide plans require employee contributions, the retiree's benefit is not tied directly to his/her contribution amount. The majority of public pension plans are defined benefit plans.^[2]

In 2009, governments provided defined benefit plans to 84% of state and local workers compared to 21% of private-sector employees.^[3]

Defined contribution plans

In contrast, in defined contribution plans both employers and employees contribute to the employees account. Then, the employee determines how the contributions are invested, usually selecting from options presented by the plan administrator. At retirement, the amount of money in the fund is the basis of the employee's retirement benefit. The sponsoring public entity does not ensure a particular benefit amount, and usually does not provide post-retirement benefit cost of living increases.^[2]

In 2009, Michigan, Nebraska, and Alaska had mandatory defined contribution plans for general state employees, and Alaska was the only state to have a mandatory defined contribution plans for teachers.^[2]In 2012, Michigan added an optional defined contribution plan for public school employees.^[4]

Hybrid plans

Cash balance plans are a kind of hybrid plan and, like defined contribution plans, they provide each member with an individual account to which, in the public sector, both employees and employers make contributions. Funds in the members’ accounts are pooled for investment purposes, members’ balances are guaranteed, and members are guaranteed an annual rate of return.^[5]

The other kind of hybrid plan makes members are eligible for both a defined benefit and a defined contribution plan. In Indiana, Oregon and Washington, for example, both components are mandatory. Employer contributions finance the defined benefit annuity and employee contributions accumulate in an individual retirement account. In Utah, employer contributions fund both components of the plan. the Virginia plan adopted in 2012, makes both components mandatory, and employers and employees will contribute to both components of the plan.^[5]

States offering optional or hybrid defined contribution plans to state employees include: Colorado, Florida, Indiana, Montana, North Dakota, Ohio, Oregon, South Carolina and Washington.^[2][6] In 2012, Kansas, Louisiana and Virginia also replaced defined benefit plans with cash balance or hybrid plans for new employees.^[4]

Deferred compensation plans

All states offer employees and teachers optional deferred compensation plans, like Section 457 plans, as a means of augmenting their primary pension coverage.^[2]

Benefits

Main article: Public employee benefits

Individuals receiving a state pension receive a financial benefit, and most are adjusted annually with a cost of living increase.^[2] They also typically receive other benefits, including disability, life, health and dental insurance coverage.^{[7] [2]} For health insurance benefits, employers make a contribution towards the member's monthly premiums, with members covering the difference between the employer's contribution and the actual premium amount.^[8] Health insurance in many states is now available to the children of recipients until the child reaches age 26.^[9]

In West Virginia, state employee and teacher retirees receive a monthly subsidy to defer the cost of their health insurance premiums. The average subsidy is $333 per retiree. New hires, however, will not receive the subsidy.^[10]

Public pension funds also typically provide death benefits for active and retired members paid to eligible beneficiaries or survivors.^[11]

In addition, some states offer supplemental benefit plan options to those receiving pension benefits. In Delaware, for example, supplemental benefit plan options include: Auto/Home Insurance, Long-Term Care Insurance, Legal Insurance, Vision Insurance and Pet Insurance.^[12] In California, CalPERS recipients may take advantage of three different long-term care benefits.^[13] and a Member Home Loan Program offers members security, protection, and choice when purchasing or refinancing a home^[14], in addition to health insurance, disability and death benefits.^[15]

An estimated 30% of public-sector workers across 12 states are not part of the Social Security system.^[16]

Employee eligibility

Main article: Public pension eligibility

When employees are eligible for benefits varies by state. The average retirement age for public employees is nearly 60 years old, whereas the average is around 63 years old for private sector employees.^[17] In New York, the Department of Civil Service estimates that state employees retire at an average age of 58.^[18]

Ten states in 2010 upped the number of years which new employees must work before they can retire with a full pension. States have done so for several reasons: longer lifespans add pressure pension systems, lawmakers to demand more years from employees given the fiscal crises facing their states and, as many states cut services, citizens are scrutinizing the compensation of public workers more than in prior years.^[17]

States have also increased either the retirement age, amount of service required prior to retirement, or otherwise changed requirements for pension eligibility. Experts say changes are less likely with firefighters and police due to the beliefs that older workers should not or cannot be in these positions and that people who do hold these often-dangerous jobs deserve long pensions. Some police and firefighters New York can retire after 20 years of service.^[17]

Service requirements

Only a few state plans provide for normal retirement benefits when a person reaches a specified age without an accompanying service requirement. As of 2011, 4 plans provide benefits without a service requirement after the age of 65.^[19]

