"There's somethin' happenin' here. What it is, ain't exactly clear."
— Buffalo Springfield, 1967
Change is in the air in the public pension world. A year ago, there wasn't a single nightly newscaster who knew beans about public pension funds. Now it's a regular topic in the media. Several columnists have made it a regular subject. Nonpartisan public policy groups like the Pew Center for the States have published in-depth research studies to provide background information on the scope of the problem. The SEC has stepped in to clean up campaign payola that the pension funds failed to fix themselves. Blogsters are having a field day. Traditional supporters of public employee unions are having second thoughts about their pension policies. Pension envy is rising in some states as the media publishes lists of "$100,000 Club" public pensioners. As we head into the November elections, public pension reform is sure to be a hotly debated topic in many states.
In several states, the legislatures have enacted changes in pension benefits for new employees, and some have increased incumbent employee contributions. In California, the governor has negotiated labor agreements with several unions that would accomplish those changes through collective bargaining. In Vermont, the teachers' union even agreed in bargaining to changes in benefits and retirement ages for incumbent employees.
Traditional union supporters have begun to question whether they made a mistake in awarding too-generous pensions. As political progressives face the Hobson's choice of (1) cutting programs for the elderly and impoverished or (2) trimming back pensions and sharing costs more equitably, some have lost their sympathy for public employees who earn better pay than many of their constituents. To restore social services, some have promoted pension reforms their union supporters hate.
So far so good, you'd think, on the cost-containment front. But the problem facing most candidates running for office this year is that the reforms announced so far are nothing more than a small down payment on the major long-term structural changes needed to achieve long-term sustainability in public retirement plans. This column will address some of the challenges confronting those running for office.
Unlike BP, this blowout has not been capped. Most pension funds have not yet billed their employers for the full costs of the stock market losses they incurred in 2008. Actuarial "smoothing" has deferred and disguised the actual costs of $1 trillion of unfunded liabilities using current accounting methods, and those delayed bills are yet to hit the public budgets. Worse yet, 90 percent of the states and localities have failed to properly fund their retiree medical benefits (known as OPEB for "other post-employment benefits"). Those bills will triple or quadruple in the coming decade as Baby Boomers retire without a public penny saved for those costs. The OPEB deficits dwarf the pension problem, totaling $1.7 trillion now. Most candidates have no clue of the depth of the problems they face when elected.
GASB won't hit until 2013 at earliest — but before you leave office! The Governmental Accounting Standards Board has announced its preliminary views of major accounting changes that will surely increase the annual costs to employers for these plans. Without getting into esoteric pension math, the easiest issue to understand is the number of years we use to pay off past-due liabilities. Current rules allow 30 years, and GASB is moving toward using the average remaining service lives of the employees now in service — to ensure that the money will be there when they retire. For police and firefighters retiring in 20 or 25 years, that makes their remaining average only 10-12 years; for civilians the average for this purpose is often less than 15. Imagine the impact on your household budget if you refinanced your 30-year mortgage to a 15-year term — at the same time your kids enter college, for which you have saved nothing (the OPEB problem, metaphorically).
It will take two labor contract cycles. Most public employers that bargain collectively with their employees must confront their retirement deficits as they negotiate their next contracts. But the full costs we face will not all be visible or even calculated until some of those contracts are settled. That means that some costs will not even be known until it's too late. Savvy unions are seeking long-term contracts with CPI escalators and token benefits concessions. This requires public officials to be very careful about "buying into" a pay package that blithely ignores the skyrocketing cost increases heading their way. In some cases, incumbent employees cannot be realistically expected to immediately bear half of the entire long-term cost to rectify the retirement plan deficits. It will be necessary to break the problem into two chunks. Labor agreements running beyond 2013 are dubious at this time, unless they leave a pension re-opener.
For starters, most employers will seek to increase incumbent employee contributions as much as tolerable for employees immediately and then by another 1 percent per year — at the same time they introduce lower benefits and higher retirement ages for new hires They can secure a toe-hold concession with their OPEB retiree medical plans with a small employee contribution and a dollar-cap on the benefits level. For new hires, dependent coverage at retirement can be eliminated. Then, in the next contract, a second round of benefits concessions can be approached at a time when it might actually be possible to award modest pay increases if the economy improves. That spreads the pain over five to six years — as long as public leaders have a clear plan.
Options for candidates to understand. Any public official or candidate for office should become familiar with these basic concepts that are likely to arise on the campaign trail:
1. Raise employee contributions. This is the fastest way to offset some of the budgetary costs to taxpayers, and to restore balance in the cost shares of employers and employees. Today, most employers pay far more into the pension plans than the employees, and most still pay 80 percent or more of OPEB costs. Few private-sector employers are so generous.
2. New formulas for new employees. When pension formulas are unsustainably rich (usually paying more than 2 percent times final salary times years of service, plus Social Security), the deal offered to new employees should be reduced. Many state laws make it impractical to change benefits formulas for incumbent employees. (See my prior column on this topic and the superb legal research of law professor Amy Monahan.
3. Rationalize retirement ages. Social Security now requires age 66 and for those born after 1960, age 67. Next year, Congress will have to consider age 70 for younger Americans, to cope with increasing longevity. Yet many public pension plans allow retirement at age 55 and even as low as age 50. That math simply doesn't work, as Greece has proven. Public pension plans must move toward the Social Security age standard for full benefits for civilians, and age 57 for public safety. Illinois is a precedent.
4. Retiree medical benefits reform. Most governments can't afford to give full-family medical benefits to workers who retire before attaining Medicare age. For a complete discussion of this topic, see my prior column on affordable OPEB plans that cost $75 a month.
5. Require sustainability analyses. Before benefits and salaries are increased, elected officials must demand an independent fiscal analysis of the sustainability of the proposed cost increases. Such reports should include the potential cost increases under GASB proposals, so that nobody is blind-sided later when the accounting rules kick in.
6. Discuss hybrids as an option. Although defined benefit plans remain the favored form for risk-averse public employees, it's time to introduce plan options that share the risks and rewards of long-term investments. The Federal Employees Retirement System gives employees a 1 percent pension multiplier and matches the first 5 percent of their payroll savings for retirement. Washington State uses a plan that is one-half pension and one-half defined contribution. As a general rule, the no-risk pension should be less generous than the hybrid, which requires a thoughtful plan design for the New Normal economy.
7. Reassure retirees. Candidates can put retirees' minds at ease and tell them they should rightfully expect to receive their benefits. To do so, however, politicians must commit to properly fund their plans. See point #8. Warning: If the plan does not actuarially fund cost-of-living increases, then don't be dumb and promise retirees what's imprudent.
8. Commit to full funding. This means making the required actuarial contributions for both pensions and OPEB. Otherwise, it's a hollow promise. We have to stop "kicking the can" to the next generation of taxpayers who get no benefits for today's failure to fund.
Public managers who work for elected officials, and those responsible for briefing candidates, can do voters a big favor if they share this article with those on the campaign trail.