Small tweaks in pensions can save state money

Even small changes in the pension system can produce big savings to taxpayers over the long run, experts say.

Sticker shock over sharply rising pension costs has the counties, local governments and officials at the state level searching for answers, even as experts say there are no quick fixes.

Like many states, New York is looking to wring savings out of its current system through tinkering, but some suggest following the examples of Alaska or Michigan, where new state and local employees are enrolled into a 401(k)-like program.

Newsday reported last week that tax-weary Long Islanders face a record $1.25-billion pension bill over the next 12 months, a whopping 40 percent increase over the previous year's contribution. A number of experts said these increases could continue for several more years.

Experts point to strategies that are being adopted or considered around the country to reduce costs to taxpayers: switching to a defined contribution plan for new public employees or adding it as an option; raising the retirement age; changing the way pension benefits are calculated; borrowing to pay unfunded liabilities; and freezing or reducing cost-of-living adjustments for public employees.

Defined contribution plan

In defined contribution plans, employees and employers set aside retirement money and the employee decides how to invest it, typically with a choice of managed investment funds. The return on the investment, rather than a fixed payout based on salary in a traditional pension, is what they have to retire on. Moving new state workers into a defined contribution plan, or giving them that option, isn't a new idea -- employees in the State University of New York have had that option for decades.

State officials are "investigating the feasibility of introducing a defined contribution plan" and are looking at SUNYs in that context, said SUNY vice chancellor for Human Resources Curtis Lloyd. Like other public employers, SUNY offers its employees the statewide Employees' Retirement System and Teachers' Retirement System pension programs. But, along with 47 other state university systems across the country, SUNY also provides a defined contribution option that both employees and the employer pay into.

Of the 39,500 SUNY employees eligible for the so-called "Optional Retirement Program," 21,341 have chosen it over the two state programs, Lloyd said. One reason, he noted, is that employees become vested in the program after one year and they can take it with them when they change jobs.

That's what Kent Gardner, president and chief economist at the Center for Government Research, a Rochester-based policy think tank, did when he joined the faculty at SUNY Potsdam in the 1980s, when he was in his 20s.

Then, he said to himself, "I don't know that I'm going to be wanting to work for the state of New York for the rest of my life, and I would like a pension plan that's portable."

A handful of states have added defined contribution plans or hybrid plans for new employees. Hybrid plans combine a 401(k)-type plan with a less generous defined benefit plan so that employees take on some investment risk while taxpayers are on the hook for less if the market tanks.

The defined contribution plan "has been very helpful to the state of Michigan," said Moody's Investors Service analyst Ted Hampton. "The state is certainly in a better position than it would be had it not pursued that strategy."

Alaska began putting new employees on a defined contribution plan in 2005. Excluding teachers, 25.5% of state and local government employees in the retirement system are now in the defined contribution plan.

Georgia in 2009 began using a hybrid plan. One challenge with Georgia's new system has been that many people aren't increasing voluntary contributions beyond the 1 percent rate they're automatically enrolled in, said Pamela Pharris, executive director of Georgia's Employees' Retirement System.

"We have to do some more education to drive their behavior to contribute more to reach their retirement goals," she said.

Later this year, Utah will be offering new employees a choice of a 401(k)-like plan or a hybrid plan.

This month, Gov. Andrew M. Cuomo's mandate relief team proposed adopting a new benefit tier for new employees that would increase employee contributions, raise the minimum retirement age and change the formula by which pension benefits are calculated. Cuomo also wants to exclude overtime as a factor, which in combination with other changes could save a projected $50 billion over 30 years.

"They seem like small changes now but these small changes can actually have some pretty significant results over the long run," said Kil Huh, director of research for the Washington D.C.-based Pew Center on the States.

Raising the retirement age and borrowing

In Minnesota, Huh said, officials in 1998 raised the retirement age by one year, a move that today affects 70% of its workforce and is expected to save $650 million over 20 years.

Some states have turned to borrowing to address liabilities. Selling debt to fund pensions is "tough to get done and politically they [the borrowing] don't sit right," said Jonathan Savage, a Michigan-based bond attorney. "What you're doing is you're burdening future generations for a liability that should have been paid. It's a Band-Aid. It's not a final resolution." 

Changes to existing pensions

Any changes to cost-of-living adjustments have been contentious. New York boosts pension payments based on a formula for retirees annually after they reach a certain age and have been retired for a specified number of years. A few states -- South Dakota, Minnesota and Colorado -- froze or reduced cost-of-living adjustments on current retirees and now face lawsuits.

"Some states like New York appear to be in a good position, which is not to say that keeping them that way isn't burdensome," said Moody's Investor Service analyst Hampton. "It remains to be seen how capable states are at putting effective reforms in place."

With Randi Marshall and Will Van Sant

States take action as pension costs soar

From 2001 through 2010, 39 states reformed their pension systems by either reducing benefits, requiring increased employee contributions, or both. Other actions that states have implemented, or are considering, to address sharply rising pension costs include:

Switching to or offering a defined contribution plan, in which an employee and employer set aside money for retirement but the investment return depends on the financial markets

Selling pension obligation bonds to close unfunded liabilities

Capping or freezing cost of living adjustments

Capping salaries on which public pensions are calculated

Raising the retirement age

Lengthening the time an employee has to work

before eligible to receive benefits

Curbing practices that inflate final salaries and

thus increase benefits

Regulating how and when retirees can return

to the public sector

Increasing or requiring public employees to contribute

part of their salary to the pension plan

Changing the formulas used to calculate pension benefits

Source: Pew Center on the States

Planning ahead: A look at three different types of plans

Defined contribution plans: Employees and often employers put a set amount of money into an account over time, and the funds are invested. The amount of money the employee ultimately collects upon retirement depends on how much is contributed and how well the investments have performed when the money is withdrawn.

Defined benefit plans: The employer guarantees that the employee will receive a certain level of payments upon retirement, based on a formula that takes into account salary and years of service. The employer, or taxpayer, is obligated to pay that amount regardless of how well a pension fund's investments perform.

Hybrid plans: They include aspects of both defined contribution plans and defined benefit plans. A hybrid plan might include a less generous defined benefit plan that is supplemented by a defined contribution plan. Both the employer and employee share some market risk without either being fully liable.