Twenty plans allow normal retirement with longer service requirements than earlier and generally increased age requirements to 65 or 67.^[19]

Nine plans require 10 years of service and one requires 25 years of service. Four plans, however, allow retirement when a member reaches 65 regardless of length of service.^[19]

Retire-Rehire

A "loophole" in the pension system is that in many of the systems, employees can retire one day, be retired for a one day, and return to work at full pay and a year later start collecting retirement benefits and salary. This "double dipping" was becoming a drain on pension funds in Louisiana and the governor signed a law in July 2010 closes the door ending the overused "retire-rehire" provision in state law.^[20]

Funding pensions

When gauging the fiscal health of state and local pension plans, the two most common metrics used are the funded ratio and the annual required contribution (ARC) levels.^[21] The annual required contribution is the amount the employer would be required to contribute for the year to pay off the liability in full over the prescribed amortization period. State and local governments are not legally required to contribute the prescribed annual required contribution for their pension plans. Therefore, the ARC is used as an indicator of assessing how well the employer is actually funding their pension plan.^[21]

Tax dollars

Taxpayer dollars fund public pensions. Taxpayers are obligated to pay government workers’ pension benefits as promised through collective bargaining agreements.^[22]

The amount of tax dollars that go to pension funds is determined by legislators and included in each state's budget. In Maine, 10% of each tax pay dollar goes toward the pensions for state employees and public school teachers, and estimates say that could rise to 20% within the next five to six years.^[23]

Employee contributions

Whether or not state employees must contribute to their pension, and how much, varies by state.^[24]

In Florida, public employees have not contributed to their pensions for the past 30 years. Lawmakers rejected a proposal to have employees contribute one quarter of one percent of their salary after it generated opposition from police, teachers, firefighters and thousands of other government employees.^[25]

The contribution of employees varies by state. Some instances of where employees do contribute and those contributions being raised include:

Pension funding levels

Funded ratios declined for almost all plans in 2011. Of the 149 state-level plans with funded ratios for 2011, the average funded ratio was 73%, and only 58 had funded ratios of 80% or above.^[21] Of the 31 local-level plans with funded ratios for 2011, the average funded ratio was 66%, and only 11 had funded ratios of 80% or above. On a weighted average basis 16 states (and the District of Columbia) are considered funded, while 34 are not.^[21]

The average funded ratio for cities is lower than states.^[21]

Rate of return

Pension funding levels typically report an expected return on investment of 8 percent,^[38] and returns have not been anywhere close to those levels since the financial crisis began in 2008.^[39] Since the 2008 financial crisis, at least 19 state and local pension plans have cut their return targets, while more than 100 others have held rates steady, according to a survey of large funds by the National Association of State Retirement Administrators.^[40]

The defined benefit plans pay full benefits even if those returns don't pan out. In effect, public employees as a group are guaranteed an 8% return on both their own contributions and those made by their employers—at a time when private-sector workers with 401(k) plans receive a yield of only 2%-3% on comparatively riskless investments such as U.S. Treasurys. The difference in retirement benefits is stark.^[41]

State unfunded pension liabilities

State government pension liabilities are the unfunded liabilities that state governments take on when they provide pension and other post-employment benefits to state government employees without simultaneously accumulating the funds to pay for those eventual liabilities.

Economist Andrew G. Biggs of the American Enterprise Institute found in July 2012 that the average public employee pension plan in the United States is only around 41 percent funded while total unfunded liabilities as of 2011 are roughly $4.6 trillion.^[42]

Economist Joshua Rauh and Robert Norvy Marx estimated in October 2011 that the total unfunded liability of state and local pensions is $4.4 trillion.^[43]

Below is a chart detailing the unfunded pension liabilities for each state according to PEW and AEI.^[44][45]

Although states do not show their pension obligations in their audit statements, Moody’s Investors Service announced in February 2011 that it would calculate states’ debt burdens in a way that includes unfunded pensions. The calculation will include adding states’ unfunded pension obligations together with the value of their bonds, and consider the totals when rating their credit. ^[46]

State pension crisis

Main article: Public pension crisis

State and local workers face retirement systems that may be short of funds by as much as $4 trillion.^[47][48][49] Experts predict insolvency of some pension funds within a decade.^[50]

State pension funding levels vary dramatically in the U.S. Several states have pension plans with high levels of funding, but the majority of states have pensions that are extremely underfunded.^[51] The crisis is due to an aging workforce, delayed and suspended contributions, increased benefits, and investment losses.

