The country’s 4,000 public sector pension systems distribute more than $228 billion in benefits annually, but all signs indicate many state and local governments likely can’t afford the expense. Public sector pensions are woefully underfunded. Estimates vary depending on the assumed rate of return pension funds use, but public finance experts estimate unfunded pension liabilities total anywhere from $4 trillion to $6 trillion.
There isn’t a one-size-fits-all solution to addressing this crisis – it takes different solutions with diverse stakeholders working together. However, there are several lessons government leaders can take from cities and states that have been successful in creating more sustainable systems.
Understand the problem — and bring people together to solve it.
Different accounting methods cause pension debt calculations to vary.
“There’s a lack of clarity for most stakeholders on what problems exist, a lack of legislative oversight and engagement, and a lack of taxpayer interest in this very complex topic, all of which has led to a lot of challenges,” says Anthony Randazzo, executive director of the Equable Institute. “It’s probably why there’s a lot of apathy — even among plan participants — toward the need to make improvements to retirement system funding.”
Amid this climate, it’s important for state and local government leaders to start by bringing individuals and groups together to understand the problems before working toward a solution.
“Leaders need to take a hard look at their current unfunded liabilities and craft a workable plan to pay that debt down over a reasonable time frame (30 years or less),” says Dr. Josh McGee, senior fellow at the Manhattan Institute. “Because of the size of underfunding, in some places that requires shared sacrifice. There needs to be a negotiation between labor and policymakers and taxpayers about how they are going to share the sacrifice to make the budget math work.”
Engaging in conversation with diverse stakeholders from the outset will make future reforms more sustainable, and potentially help state and local governments avoid undergoing protracted legal battles to defend proposed pension changes. In places where pension obligations are codified in state statutes, this is especially important to make progress and keep pension debt from ballooning to the point where municipalities must make even more severe cuts.
“The best way to ensure plans are well-designed, fully funded and solvent in the long term is to divide performance risk between the municipality and the employees,” says Chuck Reed, former mayor of the city of San Jose, Calif., who implemented numerous fiscal reforms and a 2012 pension overhaul during his time in office. “We need public employees to have more of an incentive to keep governments from overpromising and underfunding. In addition, plan governance reforms should be implemented to reduce incentives to overpromise and underfund.”
Undergo stress testing.
Stress testing can help policymakers prepare their pension plans for the next economic downturn and provides an underpinning for them to understand and respond to the impact of economic volatility on pension plans, according to Dr. Susan Urahn, executive vice president and chief program officer for the Pew Charitable Trusts.
In Colorado, a second round of reforms was needed after the state conducted a stress test and found pension reforms made in 2010 would likely not have enough of an impact. Colorado, Connecticut, Hawaii, New Jersey and Virginia now all require pension plan stress testing. Each state passed legislation requiring that a stress test capture a complete picture of the solvency and durability of the pension system, including revenue forecasts, the state’s record of making required contributions, and the ability of legislators and managers to maintain a balanced budget while ensuring the solvency of a multibillion-dollar pension plan.
Pete Constant, chief executive officer of the Retirement Security Initiative, says it’s important that leaders do their due diligence in looking at what effect changes will ultimately have. “Before you rush in to reform pensions, you need to do a deep dive and stress testing to ensure the solution you’re ultimately choosing is addressing the problem that exists,” he says. Implement financial oversight and encourage transparent reporting.
Jurisdictions should consider an oversight body or mechanisms as a key part of their reforms. The Texas Pension Review Board is an oversight body focused on improving measurement and reporting, a critical function that provides more transparency regarding pension liabilities. It also provides cities with pension funding and benefit design guidelines. The Funding Soundness Restoration Act enabled the board to increase the amount of oversight it applies to municipal plans by conducting intensive actuarial reviews and helping cities develop sustainable solutions.
And as part of pension reforms in Pennsylvania, the commonwealth created the Public Pension Management and Asset Investment Review Commission, which provides additional oversight and issues recommendations “regarding investment fee transparency, pension system stress testing, and active versus passive investment strategies and performance.” In December 2018, the commission found Pennsylvania could save $10 billion on pension costs with more transparent reporting and reduced investment fees.
Start small, if necessary, and work toward larger reforms.
Pension changes often come with dire warnings about the financial impact to government workers, but once changes are implemented and the sky doesn’t fall, lawmakers, labor unions, employees and taxpayers may be more willing to get on board with future changes.
Michigan and Arizona’s reforms provide successful examples. In Arizona, residents voted for another round of pension changes two years after 70 percent approved the first reforms. In Michigan, the state legislature passed a payroll growth bill in 2018 that will phase in a lower payroll growth assumption over time until it reaches zero, which means the state will contribute the same amount each year to teacher pension plans rather than making contributions based on assumptions about projected future income. The statute, which goes into effect in 2020, is estimated to save taxpayers $2.9 billion over the next 20 years — without putting anyone’s retirement at risk.
Says Michigan State Rep. Thomas Albert: “If I had to give any advice, it’s to take the wins you can get — when you can get them. Then just keep going.”