Unfunded state pension liabilities have become an increasingly troubling problem for states across the country, especially Alabama. In 2010, Alabama received a grade of “D” in The Heartland Institute’s 50-state public pension report card. A new study from the Alabama Policy Institute (API), written by Auburn University professors James R. Barth and John Jahera, warns Alabama legislators a massive shortfall in the state pension system looms on the horizon. The Alabama Legislature’s pension study committee is now beginning to consider new reform ideas.
The API study estimates the Retirement Systems of Alabama (RSA), which comprises the Teachers Retirement System, Employees Retirement System, and Judicial Retirement Fund, have $15.2 billion in unfunded liabilities. Barth and Jahera point out RSA has 66 cents for every dollar owed to current and future retirees.
Alabama’s unfunded liability for RSA has grown rapidly over the past decade. Between 2003 and 2013, RSA’s unfunded liability grew from $2.1 billion to the $15.2 billion, according to the API paper. This debt places a burden of $3,166 on each Alabamian. Barth and Jahera compare the $15.2 billion pension debt to the total debt outstanding for the entire state, which amounts to approximately $8.8 billion, or $4,786 per household. In 2015, the state was required to send $1 billion to the RSA to cover pensions. The second largest budget item in Alabama is now payments to state retirement systems, following only education.
Increasing pension liabilities are further complicated by the reality in many instances the regulators controlling pension funds have overestimated the value of future investments and the rate of return they can expect from the investments held by the pension fund. Regulators rely on strong investment return forecasts to allow them to reduce yearly government contributions to the fund. If the estimated rate of return for these pension funds continues to fall short of expectations, the state’s pension systems may be in even more trouble than is currently thought. The current expected rate of return RSA uses is 8 percent.
In a Troy University study, Eileen Norcross of the Mercatus Center at George Mason University examined RSA’s expected rates of return and found they were much higher than actual investment returns. Although 2013 was a relatively good year for the pension funds, Norcross found the five- and 10-year returns were all below 8 percent: 6.68 and 6.29 percent for the Teachers’ Retirement System, 6.17 percent and 5.97 percent for the Employees’ Retirement System, and 8.74 percent and 7.06 percent for the Judicial Retirement Fund. Norcross warns even if the funds were to hit the 8 percent goal, RSA would still be unable to cover the cost of pension payments over the long term.
Taxpayers cannot afford for states to continue overpromising and underfunding their pension plans. In the short term, states should change pension formulas, curtail automatic cost of living adjustments (COLAs), adjust pension rate of return assumptions to more realistic levels, and require workers to make higher contributions. API recommends the state use an expected investment return rate of 3.1 percent, a figure based on 30-year Treasury bond yields.
To protect both taxpayers and public workers, Alabama should follow the private sector’s lead and switch workers from defined-benefit pension systems to defined-contribution-style pension plans similar to 401(k) plans. Defined-contribution plans give retirees direct control over retirement and makes it possible for them to move in and out of the private sector without losing their accrued pension benefits. This allows governments to budget more accurately, because the benefits are paid directly to the employee and are a set amount of money each year.
The following documents provide additional information about state pension reform.
The State Public Pension Crisis: A 50-State Report Card
This Heartland Institute report examines problems facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of its pension plans and suggests ways states might go about solving their pension problems.
Alabama’s Public Pensions: Building a Stable Financial Foundation for the Years Ahead
James Barth and John Jahera of Auburn University make a compelling case for structural pension reform, with Alabama set to spend nearly $1 billion on public pension costs per year. The paper provides three recommendations for structural reform to the state’s pension system, which identify cost-saving measures overlooked during previous reform efforts, fund the current pension balance, and plan for the future by making pension costs more predictable and adequately funded.
Guide to the Issues: Retirement Systems of Alabama (RSA) Pension Reform
The Alabama Policy Institute argues Alabama must implement long-term reforms to protect taxpayers from RSA’s unfunded liabilities. The institute outlines five core principles to which RSA should commit.
Pension Reform in Alabama: A Case for Economic Accounting
Eileen Norcross of the Mercatus Center analyzes Alabama’s three pension plans, in this Troy University study. The paper makes several recommendations for how Alabama can improve funding in its defined-benefit plans and undertake structural reforms to meet RSA’s stated goals of “Strength, Stability and Security” for Alabama retirees and taxpayers.
Keeping the Promise: State Solutions for Government Pension Reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.
Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
John Nothdurft, director of government relations at The Heartland Institute, provides a bullet-point comparison of defined-benefit pension and defined-contribution retirement plans.
The Real Cost of Public Pensions
Jason Richwine discusses how to calculate the cost of public defined-benefit pension benefits, compares the cost of these benefits to private-sector retirement plans, and refutes two of the most common arguments that attempt to prove public pension benefits are modest.
The Municipal Government Debt Crisis
This study by The Heartland Institute and Truth in Accounting is a comprehensive analysis of Cook County’s taxing districts. “It reveals how officials in many districts have been misrepresenting their financial condition by telling citizens their budgets were ‘balanced,’ when in fact they have been accumulating an overwhelming amount of debt,” the authors write. It finds several taxing districts in Cook County, Illinois face an even worse financial burden than cities whose budget woes have made headlines in recent years, such as Stockton, California.
Research & Commentary: Public Pensions and the Assumed Rate of Return
Heartland Institute Senior Policy Analyst Matthew Glans examines the problems facing state and local pension funds, how assumed rates of return affect pension fund debt, and proposals to change the projected rates of return on pension fund investments.
Fixing the Public Sector Pension Problem: The (True) Path to Long-Term Reform
Richard C. Dreyfuss of the Manhattan Institute examines various state pension reform efforts and recommends states borrow a page from the private sector by shifting to defined-contribution plans: “Under such plans, to which employees as well as employers may contribute, investment risk is borne by plan members, not by taxpayers. A majority of Fortune 100 companies have already adopted such plans. Only 16 percent of large companies still offer their retirees medical coverage. By sharing a complex of risks with the beneficiaries, states and municipalities would be able to devote far more of their time and resources to the more immediate concerns of today’s voters and taxpayers.”
State Pension Funds Fall Off a Cliff
Barry W. Poulson and Arthur P. Hall consider different measures of historical and current funding shortfalls in state pension plans. Two case studies—the Public Employee Retirement Association of Colorado and the Kansas Public Employee Retirement System—are examined in depth to explore the fatal flaws that caused funding crises in these plans.
The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
The Reason Foundation tackles the looming crisis created by states’ continued use of defined-benefit pension plans, offering solutions and explaining why the current system is a disaster in the making.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website at https://heartland.org/publications-resources/newsletters/budget-tax-news, The Heartland Institute’s website at http://heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
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