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A Tower of Tiers

Pensions are getting less generous for a new generation of government workers. Will they tolerate equal work for unequal benefits?

Starting next July, public employees hired in the state of Kansas will be second-class citizens, in a way. They will have to pay more into the employees' retirement fund than workers who came on board before them do. They'll have to clock more years on the job in order to collect their pension. And when they do go on to retire, the new group of workers is set to receive less generous payouts than their brethren hired before July 1, 2009.

It's not for spite that the future hires are getting a lesser deal. The reason is more straightforward than that. The Kansas pension system is $5.4 billion short of full actuarial health. By lumping the next generation of workers into a second "tier," Kansas expects to take considerable pressure off the pension fund's long-term finances. What's more, since the workers getting nicked haven't even accepted the job yet, there was no natural constituency to oppose the plan in the legislature.

The notion of dinging future hires in the name of pension health is nothing new - New York State began tiering its employees back in the early 1970s. But with retirees living longer, the stock market in flux and state and local budgets getting tighter, a growing number of states are tiering in the name of maintaining their pension funds. Just in the past three years, Arkansas, Colorado, Louisiana, Mississippi, North Dakota, Rhode Island and Texas have acted to create new classes of employees. For anyone about to go into government work in those states, retirement may be a little further out , and a little less sweet, than for those who toiled before them.

As Kansas found, tiering can make for an elegant political fix. That's particularly true because state law in Kansas, as in many states, prohibits taking away benefits promised to existing employees. There's evidence, however, that bifurcating pension benefits simply pushes pension conflict down the road. As the second tier's ranks swell and gain in political power, those employees inevitably agitate to win back what they lost before starting to work.

That's what happened in New York. Over time, New York created four tiers of employees. There's been constant pressure from public employee unions to regain ground given away by previous generations. "Calls for tier equity are universal," says Dan Wall, formerly the director of the state's civil service system and now an Albany-based personnel management consultant. "It's just human nature to want what the other guy got."

The starkest example is what happened with Tiers Three and Four, created in the 1980s and '90s. Those employees were the first generations of New York State workers who were required to kick some of their own salary into the pension system. By the year 2000, however, two things had happened. Tiers Three and Four had grown to such a point that they made up a sizable population within the public employee unions. And second, the stock market was churning out huge returns. According to one longtime observer, "the pension system was making so much money it looked like it could never spend it all."

The unions got to lobbying the legislature. They succeeded in getting Tiers Three and Four off the hook in terms of having to contribute to the pension fund. They also won other sweeteners, such as fatter cost-of-living adjustments and the ability for employees to "buy back" years of service. Because of those changes, the distinctions between the benefits packages the different tiers get now is almost academic.

The lesson, says David Bronner, the longtime director of the Retirement Systems of Alabama and a respected voice in the field, is that tiering may create as many problems as it solves. "All you're doing," he says, "is passing the ball to a governor 10 years out who's going to take a beating from the employees hired under the new tier. Because they're going to want what the past guys got."

Tiers for Teachers

Such doubts aren't stopping some states from giving the tier idea a try. In North Dakota, for example, the legislature last year created a new tier for teachers. Lawmakers saw it as the best fix for the Teachers Fund for Retirement, whose actuarial projections were shaded increasingly red by sour stock market returns.

Starting July 1 of this year, teachers hired in North Dakota will be subject to a "rule of 90." That is, to be fully vested in the pension fund, a teacher's age and years of service will have to add up to 90. By contrast, teachers hired before July 1 are subject to a rule of 85. Generally speaking, that means Tier Two teachers will have to retire later in life than Tier One if they want to get their benefits. Furthermore, when they do retire, Tier Two teachers will get lower pension payouts than Tier One did, thanks to a change in how those payments are calculated.

As in Kansas, the plan was attractive because it measurably improved the fund's actuarial outlook. And the shift didn't rile up current members of the system. "Generally speaking, our members accepted the changes reasonably well," says Fay Kopp, the fund's deputy executive director. "Because of contract protection, the state can't change benefits for current members."

The bill creating the new tier of teachers sailed through both the House and Senate with relative ease. State Representative C.B. Haas was one of the key supporters. With the teachers fund looking at a 25 percent unfunded liability, Haas says, "a lot of us felt that it was important to deal with the problem early, before it reached a crisis and would require a huge infusion of cash."

