Report: Even ‘Good’ State Pension Plans Threatened by Overall Fiscal Problems

Published February 12, 2010

“No single issue threatens the fiscal health of this state” more than public pension obligations, proclaimed California Gov. Arnold Schwarzenegger (R) in a recent address to the Sacramento Chamber of Commerce.

Over the last 10 years, pension costs have risen from $150 million to $3 billion a year, the governor noted. However, a new analysis of state pension plans shows in some ways California’s pension system ranks as one of the nation’s better ones. Yet it is still threatened by the state’s dire overall fiscal situation.

Evaluating retirement plans on their own, instead of the context within which they operate, researchers at The Heartland Institute found some state pension plans that rank better than average may pose imminent problems for the states that run them, while some with poorer rankings might not pose the same challenges in reality.

Decent System, Bad Finances
The report notes, “A state with a good bond rating, few burdensome public employee contracts, and no constitutional prohibitions on changing its pension system may be able to fix a seriously broken pensions system rather easily, while a state in different circumstances may face major problems with a system that appears less bad on paper.”

For example, when assessed by the established criteria of the study, California’s pension system warrants a “B” grade. However, the real burden of the pension system emerges when the broader California environment—a hostile tax regime, an enormous state budget deficit, and the nation’s worst bond rating—is factored into the equation.

Study author Eli Lehrer said, “California is in such bad shape generally that a mediocre pension system is a bigger problem than it would be in other states. A state with better credit could easily just borrow money to cover obligations.”

Public-Private Disparities
According to the U.S. Bureau of Labor Statistics, the average government employee receives total compensation (wages and benefits combined) worth almost $83,000 a year. The average private sector worker receives approximately $61,000 in total compensation. 

Lehrer notes in the report, “The largest single cause of this disparity is not wages (although they are higher in the government) or even insurance but, rather, the size of these pensions. Only about a fifth of private sector workers qualify for any sort of pension, while nearly 80 percent of government workers do.”

The primary distinction between the public and private sectors is that government pensions involve “defined benefits” rather than “defined contributions” such as 401(k) plans. According to Lehrer, this difference exhibited itself in the rankings.

“The higher-ranked states tend to give employees the choice between ‘defined benefit’ and ‘defined contribution’ plans. Our single highest-ranked state, Alaska, has a pure ‘defined contribution’ system,” he wrote.

Various Study Criteria
With data from 2008 collected by the Wisconsin Legislative Council in its biennial Comparative Study of Major Public Employee Retirement Systems, the authors examined every major pension plan using a consistent set of criteria, including contributions, choice, taxability, vesting, salary calculation method, and funding ratio, to score each plan. 

Among the states receiving “A” grades were Florida, Nebraska, North Carolina, North Dakota, Oregon, and Washington.

Colorado, Hawaii, Illinois, Kansas, Louisiana, Maine, Maryland, New Hampshire, Oklahoma, and South Carolina warranted “F” grades.

Solutions Constraints
State constitutions and union contracts constrain far-reaching pension reform in most states, and without sufficient funding to pay expected benefits, Lehrer writes, “any switch to a pure defined contribution system would require massive tax and employee contribution increases in the short term to ‘buy out’ existing benefits.”

Instead, empowering employees and strengthening their choices is the optimal path to follow, he says.

“If I had to pick two [needed reforms], I’d say that states should give employees a choice of primary pension plans and make sure that, at minimum, employees themselves and taxpayers contribute equal amounts to the plans,” said Lehrer.

Jennifer G. Hickey ([email protected]) writes from Washington, DC.