Rewriting State Retirement Plans

States are putting limits on their pension plans and retiree benefits, usually calling for employees to pay more toward their future.
by | July 2011
Michael P. King/Wisconsin State Journal

When it comes to the fiscal health of public employee pension systems, “bending the curve” sums up what went down at the 2011 legislative sessions. Public employees gave ground, but -- with one notable exception -- that ground did not represent any major concessions.

While a lot of legislators considered the laws they passed pension reform, “reform” is probably too strong a word for the vast majority of legislation. Mostly it was tweaking -- although arguably important tweaking -- that included a broad push to increase incrementally the amount of money employees are obligated to contribute to their retirement accounts, as well as changes in vesting and length of service rules.

States also looked at “anti-spiking” measures. That is, they focused on revising how end-of-service salaries are calculated in order to prevent public employees from purposely jacking up final salary numbers in the last few years of service -- thus inflating their retirement checks.

But the anti-spiking measures were probably as much about the current anti-public employee sentiment filtering through state capitals as it was about fiscal reality. While agreeing that such measures are needed, Elizabeth McNichol, co-author of a Center on Budget and Policy Priorities paper on fixing pension problems, says anti-spiking provisions “are not what’s going to solve the problem. States simply need to make their actuarially required contributions, whether it’s the employer or the employee who pays for that.”

While in most places the additional contribution asked of employees was modest, some union officials argue that, given other administrative and legislative moves that affect workers, increases in employee contributions translate into a pay cut. “While 2 or 3 percent more might not seem like a lot, when you’re in the middle of pay freezes, that money comes right out of employees’ paychecks,” says Steve Kreisberg, head of negotiations for the American Federation of State, County and Municipal Employees (AFSCME).

In some states, the increases in what employees are being asked to contribute haven’t been modest at all. Last year, for example, California public employees saw their required contribution double from 5 to 10 percent.

Still, the increases were, for the most part, spread across the workforce. However, a significant handful of states followed an increasingly familiar pattern when it comes to who bears the brunt of changes in pension contributions and retirement policies: new hires. States from Arizona to New Hampshire ramped up the percentage of salary the newbies will be required to ante up as their share of the pension contribution. They also tightened up vesting and length-of-service calculations.

Nobody in organized labor likes to see increases in employee contributions to pensions, but there are places where labor took steps to cooperate. In Vermont, for example, the state treasurer and the Vermont State Employees Association (VSEA) sat down at the beginning of the legislative session and worked out a deal whereby state employees will kick in an extra 1.3 percent of their pay toward their pensions every year for the next five years, after which the salary surcharge will sunset. The deal softened the blow for employees and took pressure off state contributions from the general fund. More important for everyone, it puts the state, says Jes Kraus, director of the VSEA, “within striking distance of a pension that is 100 percent funded.”

While most states took incremental steps, Utah passed a radical pension overhaul. The plan gives new employees a choice between a defined-benefit plan or a defined-contribution plan starting in 2011. Under the new arrangement, the state contributes 10 percent of every worker’s salary to a 401(k)-style plan (12 percent for public safety workers). Employees then have the option of kicking more into their account if they want.

The question of defined-contribution (DC) versus defined-benefit (DB) pension plans will likely be the major fight of the future. Payouts under the former are decided based on what the employee and employer have contributed over the life of the plan and how an individual employee’s pension investment portfolio has performed. Employees, in other words, take all the performance risk of their investment portfolio. Defined-benefit plans, on the other hand, promise retirees a guaranteed monthly payment depending upon such factors as length of service and annual pay, regardless of pension portfolio performance -- including losses from the stock market crash at the beginning of the Great Recession. In this case, employers are liable for investment risk.

The battle lines for the DC versus DB fight are set up along the employer-employee divide. A handful of governors -- including Wisconsin’s Scott Walker -- are arguing that states shouldn’t be making promises that they might not be able to afford down the road, that locking states and localities into potentially unsustainable obligations over the long run is fiscally imprudent. They say the most prudent approach is to make sure the money is in hand -- hence a DC plan.

Organized labor sees things differently. Its leaders argue that defined-benefit plans are cheaper to operate and have performed quite well over the long run. Even DC supporters concede that DB plans are less expensive to operate -- because funds are pooled.

AFSCME’s Kreisberg contends that defined-benefit plans have served governments well. Even though he wasn’t thrilled with the wide-scale increases in employee contributions enacted by legislatures this year, he argues that the sessions were a “vindication” of defined-benefit systems. “It’s a viable system, and it’s a more flexible system,” Kreisberg says. “What we are seeing is that you can tweak it around the edges and over the long run get your pension fund where it needs to be.”