The plan did have detractors in the legislature, however. One was state Representative Matthew Klein, a friend of Haas' and a fellow Republican. Klein couldn't think of the tier plan without recalling previous ideas for pension reform. "I remember very well when the teachers came in 2001, and times were great, and they wanted a pension increase," Klein says, recalling the halcyon days of a stock market on steroids. "They said, 'It's our money and we want some of it back.' I tried to caution them and to say, 'Let's not get too hasty, good times can turn around fast.'" Now that fortunes have, in fact, turned for the worse, Klein believes it's similarly unwise to lay the cost of actuarial improvements on future hires. "Whenever you end up with people in different categories, it creates animosity," says Klein.

Greg Burns, the executive director of the North Dakota Education Association, agrees. One might expect that view from the head of the organization representing the state's teachers. But Burns, in fact, has a unique perspective on the situation: He is himself a veteran of the tiering phenomenon. In the late 1980s, Burns was working for the teachers' union in Minnesota when the legislature there created a Tier Two for teachers hired after June 30, 1989. At the time the law passed, there were no employees directly and immediately impacted by the change, so there wasn't any real opposition to the strategy. "Now they have a pretty substantial group of folks hired after June 30, 1989, saying, 'Hey, this isn't fair,'" Burns says.

In fact, two-thirds of Minnesota teachers now are denizens of Tier Two. So it's not surprising that Education Minnesota, the state teachers' union, now is lobbying the legislature there for a bill aimed at bringing tier parity for teachers. According to a worksheet on the union's Web site, Tier Two hires are due to receive pensions worth as much as $900 less per month than their Tier One colleagues. Ironically, that pressure is building at a time when the Minnesota teachers' retirement fund faces its own shortfall of more than $1 billion. The fund is considering a number of options to shore itself up, but according to John Wichlund, its assistant executive director, one idea is off the table. "We've had several people come and testify before the pension board about how to get back to actuarial soundness," Wichlund says. "And no one has suggested creating a Tier Three."

Cascading Savings

In Kansas, pension leaders acknowledge that bifurcating the workforce may simply trade political peace now for conflict later. They just think they were out of other options.

Before resorting to the tier plan, the legislature already had floated a $500 million pension obligation bond, the interest on which is being paid out of the state's general fund. In addition, the state had begun sloshing considerably more money into the pension pot by way of direct contributions from the general fund. Kansas weighed changing its traditional "defined benefit" pension system to a "defined contribution" system similar to a private-sector 401(k) plan. But that idea, which only Alaska has adopted for new hires, proved too controversial to gain traction in the legislature.

Stephen Morris, the state Senate president and vice-chair of the Joint Committee on Pensions, Investments and Benefits, says there was only one choice left. With no leverage to demand help from current employees, lawmakers turned to new hires to sacrifice benefits in the name of getting the pension system healthy again. "There might have been a little grumbling" on the part of state employees and teachers, who both are served by the pension fund, says Morris, "but I think they realized what is going on with the system."

In April of last year, the legislature passed S.B. 362. The law created a new set of pension rules for all employees hired by state government, local school districts or Kansas municipalities on or after July 1, 2009. The law makes three major changes. First, Tier Two employees will work under a rule of 95, instead of 85 for Tier One. Second, pension payouts will be based on the last five years of an employee's salary, rather than three, a change that in effect reduces benefits. Finally, the new law requires Tier Two hires to pay 6 percent of their salary into the system, versus the 4 percent for those in Tier One. On the plus side for employees, the law did add some mild sweeteners. The vesting period for employees was shortened from 10 years to five and new employees will become members of the retirement system on their first day on the job, instead of having to wait a year. On balance, between now and the year 2033, the changes are expected to save the state $2.6 billion and local governments $1 billion.

As Glenn Deck sees it, the trade-offs are worth it. Deck heads the Kansas Public Employees Retirement System. If there's a rebellion from Tier Two some day, Deck says, the state can check its portfolio and see whether it's in a position to give something back. "There was some discussion of that," Deck says of the potential for a backlash, "and that is a possibility. But you have to start somewhere."

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A Senior Editor of Governing, Jonathan has been covering state and local public policy and administration for more than 30 years.

Twitter: @governing


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