The biggest issue facing state pension systems is continuously growing unfunded liabilities. Under traditional “defined benefit” plans, also known as pensions, like most states currently have, certain benefits are promised to the employee upon retirement which states are legally obligated to pay. A state’s annual required contribution (ARC) is the amount it must pay each year into the pension system to be able to meet those benefit obligations.
As state budgets face historic shortfalls, many states have met deficits by paying less than the ARC and therefore increasing the pension gap. These pension demands are requiring most states to make changes to their pension system in order to keep them manageable. During the 2010 and 2011 legislative session, 39 of the 50 states enacted major retirement system revisions, with some states making revisions in both years.
Changing contributions and requirements
During the 2011 legislative session, 15 states, including Alabama, Maryland and New Jersey, enacted legislation to increase employee contributions for current and/or new employees. In half of these states, the increased employee contribution correlates with a reduction in employer contributions, which in turn reduces the amount the state must appropriate for pension contributions.
Eleven states enacted similar legislation in 2010, bringing the total number of states increasing employee contributions over the last two years to 26.
Between 2010 and 2011, 23 states, including Mississippi, Florida and Texas, increased the age and services requirements that classify as normal retirement for new employees. During that same period, 13 states, including California, Virginia, and Arizona, increased the number of years included in the calculation of an employee’s final average salary to determine benefits.
Like the Teachers’ Retirement System (TRS) in Georgia, some state retirement plans include provisions for automatic cost of living adjustments (COLAs). In 2010, eight states revised these provisions to reduce future commitments by the state. In 2011, nine other states followed suit. As was discussed in a previous column, Georgia eliminated all COLAs for state employees who first or again become members of the Employees’ Retirement System after July 1, 2009.
Creating a new pension plan
Many states are taking a broader approach and redefining the types of retirement benefits offered. One strategy some states are employing to reform their pension systems for the future is moving away from a defined benefit plan to a defined contribution plan, like a 401(k), or a hybrid plan combination of the two.
The advantage of a defined contribution plan is that it allows states to set limits on the amount they will contribute from the outset without promising employees a certain return upon retirement. The payout a retiree receives in a defined contribution system is dictated by employee contributions and market investments rather than a state promise. The advantage for employees under a defined contribution plan is that 401(k) plans offer portability between jobs, whether they are public or private sector, and more control over their contribution and investments.
As mentioned in an earlier column, Georgia enacted a hybrid pension plan in 2008 for new state employees. The Georgia State Employee Savings Plan (GSEPS), combines the security of a defined benefit plan with the portability of a defined contribution plan, in this case a matching 401(k). While the biggest reason for the change was to attract and retain the best and brightest new employees it has also helped Georgia’s pension system weather the economic downturn better than most states.
In 2010, Utah enacted legislation that gives all new state and local government employees the option of either participating in a full defined contribution plan or a hybrid plan. Under both plans, the state will contribute 10 percent of an employee’s compensation to the employee’s retirement. Under the hybrid plan, the state will contribute up to 10 percent to a defined contribution component, a defined benefit component or a combination of the two. For example, if the employer contributes 6 percent to the defined benefit portion, it will only contribute 4 percent to the defined contribution portion.
Michigan has had a defined contribution plan for general state employees since 1997, but in 2010 it became one of the few states to integrate defined contribution into its public school employee pension system. New public school employees in Michigan will enroll in a hybrid system.
Alaska, Colorado, Oregon, South Carolina and Florida are among states that have some sort of defined contribution plan for employees. While defined benefit plans remain the majority among states, defined contribution is becoming more attractive. In 2011, the Arizona, Indiana, Kansas and New Hampshire legislatures approved study committees to explore options for pension reform, including defined contribution plans.
Conclusion
While the changes that many states made during the 2010 and 2011 sessions were in response to growing concerns over meeting the cost of their annual required contributions during times of constrained budgets, Georgia’s early actions in 2008 aided the state in other ways. The ability to control retirement assets and the portability to move the plan throughout a worker’s career between sectors helps keep the state competitive in attracting quality workers and helps Georgia navigate its long term obligations.
If you would like more information on what other states are doing regarding pensions the following Web sites may be helpful:
National Conference of State Legislatures Report on Pension and Retirement Plan Enactments in 2011 State Legislatures:
http://www.ncsl.org/IssuesResearch/EmploymentWorkingFamilies/2011PensionandRetirementEnactedLegislation/tabid/22763/Default.aspx?TabId=22763
National Conference of State Legislatures Presentation on State Retirement Legislation in 2010 and 2011: http://www.ncsl.org/LinkClick.aspx?fileticket=WCg6SYg6vZ4%3d&tabid=13399
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