COLA reductions enable legislators to “spread the burden” among all benefits recipients rather than just shift the pension cost-cutting to new employees through other actions, said Jean-Pierre Aubry, associate director, state and local research, at the Center for Retirement Research, Boston College.
“Our sense is that those COLA adjustments were going from overly generous to realigning them with economic sanity,” he said. “Up to this point, this tool has been sensible. COLAs are being aligned with actual inflation.”
However, legislators who reduce COLAs below keeping pace with inflation “are cutting into peoples' standard of living,” Mr. Aubry said. “Governments are more willing to test the (state) laws when it comes to COLAs.”
Analysts point out that many COLA reform laws took effect during the years immediately after the 2008-2009 economic crisis, when plunging investments, high unemployment and shrinking tax revenues squeezed state coffers. However, COLAs often had been put in place in the 1980s, when inflation was higher.
“COLAs are expensive benefits and will continue to be examined by legislatures as they reform pension plans,” said Luke Martel, director of retirement research for the National Conference of State Legislatures. Reducing COLAs, raising retirement ages, requiring higher service requirements and imposing higher contributions by employees are the primary tools legislators are using to enact pension reform, he said.
Between 2009 and mid-2015, a NASRA survey found that 29 states had enacted laws to reduce public pension plans' COLAs. Fifteen states changed the COLAs affecting current retirees; eight states made adjustments to benefits of current employees and new hires; and six states changed the COLA system for new hires. Some were upheld by states courts; others were overturned.
“Cost savings is definitely the primary driver,” said Mr. Brainard, noting that COLAs can have a profound effect on overall pension costs. “As a rule of thumb, a pension plan with an automatic 3% annual COLA will add 25% to the plan's cost.”
COLA reform involves a succotash of strategies, thanks to different COLA formulas among the states, different roles that state constitutions play in governing pensions and various legal challenges challenging COLA reform.
For example, the NASRA study points out that some state pension plans have automatic COLAs, while others have ad hoc COLAs that require a governing body to approve a benefit increase.
Many public plans peg COLA to inflation, measured by the Consumer Price Index, but even then there is variation. Formulas can be designed to reflect a percentage of the CPI or place a cap on the COLA increase regardless of how high the CPI grows.