Public Plans’ Actions Offset Recession Impact

A study from the Center for Retirement Research at Boston College examines the long-term effects of pension reforms on employer costs and on state budgets for a sample of 32 plans in 15 states. Nearly all of the sample plans (29 out of 32) have enacted some reforms since the 2008-2009 financial crisis in order to reduce future costs. On the contribution side, 14 plans increased employee contribution rates. On the benefit side, the most common type of change, adopted by 24 plans, was tightening age and tenure requirements for benefits.    

Other changes included increases in the salary averaging period used in determining benefits, reductions in the benefit accrual factor, and cuts in cost-of-living adjustments (sometimes for current retirees as well as new hires).  

About 40% of the plans took actions that roughly offset the impact of the financial crisis on the employer’s annual required contribution (ARC), about 20% did not make enough changes to fully offset the impact of the financial crisis, and the remaining 40% of the sample appeared to take the crisis as an opportunity to reduce costs below pre-crisis levels. 

The research found changes in the employer normal cost contributions were systematically related to plan characteristics.  The plans with the largest projected reductions are those that were poorly funded and those with generous benefits.The poorly funded plans reduced their normal cost as a share of payroll from 7.8% to 3.3%, on average, compared to 8.5% to 5.6% for well-funded plans.The story is similar when comparing generous plans—those in the top half of the sample in terms of total normal cost—to plans with low to average benefits.This behavior suggests that plans were generally reacting in ways that were calibrated to the size of the challenge they faced, researchers said.  

In addition to revisions in benefits and contributions, many plans changed their amortization period and/or their assumed rate of return used to discount future benefits.Thirteen plans changed their amortization periods, with six plans lengthening the period and seven plans shortening the period.Lengthening the amortization period stretches out the schedule for paying off unfunded liabilities; a longer amortization period lowers the required amortization payments and provides some immediate relief in the form of lower ARC payments.Shortening the period has the opposite effect; it raises a plan’s ARC.    

With respect to the assumed rate of return, all of the changes went in the same direction with 10 plans lowering their rates, typically by about 0.5 percentage points.Lower discount rates raise the ARC by increasing plan liabilities; these changes are clearly a reaction to the post-financial crisis environment in which many observers consider the traditional assumed asset return of 8% too optimistic, the researchers noted.