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Plug Pension Hole By Curbing Traditional Plan? It May Not Be Best Strategy

Closing their so-called defined benefit plans to new workers has not worked out well in four states that tried it

Pensions NJ State workers
Credit: NJTV News

Closing a traditional pension plan to new workers has yet to fix pension-funding problems in several states where it’s been tried, according to a new report that takes a close look at reform efforts across the nation.

Instead, the report from the National Institute on Retirement Security, a nonpartisan and nonprofit research organization, found that costs often increased. In some cases, the authors noted, the states had trouble recruiting and retaining workers without being able to offer them a so-called defined-benefit retirement plan, one in which payments are based on salary and length of service and not investment results.

The NIRS report — which used Alaska, Kentucky, Michigan and West Virginia as case studies — also highlighted how important it was for government employers to adequately fund their workers’ retirement plans.

“Responsible funding of pension plans is key to managing legacy costs associated with these plans,” the report said. “The experience of these states shows that changing benefits for future hires does not address an existing funding shortfall.”

New Jersey has one of the nation’s worst-funded public-worker retirement systems. It’s also one of the states where some lawmakers have backed the idea of moving at least some employees out of traditional retirement plans to address the pension deficit.

Sweeney has pushed hard to change pension

Leading the latest push in New Jersey is longtime Senate President Steve Sweeney (D-Gloucester). Among other reforms, Sweeney has backed the proposal of a nonpartisan fiscal policy group he empaneled to establish a new, hybrid retirement system for new workers and those with less than five years of service.

Under that plan, teachers and other government workers — but not police officers, firefighters and judges — would start to receive a defined-benefit pension on only up to $40,000 of salary. For any additional earnings, the affected workers would be enrolled in a hybrid “cash-balance” savings plan that would not require a matching contribution from the state. The plan would guarantee a 4-percent annual return for workers, and also offer a chance to do better based on how general pension-fund investments perform. Workers would also be required to continue making their full contributions into the retirement system, a feature that is specifically designed to avoid the funding problems experienced in other states that have gone away from a traditional plan.

Public-worker union officials have contended the changes would erode retirement security while doing little to address the pension system’s already huge unfunded liability — more than $100 billion, according to some estimates.

They have also accused Sweeney of using the pension-reform proposal as a distraction after he signed off on major tax breaks enacted during former Gov. Chris Christie’s tenure that significantly reduced the state’s revenue stream — just as a new effort was being made to ramp up state pension contributions in response to the growing deficit in state retirement funds.

Sweeney maintains the reforms, coupled with proposed changes to employee healthcare plans, would save the state and local governments billions of dollars in coming decades. He’s also threatening to put the proposed benefit changes before voters next year as a constitutional amendment if Gov. Phil Murphy — a union ally who favors increased pension funding and negotiated healthcare savings — stands in the way.

Murphy has increased state pension payments incrementally in recent years, but he’s also continued the longstanding tradition of only partially funding the state’s annual pension contribution as he’s also boosted spending on K-12 education, mass transit, community college tuition assistance and other areas.

Not much success elsewhere

According to the NIRS report, Kentucky, when faced with its own severe pension-funding challenges, moved new employees into a hybrid system in 2014. But that change will not “meaningfully impact” the state’s pension-plan payments for decades because of the state’s already huge “legacy costs,” the report said.

“As an alternative strategy, the state might have been better served by incentivizing those near retirement to work a few additional years and to delay benefit payments from a solvency-challenged system, instead of focusing on policies that would take decades to impact plan cash flows,” the report said.

The authors gave credit to Kentucky policymakers for sticking with a plan to boost state pension contributions. But they also noted one of the state’s five funds saw its funded ratio plummet from 23 percent to 13 percent even after the benefit change was enacted.

“The state cannot cut its way out of its funding problems by continuing to reduce retirement benefits for public employees,” the report said.

Recruitment efforts are hurt

The changes made in Alaska, Michigan and West Virginia all predate Kentucky’s more recent reforms, and all three opted to move employees from defined-benefit into investment-results-based plans, also known as defined-contribution retirement plans. Yet despite closing its traditional plan in 1997, Michigan is still struggling with a significant unfunded pension liability, the report said.

“Meanwhile, the financial security of its public employees is at risk, as the defined contribution plan that replaced the (traditional) pension plan will provide far less income in retirement.”

Alaska closed its defined-benefit pension plans for teachers and other government workers in 2005, and the report’s authors cited evidence that not offering employees a defined-benefit retirement plan has been hurting efforts to recruit workers. They also noted that the state’s rural geography plays a role in thwarting recruitment efforts.

“The lack of a defined benefit pension plan and competitive benefits in general is often directly cited as a major reason why Alaska struggles to recruit teachers, state troopers, and other public employees,” the report said.

Meanwhile, in West Virginia, policymakers decided to reopen the pension plan for teachers in 2005, and it has resulted in funding improvements as new members have joined the plan and begun making contributions that help offset its liabilities, the report said.

“Importantly, West Virginia committed to full funding after reopening the plan,” the report said. “That commitment, combined with the contributions of new members and positive investment returns, have allowed the plan to slash its unfunded liability.”

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