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The Pension Time Bomb: Why Public-Sector Retiree Benefits Need to Change, and the Barriers to Meaningful Reform - Page 2 PDF Print E-mail
News/Features - Feature Stories
Written by Jeff Ignatius   
Thursday, 08 November 2012 05:00

Simple Math or Union-Bashing?

McNeilly emphasized that the pension issue is “a matter of mathematics. The math doesn’t work. It’s pure arithmetic. So there’s no ideology here; the system doesn’t work and it’s been proven not to work.”

She also said that beyond a core lack of sustainability, Illinois’ pension system is rife with abuse – double-dipping and “spiking” pensions through overtime and higher end-of-career salaries. She said that 6,700 current Illinois pensioners take home more than $100,000 annually, and her organization estimates that number could be 25,000 by 2020.

Taxpayers United advocates shifting employees to a defined-contribution system. “Any reforms that we can make for current employees need to be made,” McNeilly said. “As far as new hires, they really need to be out of the pension system altogether and into a defined-contribution plan.”

She acknowledged, however, that pension reform has “become a left/right issue – another divisive issue.”

There’s certainly some anti-union sentiment at work here. When asked why states haven’t shifted more quickly to defined-contribution plans for new employees, McNeilly answered: “Votes. The unions deliver a ton of votes to people who vote for the defined-benefit system. ... It’s a game; it’s a ploy.”

She further argued that maintaining the current retirement system is the primary reason public-sector unions exist today: “Without the pension benefits, there really is no need for union leadership. That’s the biggest negotiating point – pensions. Health care, too; that’s a whole other unfunded liability.”

She stressed that Taxpayers United does not intend to “blast rank-and-file [union] members. It’s to blast the [defined-benefit] system that’s sold to them as a good thing.”

Nonetheless, efforts to reform state pension systems are often seen as de-facto attacks on union workers. Defined-benefit pensions and retiree health care were negotiated, and any changes that make those systems more sustainable will inevitably come at the expense of employees – through higher worker contributions, reduced benefits, or later retirement ages.

So unions tend to fight structural reform efforts, and politicians allied with unions are hesitant to seriously consider them. In a June statement, a coalition of public-employee unions under the banner of We Are One Illinois bemoaned the Illinois Senate’s passage of legislation that would “shift the lion’s share of the burden for Illinois pension debt onto employees and retirees, who have faithfully contributed their share over their working lives.”

The Illinois Policy Institute’s Dabrowski acknowledged that it’s difficult to bring unions on board, but he said it’s in their long-term interest: “Without those reforms, the pension system will go bankrupt anyway, so state workers will have to get behind some form of reform if they want to see their future benefits.”

Yet even if unions decide that structural pension reform benefits their workers in the long run, the existing problem doesn’t go away.

As Dabrowski said: “Most people will agree that benefits that are already earned and promised should not be diminished.” This is actually written into the Illinois Constitution’s pension clause, which states that “benefits ... shall not be diminished or impaired.”

The Pew Center on the States report noted that “between 2009 and 2011, 43 states enacted benefit cuts or increased employee contributions, or did both, according to the National Conference of State Legislatures. The trend continued in 2012: Alabama, Kansas, Louisiana, New York, Virginia, and Wyoming were among the states that adopted major reforms.”

But it added that “the reforms that states have enacted in the last three years mostly affect future state workers, as it is legally difficult to reduce benefits for current employees and retirees.”

At RealClearMarkets.com, Steven Malanga suggested that states cannot truly address pension debt without changing benefits for current employees. Despite retirement-benefit changes, he wrote, “pension debt keeps rising and annual payments to pension systems from government budgets are spiking in many places, in part because many of these so-called reforms are superficial in nature. ... The states left benefits untouched for the vast majority of their workforce. The savings make only a small dent in future costs.”

Options for Reform

That’s one reason that Rhode Island has been cited as a model for reform. The Pew report said: “In 2011, Rhode Island lawmakers approved an unprecedented overhaul of the state’s traditional defined-benefit-pension plan. If the legislation survives a likely legal challenge, it will cut benefits for current as well as future employees and trim the state’s unfunded liability by an estimated $3 billion. Current workers will keep the retirement benefits they have earned already, but beginning July 1, 2012, they will earn new benefits at a lower rate. These workers will also get access to a newly created individual retirement account, which will add to their benefits based on the retirement contributions by both the worker and the state. The overall plan is called a hybrid because it combines features of the traditional defined-benefit and defined-contribution plans.”

Still, even modest reforms can have some impact.

McNeilly cited Iowa’s reforms as a good start. In 2010, the legislature enacted a handful of changes, according to the Center for State & Local Government Excellence:

• “The vesting period for new employees will increase from four years to seven years.

• “The reduction for early retirement will increase from 3 percent to 6 percent for each year before age 65.

• “The number of years used to calculate highest average salary for benefits will increase from three years to five years.

• “The amount that the combined employer and employee contribution rate can be raised or lowered annually will change from 0.5 percent to 1 percent.

• “There was a one-time increase of 2 percentage points (11.45 to 13.45 percent) in the total employee and employer contribution rate effective July 1, 2011. Before a contribution increase of 0.5 percent in 2008, the legislature had not changed contribution rates since 1979.”

Alex Brown, a research and policy analyst for that organization, wrote to Pensions & Investments that Iowa recognized the urgency of reform but also the need to be fair to employees:

• “Employees were allowed to retire before reaching normal retirement age with the old reductions; the increased penalty for early retirement applies to those years worked after the reforms take effect.

• “Employees are provided a ‘benefit snapshot’ when electing to retire. Employees will choose between the benefit calculated using the pre-reform salary calculation or the post-reform salary calculation, whichever yields the highest benefit. ...

“Iowa has provided an example that can be followed to ensure employees are eased through what can be an anxious process.”

In Illinois, Governor Pat Quinn earlier this year signed Senate Bill 1313, which will allow the Department of Central Management Services to determine what health-care premiums retirees will pay. (Roughly 90 percent of retirees in the state’s plan pay no premiums.) That could shave $30 billion off the state’s retiree-health-care liability, Dabrowski said.

Other reform, however, has been elusive.

Dabrowski said the state needs to move to defined-contribution benefits for all future work.

Beyond that, he said, eliminating cost-of-living adjustments (COLAs) to pensions for a long period of time could eliminate $30 billion in unfunded liabilities from the official $83-billion estimate. “If you don’t ... reduce COLAs – if you don’t freeze them – then you can’t get out of the hole,” he said.

Increasing retirement age to age 67 could save more than $10 billion, he noted. Furthermore, the state could cap pensions, and also change the number of years that go into the pension calculation.

“All these reforms would chip away at the unfunded liability,” he said. “The state would be left with an unfunded liability, but one that would be much more manageable, that can be chipped away over time without destroying funding for kids’ classrooms, and health care, and other important needs.”

Dabrowski said pension reform could be passed in January’s lame-duck legislative session, although he said he’s skeptical the changes will be meaningful: “We think it can be done. Of course, it takes a lot of political will and a lot of leadership, which we haven’t seen yet.”

He added that two triggers could push the legislature to truly address the issue.

“We’re going to see funding for education start to be cut. We’re going to see funding for ... a lot of core services the state needs to be cut,” he said. “At some point, people are going to get angry. ... We’re nearing that point over the next few years.”

Alternatively, he said, the bond market could further downgrade Illinois’ rating, which “would send a signal.” The state isn’t at that point yet, he said, but “we’re doing all the wrong things to move us in that direction.”

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