Pension plans have long been a mechanism to attract quality employees to local and state government. However, according to a report by the Center for State and Local Government Excellence (SLGE), wages and salaries as a portion of total compensation have been declining as health insurance and defined benefit retirement costs have risen.
Some state and local governments have been struggling to meet their pension obligations. In order to meet these obligations, there have been additional strains placed on other aspects of government budgets. This has led to decreased spending on public services and increased taxation on their residents.
A recent article by the New York Times highlights the Oregon Public Employees Retirement System's struggle with funding its system, asking cities, counties, school districts, and other local entities to contribute more to keep it running. In California, the California Public Employees Retirement System (CalPERS) has been faced with major gaps that have left them struggling to meet their contribution obligation to retirees.
Changes in Pension Plans
Ten years after the 2008 economic downturn, state and local government pension plans have steadily recovered -- some more than others. A 2016 report by SLGE points out that, while most pensions plans are making steady progress with 38% of plans being more than 80% funded, 20% of plans still remain under 60% funded. If you'd like to compare your city's pension funding to the 43 largest U.S. cities, this GovRank website provides a breakdown.
State and local governments are faced with two options to make up for these tremendous gaps: bring more money into the system through investments or employee earned contributions, or pay out less money. A National Association of State Retirement Administrators' report on retirement system reforms showed that budget challenges and rising pension costs made employee contribution increases a central part of pension reform.
Keith Brainard, research director for the National Association of State Retirement Administrators, mentioned that while not every municipality and state retirement system is facing issues, those that are, are having trouble mitigating the impact due to an inability to change pensions for people already covered in the plan.
Some states, like Illinois and California, are prohibited from making changes to pensions for those already covered under the plan. This creates an even larger pension challenge, according to Brainard, because governments can only change benefits for new hires.
Strategies and Best Practices for Mitigating the Impact
Some popular strategies that systems have begun to incorporate include cost-of-living adjustments, changes in the vesting period to become eligible to receive any pension benefits, and final average salary pension benefits. In addition, some jurisdictions have adopted hybrid retirement plans, and while most of these plans affect just new hires, they can sometimes impact those already in the plan.
SLGE identified three practices of a well-funded retirement plan based on an analysis of several states with a long tradition of having well-funded pension systems:
- A commitment to fund the annual required contribution in both good and bad financial times.
- Conservative, realistic assumptions that are adjusted based on experience.
- Changes to benefit levels and contribution rates as needed.