Demographics are exacerbating the budgetary burden of the public-sector workforce. Current retirees leave work at an earlier age and live longer, thus drawing substantially more retiree health care and pension benefits than their predecessors. Currently, every private sector worker in America would have to pay $12,000 to support the current pension promises to public sector workers.^[52] This figure does not include health benefits.

The current pension crisis started in the late 1990s when the stock market was booming. Growing stock prices increased the value of pension funds to such levels that many state and local governments reduced or eliminated the annual benefit payments made by employees.^[53]

According to the Pew Center on the States, in 2000, states only needed to pay $27 billion total into their pensions funds. That amount more than doubled to a $64 billion deposit required in FY 2008 when an economic recession had reduced states' revenues.^[7]

The pension crisis is worsened by the large numbers of retirees and the challenging economy, and also by financial institutions. The Ohio Public Employees Retirement System saw a decline in value from $441.4 million in December 2007 to just $73.3 million in December 2008, three months after Lehman Brothers, which managed the system’s investments, filed for bankruptcy protection.^[54] In the second quarter of 2010, state and local pension funds lost $58 billion on investments, the worst lost since 2008.^[55]

In response to the bad financial performance, many states are also considering lowering their assumptions of pension fund earnings, which will further hurt revenues for future state budgets.^[56]

Cost of Living Adjustments (COLA)

Cost of living increases in pension benefits also exacerbate the fiscal crises facing public pensions. Rhode Island included in its FY2011 budget a limit on the cost-of-living adjustments (COLA) provided future retirees to the pensioner's first $35,000 in benefits and require eligible individuals to wait until age 65 to begin collecting the annual COLAs.^[57] Other states that have recently limited cost of living adjustments include Colorado, Maryland, Michigan, Minnesota and South Dakota..^[26]

State pension plan executives and state legislatures increasingly are turning their attention to cost-of-living adjustments to pensions for current and future retirees as a way to get immediate and dramatic results in retirement program reforms. ^[58]

COLA changes for current retiree benefits were made by the Arizona State Retirement System, Public Employees' Retirement Association of Colorado, Kansas Public Employees Retirement System, Maine Public Employees Retirement System, Massachusetts State Employees Retirement System, Public Employees Retirement Association of Minnesota, Public School Retirement System of Missouri, New Jersey Division of Investment, Oklahoma Public Employees Retirement System, Employees' Retirement System of Rhode Island and South Dakota Retirement System. ^[59]

COLA changes affecting the retirement benefits for current employees were made by the Florida Retirement System, Kansas public employees' plan, Maryland State Retirement & Pension System, Virginia Retirement System and Washington Public Employees' Retirement System. ^[60]

Future hires' benefits were changed by the Employees' Retirement System of the State of Hawaii, State Employees' Retirement System of Illinois, Kansas public employees' plan, State of Michigan Retirement Systems and Utah State Retirement Systems. ^[61]

Cost of health benefits

Of the unfunded pension and other post-retirement promises made to workers by states, $587 billion is for retiree health care, according to Pew,^[10] with less than 6% of that amount funded as of fiscal year 2008.^[62] Only two states, Alaska and Arizona, have set aside at least 50% of the needed assets.^[62] On average, states have a 7.1% funding rate of their non-pension benefits.^[62]

Delayed and suspended contributions

States have stopped paying into pension funds. The economic downturn isn't the only cause of the current pension funding crisis. "Over the last 10 years, many states have shortchanged pension plans in good times and bad," said Susan Urahn, the managing director of the the Pew Center on the States, who called the beginning of the century a "decade of irresponsibility."^[7] The levels to which states opt to fund pension benefits seem to depend largely on budgetary convention and the appropriation levels of previous legislatures, experts say.^[50]

Impact on local governments

Main article: Local government public pensions

Local governments also face pension problems. The pension crisis is "the largest single financial issue facing state and local governments," according to David Crane, Gov. Arnold Schwarzenegger's special adviser for jobs and economic development.^[53]

A majority of states have relatively few locally-sponsored plans. Hawaii, Maine and Montana have none. A few states have more than 100 local plans. Illinois reported having 365 local plans, and Pennsylvania reported that it had 928, as of 2002.^[63]

One of every five dollars collected in local taxes are now going to pay benefits for government employees.^[64] Rising retiree costs are likely to have a large impact on local governments, which not only employ more workers than the state, but also dedicate most of their payrolls to police officers and firefighters, who enjoy the best benefits and earliest retirements.^[53]

Transparency

Main article: Public pension disclosure

The Ohio News Organization reported that at least 21 states consider financial benefits for retirees to be public records, including New York, Florida and Illinois, but at least 26 states prohibit the release of such information.^[65]

Public pension accounting

Main article: Governmental Accounting Standards Board

Public pension accounting standards are set by the Governmental Accounting Standards Board (GASB). In June, 2012, GASB approved updated accounting and reporting standards.^[66]

Public pension reform

According to the Loop Capital Markets 2012 Tenth Annual Public Pension Funding Review:^[21]

• The public pension plan problem is state specific, and not systemic in nature
• The pace of improvement across the states is uneven, with some states making little or no progress while others advance
• Each state has its own unique path to recovery
• Confusion remains about the problem and its severity, with states doing essentially nothing to confront the general anxiety or provide appropriate reassurance that progress has been, or will be, made.

