Some Good News on Pensions, for a Change

Over the last four years, state governments across the nation have been trying to bring their labor costs under control, especially pensions, which are now imposing huge unfunded liabilities. This has been an uphill battle, as reforms generally face opposition from government employee unions. Yet, despite that opposition, lawmakers in most states have been able to enact some reforms, of varying boldness. A new report from the National Conference of State Legislatures (NCSL) has some encouraging news.

The NCSL report states, “From 2009 through 2011, 43 states enacted major changes in state retirement plans for broad categories of public employees and teachers to address long-term funding issues.” Reforms enacted include:

  • Increased employee contributions;
  • Higher age and service requirements for retirement;
  • Reduced commitments to post-retirement cost of living benefit increases; and
  • Changes in formulas for calculating benefits.

The last change is especially significant, because in many jurisdictions public employees have been gaming the system through a practice known as pension spiking. This is made possible by pension systems setting retirement benefits based on an employee’s final year earnings. That allows an employee nearing retirement to rack up a large amount of overtime, which then gets calculated into the pension payout.

Some pension systems set benefits based on an average of an employee’s last few years of service. This helps to alleviate the costs from spiking, but it can only do so effectively by covering a long enough period. California Governor Jerry Brown recently has proposed basing pension payouts on a final three years’ average — much too narrow a time window. A more effective reform would use either a career average or a considerably longer time period. Some states, wisely, do use longer time periods; more should.

Still, many states are moving in the fight direction. The NCSL notes:

All state defined benefit plans use a formula to calculate benefits based on a person’s final average salary and years of service credit. Final average salary usually is the average of between three and eight years’ compensation. The formula then provides a percentage of the average for each year of service credit. Increasing the number of months or years used to calculate final average salary usually means a lower benefit. A number of states have provided for longer periods for calculating average salary. A smaller number of states have reduced the percentage multiplier for calculating the actual benefit.

• In 2009, one state adopted a longer period for average salary and one other state reduced the percentage multiplier.

• In 2010, eight states provided for longer periods for calculating final average salary and four states reduced the percentage multiplier for some employees.

• In 2011, eight states provided for longer periods for calculating final average salary and seven, mostly the same states, reduced the percentage multiplier for some employees.

Even more encouragingly, pension reforms are being enacted in states with all sorts of political environments, including Democratic-leaning, union-friendly ones. Deficits bear no party label.

For more on public pensions, see here and here.