New Jersey Senate President Rolls Out Important Path to Pension Reform Progress
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Commentary

New Jersey Senate President Rolls Out Important Path to Pension Reform Progress

The reform appears to be a bold and creative way to slow the growth of pension costs while still keeping the retirement promises made to public workers.

New Jersey Senate President Steve Sweeney just released a package of bills that look to improve many of the state’s ongoing fiscal problems. As the centerpiece of these reforms, the proposed bills—coined as the “Path to Progress”—intend to fix New Jersey’s growing pension debt. More detailed analysis of the bills will be necessary, but the reform appears to be a bold and creative way to slow the growth of pension costs while still keeping the retirement promises made to public workers. Still, there will be much more work to do even if it passes.

The 27 bills would make several significant structural changes to the pension and health plans for future New Jersey workers, as well as those with under five years of service by 2020. The reform also includes bills that will restructure school districts and cap the payouts given for unused sick leave. Citing an actuarial analysis, Sweeney has stated that the reforms to the retirement plan alone could save around $25 billion in budget and taxpayer dollars over the next 30 years.

These newly-released reforms are the culmination of over a year of work by the New Jersey Fiscal Policy Working Group, a bipartisan organization of state legislators and experts. The workgroup began convening in early 2018, and eventually produced a report of recommendations. These recommendations were used to develop the Path to Progress plan, which the legislature will now consider in the group of over twenty bills.

This set of reforms come at a time when the need for an urgent fix to New Jersey’s pension plans has long been abundantly clear. The Teachers’ Pension and Annuity Fund (TPAF)—the state’s largest pension—has seen its unfunded liabilities grow to $24.8 billion. The next largest, the Public Employees’ Retirement System (PERS), is facing a $22.9 billion shortfall in pension funding. In its most recent financial report, TPAF indicates that it can only cover 59.3 percent of the retirement benefits promised to its past and current members; PERS reports a similar rate at 59.8 percent. However, using discounting methods established by the Government Accounting Standards Board (GASB), these shortcomings look even more dire for TPAF and PERS (26.5 percent and 40.5 percent respectively). Reports from the other five state systems paint a similar picture.

Among Sweeney’s new group of bills is Senate Bill 3753, which contains several significant changes to how New Jersey handles the retirement of its largest groups of workers. Namely, it creates a new “stacked hybrid” pension plan for teachers and non-uniformed state, county, and municipal employees, establishes an amortization structure that will accelerate the payment of pension debt, and raises the retirement age of new workers to 67. The new plan will apply only to new hires and those who have not yet vested in the old pension plan (e.g., those with under five years of credited service). Current workers with over five years of service in 2020 will see no changes to their benefits.

The stacked hybrid plan allows new hires to continue to have the guaranteed benefits of the current pension plan but limits the amount of pay eligible for this pension benefit calculation. Those enrolled in the new plan will still have the same pension benefits applied to the first $40,000 in income, with a supplementary cash balance plan—like a pension or an annuity, also a guaranteed return plan—applied to any income that exceeds that amount. The cash balance plan is thus “stacked” on top of the pension benefit.

Cash balance plans are often compared to defined contribution (DC) retirement plans, because while their assets are invested and managed in a common pool like a pension, they are set up using notional individual retirement accounts for each employee, with the account balances adjusting based on the returns of the pooled investments.

This increasingly popular retirement structure, however, provides a guaranteed minimum investment return and downside risk protection not seen in the typical DC plan, as the employees’ cash balance accounts are guaranteed a minimum on their annual investment returns. That means that employees’ retirement funds are still shielded from tumultuous market ups and downs, similar to a defined benefit pension plan. Yet, the employee has no investment choice, like they would in a typical DC retirement plan. Instead, the individual’s “returns” are those of the entire pension fund, subject to the minimums and thresholds established by the plan.

The cash balance plan proposed in Sweeney’s bill would set the minimum return at 4 percent, meaning even in years of low or negative returns on investments, the state would still allocate funding into the plan as if they had achieved a 4 percent return. In years that have returns higher than 4 percent, investment returns will be allocated into both the employee’s plan and the general pension fund at a rate of 75 percent and 25 percent respectively, which provides a necessary cushion for years of underperformance in the market. This aspect of the proposal would look very similar to plans used in Kentucky and Kansas.

The primary message from those who oppose the proposed transition to a new hybrid plan is an argument centered on keeping promises made to the public workers of New Jersey. Contrary to this messaging, the proposed reform would have no effect on the retirement benefits of workers who have already vested in their pension plan. Furthermore, the new plan going forward would still provide the same pension benefits, just applied to a more limited amount of pay, and then a guaranteed minimum investment return on the contributions beyond that. Both “stacks” of the hybrid offer guaranteed returns on retirement assets unavailable to most taxpayers in New Jersey today.

In a recent response to the newly submitted reform proposal, the New Jersey Education Association (NJEA)—one of the state’s teachers’ unions—stated that they “support pension funding practices that reduce the state’s long-term liabilities while meeting its obligation to public employees.” Sweeney’s proposal fulfills both of these requirements set by the NJEA, despite their stated opposition. As new hires enter the hybrid plan, the state would see a slowing in the accrual of pension liabilities. And all of this would be accomplished without altering or impeding on the benefits promised to workers already vested in the current pension system.

In short, the Path to Progress proposal would establish a post-employment plan with a lower guarantee relative to the previous plan (though also some real upside potential). This change would not only reduce future growth in pension liabilities but it would also greatly reduce the level of financial risk borne by the state and taxpayers. The factors that created New Jersey’s current pension crisis would have less of an effect in the future under the proposed policies.

But more importantly, the proposal creates a new retirement plan that applies less risk to the state and local employers while still providing attractive benefits to new public workers. Future teachers and those who will work for state and local governments would still have a valuable retirement plan that is guaranteed. Also critical to the success of the reform, the changes do not alter and reduce the benefits that were already promised to vested state workers.

The bipartisan Path to Progress proposal represents a significant and necessary change to New Jersey’s pension policy, and Senate President Sweeney deserves a great deal of credit for effectively listening to stakeholders and communicating the urgent need for change. If successful, the reform will help to slow the growth of pension liabilities in the future, which would go a long way in preventing more unfunded liabilities going forward.

That said, this significant reform ought not to be seen as an all-encompassing solution to the state’s pension woes. New Jersey policymakers must take note that the group of reforms under consideration still fall short of addressing many of the problems that created the huge gap in pension funding in the first place (i.e. insufficient contributions and overly-optimistic actuarial assumptions). This set of reforms should be viewed as an important first step, one which will hopefully lead to more reforms in the future that fix the various problems that still exist with the legacy plan.

Zachary Christensen is a policy analyst for Reason Foundation's Pension Integrity Project.