State Pension Systems on the Rebound

Things are starting to look up for state pension systems.

“Conditions affecting public pension plans continue to improve,” said Keith Brainard, research director for the National Association of State Retirement Administrators.

That’s good news following years of warnings about the sustainability of state public pension systems. A Pew Center on the States 2010 report warned of a $1 trillion gap between what states had set aside for pensions and the real price tag for those benefits.

Economic conditions in general have been improving, especially on Wall Street, which is closely tied to the financial health of public retirement systems. Corporate stocks and bonds make up more than half of all cash and investment holdings for state and local public employee retirement systems.

But the improved health of pensions isn’t just because investment markets are on the rebound; states have taken decisive action that also has helped the ailing systems.

“States have taken on some major reforms over the last few years,” said Brainard.

Those reforms include higher employee contributions, a higher age or more years of service to qualify for retirement, and reductions in cost-of-living adjustments, or COLAs, for future or existing public employees.

Making Changes

Rhode Island employed many of the strategies Brainard cited in a complete overhaul of its pension system this year. It had taken three previous attempts during the past six years to get its pension house in order, Richard Licht, director of Rhode Island’s Department of Administration, said during a session at The Council of State Governments’ 2012 National Leadership Conference.

“We set out saying we’re going to do this comprehensively and (it is) the last time, hopefully, we ever have to do it,” said Licht.

The big changes took leadership, he said. The governor, treasurer, house speaker and senate president all made important contributions. While there were some disagreements, “there was a commitment to collaborate to get it done,” Licht said.

“This can’t be done from the bottom up,” he said. “This was a top down effort.”

Among the actions Rhode Island took to transform its pension system, the state:

  • Changed the formula for cost-of-living adjustments from a 3 percent per year hike to a COLA based solely on investment return. No COLAs will be given until the fund is at least 80 percent funded, which could take as long as 19 years;
  • Changed the retirement age. For those who are vested in the system, that went to Social Security retirement age, but no older than 67; and
  • Created a hybrid plan, moving from solely a defined benefit plan to a combination defined benefit-defined contribution plan.

The need for change became obvious in 2010, when the funding status dropped from 82 percent in 1999 to 58.5 percent in 2010. Part of that could be attributed to the change in the assumed rate of return—the state had been using an 8.25 percent calculated return but changed it to 7 percent, Licht said. It also had been using the wrong mortality rates, he said.

Improving Credibility

California’s Public Employees Retirement System, or CalPERS, is the largest pension fund in the country, wielding $232 billion assets and serving 1.6 million members. It has seen its share of hardship and controversy during the past decade.

According to Grant Boyken, pensions and benefits officer in the California State Treasurer’s office, the state system experienced a “perfect storm” of events—increased benefits during boom times coupled with unprecedented market downturns, a decline in private sector pensions and individual losses in 401(k)s.

On top of all that, there have been a number of scandals related to placement agents, third parties paid by money managers to raise capital from institutional investors like pension systems. That’s not just in California’s system, although the state has had its share of very high profile cases.

In response, the state changed its laws to require more transparency, particularly in its use of placement agents.

“This is one of the issues that go to credibility of pension systems at a time when reform is such an important issue,” Boyken said.

Boyken said Gov. Jerry Brown’s office has proposed a number of reforms for the state’s pension system, including moving to a hybrid plan and increasing the retirement age.

“People are hopeful and the governor is really hopeful,” Boyken said about the proposal, which is under consideration by the Joint Conference Committee.

Legal Challenges

As states have moved to revamp their pension systems, some have been met with legal challenges—especially when policymakers make changes to existing employee benefits, which at least seven states have attempted recently. But the courts haven’t provided a lot of guidance for states.

“The results have really been a mixed bag, with some courts siding with states and others siding with the employees,” said Brainard.

Oregon Sen. Richard Devlin, co-chair of his state’s Joint Ways and Means Committee, has some advice for states making major reforms: “If you get involved in this, I hope you have the best legal counsel you can obtain and the best actuarial support you can obtain. Please don’t get people who want to agree with you, because you need to hear the entire story.”