Unfunded state pension liabilities have become an increasingly troubling problem for states across the country, including Alabama. In 2010, Alabama received a grade of D in The Heartland Institute’s 50-State Pension Report Card. According to the Huntsville Times, Alabama’s three pension funds, including separate funds for education workers, judges, and state and local government workers, currently have only $28.1 billion in total assets but $42.5 billion in total liabilities. These three programs serve 114,050 retires and 221,735 current workers.
The Alabama Policy Institute (API) points out in its Guide to the Issues that the Retirement Systems of Alabama (RSA) had the worst-performing public pension fund in the nation in 2008 and 2009, with total losses of approximately $13 billion. The most recent financial report released by the RSA found all three funds were underfunded as of the end of September 2012. The teachers’ pension system was 66.5 percent funded, and the funds for other government workers and judges and justices were 65.7 percent funded and 61.6 percent funded, respectively.
Increasing pension liabilities are further complicated by the fact that 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, relying 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 rate RSA uses is 8 percent.
In a Troy University study, Eileen Norcross of the Mercatus Center at George Mason University examined the RSA’s expected rates of return and found they were much higher than the actual investment returns. Although 2013 was a good year for the pension funds, Norcross found the 5 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. Even if the funds were to hit the 8 percent goal, the RSA would still be unable to cover the cost of pension payments long-term, Norcross warns.
Taxpayers cannot afford for states to continue over-promising 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 more a realistic expected investment return rate of 3.1 percent, based on 30-year Treasury bond yields.
To protect both taxpayers and public workers over the long term, Alabama should follow the private sector’s lead and switch workers from defined-benefit pension systems to defined-contribution-style pension plans like 401ks. Defined-contribution gives retirees direct control over their retirement and allows them to move in and out of the private sector without losing their accrued pension benefits. This also 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 articles examine state pension reform from multiple perspectives.
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 the pension plans in the 50 states and suggests ways states might go about solving their pension problems.
Guide to the Issues: Retirement Systems of Alabama (RSA) Pension Reform
This paper from the Alabama Policy Institute argues that Alabama must implement long-term reforms that protect taxpayers from the RSA’s unfunded liabilities. The Institute outlines five core principles the RSA should commit to.
Pension Reform in Alabama: A Case for Economic Accounting
Eileen Norcross of the Mercatus Center provides a fair-market analysis of 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 the 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 that governments use today and the advantages and disadvantages of each plan. It also provides several tools that legislators can use to ensure that 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 public pension benefits are somehow modest.
The Municipal Government Debt Crisis
This study by The Heartland Institute and Truth in Accounting (TIA) is the 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 currently in the news, 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 Dreyfuss of the Manhattan Institute examines various states’ pension reform efforts and recommends they 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 (PERA) and the Kansas Public Employee Retirement System (KPERS)—are examined in depth to explore 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 Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at http://heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on a topic, The Heartland Institute can assist you. If you have any questions or comments, contact Heartland Institute Senior Policy Analyst Matthew Glans at [email protected] or 312/377-4000.