It’s Time to Hit the Panic Button on Pension Reform

Screen Shot 2015-05-22 at 3.17.41 PMOver the past 10 years, Alabama’s public retirement system has seen its liabilities overtake its assets by more than $15 billion. This means the system has only 66 cents for every dollar owed to current and future retirees.

Worse still, the shortfall has been growing by $4 million each day that our elected officials fail to tackle three of the biggest contributors to the problem.

This deteriorating situation is in part the result of both good news and bad. Decades ago, when the first public pension plans were designed, life expectancies were far shorter than they are today. The good news is that the life expectancy for the average 65-years-old is now 79, a full five-year gain from just the 1950s.

Moreover, a 65-year-old man has on average a 50 percent chance of living to age 88 and a 25 percent chance of living to age 96, while a 65-year-old woman has a 50 percent chance of living to age 90 and a 25 percent chance of living to age 97.

The bad news? This longer life expectancy means longer retirements – and pension costs that have skyrocketed to such a degree that if we decided to fully fund the public retirement system right now, each Alabama household would have to contribute $8,274

The unfunded public pension shortfall is much larger (it’s heading toward twice as large, in fact) than the state’s current total outstanding debt, which has funded public schools, colleges and universities; bridges and roads; the Port Authority; Mental Health; and more programs.

Look at the two numbers: the state’s $8.8 billion debt vs. the public pension fund’s $15.2 billion liability – but you wouldn’t necessarily know this because pension fund figures are hidden in layers of budget lines, and are spread across agencies under neat labels like “employee benefits.” This liability now represents 12 percent of annual state spending, up from 7.5 percent just five years ago.

In recent years the Alabama State Legislature has made significant changes to tackle some of the drivers behind the massive rise in pension costs. However, those reforms left unresolved three of the largest causes of underfunding: fund structure, payout disparities and fund eligibility. If these three issues are not addressed, and soon, taxpayers will face potentially disastrous shortfalls.

Any permanent solution to the pension problem must involve a transfer of some portion of the longevity risk to the individual and away from the state. We therefore recommend that serious consideration be given to the following reforms to shoring up the financial soundness of Alabama’s public retirement system. First, the state should implement a “cash balance” pension plan structure for all new employees, similar to plans recently implemented in Kansas and Kentucky. The plan would have three primary components: (1) an individual account (lump-sum account) that would contain the initial employee contribution and the employer match, and (2) a state-guaranteed minimum rate of interest (5.0 percent), and (3) a profit-sharing component between the employee (75 percent) and the employer (25 percent) if and when the return on investments for the year exceeds the guaranteed rate of interest.

Second, Alabama’s judicial pensions are now some of the richest in the nation; they cover justices, judges, circuit clerks and district attorneys, and can be as much as four and a half times the pension payment of any other state employee (including attorneys). Unlike most state employees, who receive a simple benefit percentage per year (i.e., 3.0 percent), vested judges receive a flat 75 percent of salary, regardless of their years of service. The judicial retirement plan should be amended to bring these benefits more in balance with the pensions of other state employees to reduce the significant disparity that exists.

Third, the Alabama Education Association (AEA) staff is allowed to participate in Alabama’s public retirement system, which provides a group of lobbyists with an extraordinary benefit that Alabama’s taxpayers should not pay for. The association staff should no longer be able to participate in the public pension system and should instead select a private retirement plan of its own.

These three reform measures will produce a more viable retirement system for all public employees and state taxpayers in the years ahead. They would also greatly reduce the financial resource drain that the public pension system now places on the budgets of the state’s Education Trust Fund and the General Fund. While much of the savings wouldn’t be immediate because they primarily involve new employees only, the cumulative positive savings effect of these three reform measures could be well in excess $1 billion per year after paying back the current pension liability.

Dr. James R. Barth and Dr. John S. Jahera, Finance Department, Auburn University. This is based on the report done with the Alabama Policy Institute, Alabama’s Public Pensions: Building a Stable Financial Foundation for the Years Ahead, 2015.