The Brown Center on Education Policy at Brookings released two papers that examine pension reform efforts across the nation and provide actionable policy solutions aimed at those states still struggling with underfunded pension systems. Patten Priestley Mahler, economics Ph.D. candidate at the University of Virginia, told event attendees that “Improving Public Pensions, Balancing Competing Priorities” offers a framework for evaluating reforms and discusses a pension plan that meets these goals. “It’s not a silver bullet, but it shows how workers’ and taxpayers’ competing interests can be met,” she says.
According to Mahler, the paper establishes three goals for pension reform. The first goal—to provide sufficient retirement security—is better met by defined benefit (DB) plans, she contends, because DBs do a good job of protecting participants from market risk, while defined contribution (DC) plans subject participants to market risk. However, she adds, it could be argued DBs are only better for long-term employees.
With the second goal—to maintain fiscal sustainability—DBs have an issue with governmental accountability, Mahler notes. Governments can skip payments; and the costs of DBs are complex, not transparent. DCs do not have these issues.
For the third goal—to maintain public employee productivity—it is uncertain which type of plan is better. Both DBs and DCs have pros and cons for encouraging productivity, she says.
The report—written by Mahler; Matthew M. Chingos, a fellow in the Brown Center on Education Policy at the Brookings Institution; and Grover J. “Russ” Whitehurst, director of the Brown Center—outlines a “collective” defined contribution plan that combines the strengths of a DC plan with the advantages of risk pooling and shared investment management, to strike a balance toward attaining the goals above.
Similar to other DC plans, a collective DC provides each individual a retirement savings account where employer and employee contributions and investment accruals are held. Distinct from DC plans, all accounts are managed collectively, meaning that the plan provider chooses how money is invested, as well as how and when investment returns are divvied among plan members. A collective DC plan capitalizes on risk pooling to lessen the risk borne by individuals without increasing the risk to employers.
An example of a collective DC plan is the SAFE Retirement Plan proposed by the Center for American Progress (see “Think Tank Proposes New Retirement Plan”).
Mahler says a nationwide public sector plan could help mobile workers as they move between states and across the country.
However, political barriers to implementing public pension reform are high, according to Patrick McGuinn, associate professor and chair of the Department of Political Science at Drew University. In another paper, “Pension Politics: Public Employee Retirement System Reform in Four States,” McGuinn provides an overview of the political dynamics around pension reform nationwide, as well as comparative case studies of reform efforts in four states with diverse political climates. Two of these states—Utah and Rhode Island—enacted significant structural changes to their pension systems while the two others—New Jersey and Illinois—enacted more limited, less innovative changes, the paper claims.
McGuinn believes states should make their complete actuarial payments to pensions every year. “When payments are skipped or only made in part, unfunded liability can grow quickly, especially in down markets,” he says. “States should require this, and unions should be prepared and empowered to sue when this does not happen.”
McGuinn also suggests states “gather and disseminate the hard data”—they should provide data on plan health and more accurate cost projections with more realistic assumptions. “Communicate and educate,” he says. “It is difficult to impress upon leaders that liabilities of future years must be addressed today, especially when it causes financial pain now.” He adds that states need to take this information to the public.
He suggests states sell the need for pension reform to teachers and other workers, telling them that the pain now will mean sustained benefits in the future, and impaired benefits hurt their ability to recruit the needed work force. “Pension changes should be framed as ultimately in the best interests of pension participants, relative to the consequences of the pension plans getting to the point where they can’t meet their obligations,” he says.
States should focus on advocacy groups for more broad school reform, for example, and establish a competing group to unions, which can take the message to workers about why reforms are needed.
McGuinn also told event attendees states should anticipate legal challenges. The U.S. and states give a high level of protection to contracts; reformers can be strategic in designing changes that can survive legal challenges.
“Debate about what kind of system is best for public sector workers and whether changes for current workers are adequate and fair—there are legitimate concerns that reforms can affect the lives of workers, but changes are necessary to protect sustainability. If there are no changes, pensions may become insolvent and it will affect public services,” McGuinn says. He adds that raising taxes is possible to address underfunding, but it is politically difficult and, as was the case in Illinois, may not solve the problem.
“By highlighting how some states have enacted reform, we can move forward the discussion for all public pensions,” he concludes.
Mayor Chuck Reed of San Jose, California, argues for employee choice. He told event attendees that his city first tried cutting services; it laid off 20% of employees across all services to try to address liabilities. “The effect of underfunding was worse than the effect of reform,” he says.
The city wanted to make sure employees and retirees were paid what they earn, did not want to file bankruptcy, and wanted to make sure taxpayers got the services they deserve. So, San Jose gave public employees a choice: They could either pay an additional 16% through higher contributions or pay cuts and keep the same benefits, or not pay more and get lower accrual rates and lower cost-of-living adjustments.
San Jose is facing lawsuits from this action. Reed says a state constitutional amendment is needed to allow governments to negotiate changes for contracts. He contends the fundamental problem with DBs is that they are a high risk and high cost for plan sponsors; the day a government hires an employee, it takes on 70 years of obligations. “The future should be negotiable,” he says.
Reed feels it is likely that DC plans will take over in the public sector, but he believes allowing governments to give employees a choice can reduce costs, enabling them to preserve DBs.
Mark Dingley, chief legal counsel and chief of staff in Rhode Island’s Treasury Office, says the legal argument for amending statutes to allow for negotiating contracts should address the well-being of the state currently and in the future. “If you say you want to make changes solely for budget reasons, you will lose,” he says. "If you could break a contract because you can’t pay, you could break any contract."
He notes that every pension reform in the U.S. has been challenged legally. Governments must know the legal precedent before embarking on their own initiative.
One of Rhode Island’s arguments when proposing pension reform was that paying 45% of salary for retirement benefits limits the ability to hire new employees and to make pay increases for current workers. Rhode Island has many young teachers on board with its pension reform, because they were not sure benefits would be there for them in the future, and thus were not sure if they would continue to teach for long, Dingley explains.
The state realized it had to establish a legal foundation for proposed changes, Dingley says, “as soon as you introduce legislation, it becomes an ideological battle between employees and officials.” He agrees with McGuinn that before governments introduce legislation, they must put a proposal on the table and discuss it at public meetings. He also suggests the legislature have a special session for pension reform. “Budget and pension reform get mixed up, and discussions are so volatile, nothing gets settled before the regular session ends, so in a special session more is likely to get done,” he contends.
Rhode Island has moved to a hybrid plan, which shares risk and mitigates some risk for employees, Dingley notes. He points out that in many states, public employees do not get Social Security, so it is important to keep some core DB benefit.
The papers discussed during the Brookings event may be downloaded from here.
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