More states are enacting measures to help improve the solvency of their public pension funds as funding ratios remain low.
While pension reform is not a new phenomenon — 43 states enacted retirement plan changes between 2009 and 2011, according to the National Conference of State Legislatures — states are taking different paths, including efforts to move to cash balance plans, alter cost-of-living adjustments or shore up funds through alternative revenue sources.
“There's been a lot (of pension reform) on the table and every state has approached this differently,” said Chris Mier, managing director at Chicago-based Loop Capital Markets LLC, an investment services firm that tracks public pension funding every year. “I think 30 states are in roughly good shape, but there are probably five that need to get going. I don't view this as a systemic problem; I view this as a state problem.”
Among the entities making changes this year are Kentucky, Puerto Rico, Florida, Kansas and Maryland.
Kentucky, which has about $18 billion in unfunded public pension liabilities, passed legislation on March 26 that will develop a cash balance plan for state and local employees hired on or after Jan. 1, 2014. Under the new plan, employees also will be able to purchase an annuity or receive a lump-sum payment on retirement.
“The most significant reason for passing the legislation was to address the underfunding problem in at least two of the plans we administer,” said William Thielen, executive director of the Kentucky Retirement Systems, Frankfort, which oversees the state's five pension plans with $10.9 billion in assets. “For 14 out of the last 21 years, (the Kentucky General Assembly) has not put in the actuarially required contributions.”
The two most underfunded of the state's plans are the Kentucky Employees Retirement System (non-hazardous plan), which was 27.3% funded as of June 30, 2012, with $11 billion in liabilities and $3 billion in assets; while the Kentucky State Police Retirement System was 40.1% funded as of the same date, with $648 million in liabilities and $260 million in assets.
The law will generate the $100 million a year needed to fully cover actuarially required contributions through changes in the tax code and reducing the personal tax credit by $10.
Another provision of the law requires a cost-of-living adjustment to be fully prefunded by the General Assembly in the year it is provided, which “essentially eliminates” them, according to Mr. Thielen.
“It's not something that was desired from the standpoint of retirees, but I think everyone realized the necessity,” he said.
According to Loop Capital's annual Public Pension Funding Review, the changes to defined benefit plans that are met with the highest level of opposition from employees and retirees are eliminating the COLA and moving to a cash balance plan, followed by increasing the retirement age, increasing contribution rates, and reducing disability and death benefits. But Mr. Mier said the most controversial changes can sometimes be the most effective, too.
“The trade-off you face is, "Do I want to solve the problem in the shorter term or the longer term?'” Mr. Mier said. “Migrating to a DC plan doesn't give you an upfront benefit, but it gradually happens.”
Puerto Rico opted to overhaul its cash-strapped public pension fund by keeping the defined benefit plan but making significant changes to funding requirements and retirement age.
The law, effective July 1, 2013, will increase employee contributions to 10% from 8.275% of pay, increase the retirement age for some workers, and lower future monthly pensions and benefits.