Is reform legally possible?

As many states face billions in unfunded liabilities, some are attempting to change pension systems themselves. Seven states—New York, Illinois, Louisiana, Michigan, Alaska, Arizona and Hawaii—state pension benefits cannot be "diminished or impaired."^[67] Though some believe this applies strictly to those who have already retired and not to existing workers.

Many states, including Arizona, Colorado, Minnesota and South Dakota, have been sued by public employees for passing laws that trim the benefits for current pensioners.^[67] Colorado and Minnesota courts found that cost of living raises can legally be reduced.^[39] In Arizona, the Maricopa County Superior Court held that the law changing the contribution scheme of pensions was unconstitutional, and thus a violation of the state constitution and state statutes.^[68]

Many states have avoided reducing benefits for current workers or retirees because they believe that those the plans are legally protected.^[39]

Reform for new employees only

Changes made to the retirement plans of newly hired workers are expected to reduce pension costs by 25% over the next 35 years, according to Boston College estimates.^[39]

Many of the reforms passed by state legislatures apply only to new hires and not to retirees or current employees.^[39] For example, in September 2012, California passed pension reform which Gov. Jerry Brown called the "biggest rollback to public pension benefits in the history of California pensions." The changes are mostly aimed at newly hired workers, and thus the measures do not reduce the state's current unfunded pension liability, said spokesman for Calpers, the state pension fund. ^[39]

Enacted reforms

Since 2009, 45 states have rolled back pension benefits for teachers, police, firefighters and other public workers, but those changes have reduced by only $100 billion of the gap between what the states and their workers put into their retirement plans and what the states owe in retirement benefits, with at least $900 billion, or as much as $4.6 trillion remaining, depending on the method of calculation.^[39]

• Cost of living raises decreased or no longer given;^[39]
• Shifting more pension costs to employees (As of 2010, state workers were paying 10% more toward their retirement plans compared with three years earlier);^[39]
• Increase in retirement eligibility age.^[39]

The Bureau of Economic Analysis has announced that, beginning in 2013, the National Income and Product Accounts of the United States will calculate defined-benefit pension liabilities—and the income flowing to employees in those plans—on an accrual basis that reflects the value of benefits promised, regardless of the contributions made by employers today. ^[69]

Union resistance to change

Some unions have resisted changes to public pension funds and the age of eligibility. In Colorado, the teachers' union prevented an increase in the retirement age. In addition, fire and public safety workers struck down a proposed 15-year increase in required years of service in Utah. Instead, the change adopted was an added five years.^[17]

Six public employee unions in California reached a tentative contract agreement with Gov. Schwarzenegger that raises the retirement age for new hires by 5 years. The retirement age is a sticking point with the remaining six public employee unions that have not reached an agreement with the governor.^[17]

See also

• Public employee salary
• Public employee benefits
• Government budgets

External links

• Public pensions primer, State Budget Solutions, April 16, 2012
• National Conference of State Legislatures--Pensions and Retirement Plans: Resources
• 2008 Comparative Study of Major Public Employee Retirement Systems
• State & Local Public-Employee Retirement Systems
• Public Pensions Online
• Pension Watch
• Pension Tsunami
• State Integrity Investigation
• Institute for Truth in Accounting, Issues
• National Conference of Public Employee Retirement Systems
• BP Oil Disaster Costs U.S. State Pensions $1.4 Billion in Value, June 21, 2010
• "Private Pensions and Public Pensions: Theory and Fact," Dec. 1983, Ann Arbor: University of Michigan
• "Public Pensions, Once Off Limits, Face Budget Cuts," New York Times, April 25, 2011
• National Institute on Retirement Security
• Center for Retirement Research at Boston College
• State pension stories, Sacramento Bee
• "Public pensions are not the enemy," New York Daily News, January 25, 2012
• "The Gaming of Public Pensions," Governing Magazine, March 13, 2012
• "Defending Public Pensions," ABC News, June 29, 2011
• "Public pensions strike back," The Buckeye Institute, February 17, 2012

References

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