Pension Reform: Hits and Misses

Big changes are under way in some locales, but some unions are holding out.

The great public pension debates of this century began in earnest when the Great Recession clobbered investment portfolios by 30 percent in early 2009 and the magnitude of pension deficits were magnified to levels that attracted media attention nationwide. Even with the stock market recovering 75 percent of its 2008 losses, the liabilities of these plans have swollen by 25 percent since the beginning of the great recession as workers aged and earned more service credits. So we still have a nationwide public pension funding shortfall of nearly $1 trillion using the current market values of assets, depending on whose calculations you chose to believe.

Until this year, very little of real substance was done to whittle down those liabilities. Although a dozen state legislatures took action to "reform" their pension plans, many of the early actions were more symbolic than substantive. Often they tweaked the benefits for new hires and but left current workers untouched. A few of them raised the employee contributions by a percent or two. But in the grand scheme of funding shortfalls, they were almost cosmetic.

But now, we're beginning to see some real reforms. The city of Atlanta drew national headlines last month when its city council unanimously approved a major overhaul of the pension plan. Current employees escaped a proposed reduction in benefits, but will pay an additional 5 percent of pay into the pension plan. New hires will join a hybrid retirement plan that uses a slimmed-down 1 percent pension multiplier and a 401(k)-style defined contribution plan with a city match. Retirement ages are increased to 62 for civilians, with new public safety workers subject to an age 57 requirement that I've been suggesting as the model nationwide. That structure is much more consistent with the kind of pension reform that taxpayer watchdog groups have advocated, and it deserves serious study by public officials seeking to design sustainable benefits plans.

New Jersey's controversial GOP governor Chris Christie, with bipartisan support from labor-friendly Senate President Stephen Sweeney, successfully cleared a bill through that legislature to require higher employee contributions, remove health benefits from the bargaining table, and freeze cost-of-living allowances. Projected savings are in the billions and could top $100 billion over time if you believe the press releases.

Similar accounts are popping up elsewhere, and the tide has clearly turned in favor of reduced benefits in many states and localities. Even in California, where statewide pension reform is still elusive as the legislature failed to address it in its new FY2012 budget, workers in many unions have agreed to pay more to preserve benefits. Outgoing Governor Schwarzenegger negotiated a half-dozen such increases in his final year in office, and the City of Los Angeles has set a national precedent with an agreement for employees to contribute 4 percent of pay into their retiree health care plan which has been pay-as-you-go until now. Even the notorious six-figure lifeguards in Newport Beach have agreed to lower future benefits and higher contributions

Some commentators see a growing national movement toward reduced union power and taxpayer envy of public pensions. Certainly the recent legislation in Indiana, Massachusetts, Ohio and Wisconsin would support that claim. But unionists in other states would say they have stepped up to the plate to negotiate responsible changes in their benefits and are willing to make sacrifices to retain "hard-earned pension formulas." Public pension advocacy groups have ramped up their efforts to dispel "myths" about pension funds, and a more centrist, pragmatic tone has been seen in some states as genuine solutions are sought and sometimes achieved.

Meanwhile, however, there are some notorious hold-outs. Some unions, especially police unions, have have played hardball with their elected officials. They have bet their jobs — and sometimes lost — that city councils will blink and cut other departments rather than lay off cops. That strategy has worked in many municipalities, but not all of them. Some mayors, city managers and city councils have stared them down and cut the workforce after trying unsuccessfully to negotiate pension reductions and fair-share employee contributions. They had no other choice in most instances. It's become a giant game of chicken with the public's safety, in part because union members have taken the view that the public will always stand by the public safety workers who became heroes in 9/11. Public opinion polls taken by one of the pension reform groups suggest that the mood has shifted decisively against that conventional line of thinking, and that pension envy now outweighs support for, and fears about, public safety. The "$100,000 pension club" headlines in some states have eroded public sympathy.

It's said that local government is the laboratory of American democracy, and the pension reform trend is a good example of widespread variations on a theme. In some states, the rules of the game are rigged against policymakers seeking to make obvious changes to over-rich benefits formulas awarded to incumbent employees in the halcyon days of the Internet bubble — which cannot not be retracted under judicial precedents in certain states. The standard union line is that retirement benefits should be bargained on an employer-by-employer basis and there is no need for the legislature — or the voters — to get involved. The problem with that line is that the resulting hodgepodge of benefits formulas, contribution rates and funding schemes will eventually result in great disparities in employee compensation and taxpayer impact. Municipalities in particular are then left with a "beggar-thy-neighbor" labor market the next time the economy gets back on its feet. And the unions will of course make the case to restore their shrunken benefits, often through labor arbitration by pitting one employer against another as they did in the late 1990s in several states. That's why some pension reformers would advocate a level playing field with common statewide limits on how rich a retirement benefit can be, with mandatory use of a hybrid plan similar to Atlanta's new deal — so that the defined contribution portion of the plan can be dialed up or down as the economy waxes and wanes.

Even with all this activity to fix pensions, most public employers still haven't begun to tackle the trillion-dollar problem of unfunded retiree medical benefits (OPEB) which are double the size of pension deficits. Once all these obligations start showing up on the balance sheets of state and local governments under the Governmental Accounting Standards Board's pending standards, a further round of benefits reductions and contribution increases is inevitable. I've done some simple ballpark math, and nationwide the combined annual cost to amortize the pension and OPEB liabilities under the new standards will average 30 percent of full-time payroll, in addition the normal cost of current benefits. That's about $16,000 per employee per year — around $8,000 to $10,000 more than the average employer now pays annually for the average public employee. Piecemeal collective bargaining and trivial ad hoc reforms will not fix these problems in many states. Although incrementalism may work in some states, more major surgery is inevitable in many jurisdictions.