As unfunded government liabilities have raced out of control, the high cost of traditional defined-benefit public pensions has become a big issue for Vermont. State Treasurer Beth Pearce and economic advisor Tom Kavet have warned legislators and public employees alike that the state needs to address pensions during the next legislative session. Kavet says the funds face a potential $72 million shortfall.
According to the Ethan Allen Institute, Vermont currently carries an unfunded liability of $3 billion for its pension fund and health care expenses for retired state employees and teachers. This represents a significant risk for taxpayers. David Coates, formerly of the Vermont KPMG Office, wrote in VTDigger.org that Vermont’s pension fund and health care debt per capita averages $5,000 for every person in the state. In addition, the state has been removing $20 million each year from Teachers’ Pension Fund assets to pay for retiree health care costs.
In 2010 the legislature passed a series of changes that increased the retirement age, raised the amount contributed from 3.4 percent of salary to 5 percent, and increased the maximum retirement benefit from 50 percent of average final pay to 60 percent. Unfortunately, none of these changes addressed the underlying fiscal problems created by the defined benefit pension system itself. These plans guarantee set payment amounts (that can increase over time) for the life of a retiree, which means states face open-ended liabilities that grow as life expectancy increases. Also, under the defined benefit model the state is held responsible for investment losses, which can place taxpayers at risk when pension fund investments come up short.
One primary cost driver for public pension plans is automatic cost of living adjustments (COLAs). COLAs are implemented automatically regardless of the government’s ability to pay for them and make the cost of pension plans compound annually. A Milken Institute study found limiting the career years considered when determining COLAs could lower the overall cost of funding by up to 30 percent.
In the short term, pension formulas should be changed, automatic cost of living adjustments (COLAs) should be curtailed, pension rate of return assumptions should be changed to more realistic levels, and workers should be required to make higher contributions.
Ultimately, sustainability will require Vermont to 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 Real Cost of Public Pensions
http://heartland.org/policy-documents/real-cost-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.
Vermont’s Expanding Pension Crisis
http://vtdigger.org/2012/05/17/coates-vermonts-expanding-pension-crisis-2/
In this op-ed David Coates outlines several worrisome aspects of Vermont’s state and teacher pension and retiree health care costs. A PowerPoint presentation on this topic to the Ethan Allen Institute is available here.
Vermont Treasurer: Pension Problem Needs to be a Priority in 2014
http://www.burlingtonfreepress.com/article/20131202/NEWS03/312030005/
The Burlington Free Press outlines Vermont’s pension problems and Treasurer Beth Pearce’s call for reform in 2014.
Fixing the Public Sector Pension Problem: The (True) Path to Long-Term Reform
http://heartland.org/policy-documents/fixing-public-sector-pension-problem-true-path-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
http://heartland.org/policy-documents/state-pension-funds-fall-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 have caused funding crises in these plans.
The Gathering Pension Storm: How Government Pension Plans Are Breaking the Bank and Strategies for Reform
http://heartland.org/policy-documents/gathering-pension-storm
The Reason Foundation tackles the looming crisis created by states’ continued use of defined-benefit pension plans. This paper offers solutions to the pension problem and an analysis of why the current system is a disaster in the making.
Research & Commentary: Defined Contribution vs. Defined Benefit Pensions
http://heartland.org/policy-documents/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 Municipal Government Debt Crisis
http://heartland.org/policy-documents/municipal-government-debt-crisis
This study by The Heartland Institute and Truth in Accounting (TIA) offers 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 study states. 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
http://heartland.org/policy-documents/research-commentary-public-pensions-and-assumed-rate-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.
The State Public Pension Crisis: A 50-State Report Card
http://heartland.org/sites/all/modules/custom/heartland_migration/files/pdfs/27578.pdf
This Heartland Institute report examines problems currently 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 system problems.
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 FIRE Policy News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or [email protected].
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance.
