ALEC Puts Forth Ideas for State Pension Reform

Public awareness of the scope of the state public pension crisis seems to be growing every day. That’s a welcome development, in that it has led to state officials to look for ways to reform their underfunded pension systems. The question they face is: How?

For ideas for reform, they should look to a new report by former Utah state Senator Dan Liljenquist, who led his state’s wide-ranging and successful pension reform. The report, published this week by the American Legislative Exchange Council (ALEC), puts forth ideas for reform based on some basic principles. First, all new employees should join a defined contribution (DC) system. Second, payments that are due under state’s current pension systems must be paid and reasonable adjustments to current benefits should be made, as courts allow.

For specific reforms, the study offers three basic options: 1) defined contribution plans, such as 401(k) plans; 2) cash balance (CB) plans, which have aspects of both defined benefit (DB) and defined contribution plans; and 3) hybrid plans, in which the employer makes a fixed contribution, as in a defined contribution plan, and employees have the option of joining with other employees to create a defined benefit option.

One advantage for employees of shifting away from defined benefit plans is clear from the outset:

In a DB plan, a worker has no legal claim on an employer who fails in a given year to make the contributions that actuaries call for. That same worker, though, does have a legal claim on the employer who fails to make a payment called for under a DC plan.

This is important because it curbs elected officials’ propensity to lowball pension contribution payments, as payouts to retirees don’t come due for years — usually when they’re out of office and it’s somebody else’s problem. Why keep promises to future retirees when you can dispense largess to supporters today — especially when you can justify it by using discount rates based on overly optimistic investment return projections?

It is a public choice defined benefit/diffuse costs situation, except that the distribution works across time — from future taxpayers (and future retirees who may not get the full benefits they were promised) to public employees today. To tackle the problem, public pensions systems’ incentive structure needs to change, which requires moving away from defined benefit plans.

To move reform forward, Liljenquist argues that it is important to make the case in terms that most people can understand (for example, by pointing out the number of teachers who won’t be hired for the state to make pension payments instead) and to convey to public employees that reform is in their interest, since it aims to put state retirement systems on sound footing. It is also important to build a broad base of support among the public, by emphasizing math, not ideology.

Reform will not be easy, but lawmakers who are now trying to deal with their own states’ pensions can take some encouragement from Liljenquist’s own experience:

As a first step, policy leaders need to cap the existing liabilities of underfunded DB plans by closing them to new hires, freezing the amount accrued by current employees and retirees, and moving toward a more sustainable approach. In Utah, the effects of the 2008 market crash were akin to a chemical spill, requiring a two-step response. First, contain the situation. Second, work overtime to clean things up. That is not a message anyone welcomes, but it is one that citizens, public employees, and policymakers had to come to grips with in Utah.

Read the whole thing here.

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