Saving the Nest Egg

It's time to restore balance to the funding of pension plans.
August 2009
Girard Miller
By Girard Miller  |  Finance Columnist
The finance columnist for Governing.

The most sacred cow in public personnel management is this: You can't take away pension benefits. It's more than sacred. Many states have constitutional or statutory prohibitions against reductions. And labor agreements typically stipulate the pension and retiree medical benefits that must be provided, so those are untouchable. It's almost as difficult to change the formulas for prospective benefits to be earned from future service.

Meanwhile, although many state and local governments are laying off workers and cutting public services to balance budgets, their retirement-plan obligations continue to pile up. The liabilities keep growing every year, regardless of whether the employer puts aside money for the pension plan. For retiree medical benefits, most governments have not even started the proper actuarial funding process.

In an effort to trim the future liabilities, some public employers are now bargaining with unions to "tier" their retirement plans--that is, to reduce benefits for new employees. Unions often accept these arrangements in the expectation that they will regain the current benefits level for the new hires after today's politicians' terms expire. These reduced benefits for new employees don't make a very large difference in upcoming budgets, yet few politicians have the stomach to demand a reduction in the retirement benefits formula for senior incumbent employees. And guess who sits on their bargaining committee? Senior incumbent employees.

State and local government revenues are unlikely to return to previous robust levels anytime soon. Employers' costs of retirement plans, however, will increase by 40 to 50 percent in the coming five years. Pension plans and retiree health benefits must eventually require full actuarial payments. In many cases, the increased costs of retirement plans will consume all new revenue and leave virtually nothing for salary increases or restoration of public services. We're like a house-poor family that owns a trophy home with a big mortgage and can't afford groceries.

The obvious solution to this financial dilemma is to shift the focus of collective bargaining from the benefits formula, which is mostly untouchable, to the contributions side of the ledger. Public managers and elected officials must ask public employees to pay their fair share of the retirement benefits they now expect.

In the private sector, only a few employers offer a 100 percent matching contribution to their employees' 401(k) plans. Yet in the public sector, most employers are now expensing 200 percent to 500 percent of the employees' share of total retirement costs. When the actuarially postponed liabilities for these systems are finally billed by 2012, those ratios will explode upward.

The solution is quite simple: Require public employees to pay one-half of the cost of their retirement plans--eventually. Start with an extra small percent and work upward each year until employees' and employers' contribution rates are equal. A 50-50 partnership will enable states and localities to restore vital public services that could be lost if we fail to break the stranglehold on retirement plans.

Girard Miller
Girard Miller | Finance Columnist |