Pension Solution Blooms in the Desert

New accounting standards are forcing California policymakers to confront the major financial risks inherent in public pension systems. At the same time, a recent overhaul of Arizona’s statewide pension system for public safety workers shows how governments and unions focused on reducing such risk can produce a bipartisan consensus on reform.

The routine releases of annual government financial statements are making big headlines this year because new accounting standards require unfunded pension liabilities to be reported on governmental balance sheets alongside traditional debt, not hidden as they’ve been historically. This simple reporting change added $60.5 billion in pension debt to California’s balance sheet. Orange County’s liabilities jumped 275 percent, or $3.8 billion, over the prior year after factoring in previously obscured pension debt.

The hope is that increased transparency will raise awareness of pension-related risks to taxpayers and inspire efforts to reform debt-ridden, financially unsustainable pension systems. Arizona’s recent experience may offer reason for optimism.

Since 2002, Arizona’s public-safety pension system dropped from 100 percent funded to 48 percent funded, accruing $6.6 billion in unfunded liabilities along the way. Overly optimistic investment return assumptions and a flawed mechanism for adjusting post-retiree benefits were the biggest culprits in this decline, which caused state and local police and fire pension contributions to skyrocket, crowding out other public services.

A coalition of statewide public employee unions concerned about rising costs and future system solvency actually came to the table proactively and proposed reforms. Conservative legislators convened a diverse stakeholder working group including unions, government associations and Reason Foundation to analyze the fiscal problems and propose a package of reforms guided by the primary goal of reducing financial risks to taxpayers.

After a year of analysis and negotiation, the group unveiled comprehensive, bipartisan pension reform legislation that passed overwhelmingly in the legislature and was signed into law by Republican Gov. Doug Ducey in February.

The legislation affects current public safety workers and retirees by placing a constitutional amendment on the statewide ballot in May that, if approved by voters, would change the way benefit increases are calculated for retirees, implementing a sustainable cost-of-living adjustment tied to inflation that is capped at 2 percent per year.

Further, starting next year, all newly-hired workers will have the option of taking a modified defined benefit pension plan or a 401(k)-style defined contribution plan, allowing them to make the choice that best suits their individual needs. In either case, governments and employees will now share all retirement costs equally. Employee contributions to pensions are currently capped in Arizona, meaning taxpayers bear the full and growing cost of unfunded liabilities.

The new legislation will also increase the retirement benefit eligibility age from 55 to 57.5 and curtail pension spiking for new hires by reducing the current cap on pensionable pay from $265,000 to $110,000.

The whole package of reforms will benefit taxpayers by lowering the retirement costs for every new employee hired, saving taxpayers an estimated $1.5 billion over the next three decades. It will also reduce the future accrual of pension liabilities by over a third and decrease governments’-and thus taxpayers’-exposure to future market risk by more than 50 percent.

Meanwhile, current public safety personnel and retirees will benefit from putting the beleaguered system on the path to solvency. Future employees will have a choice in retirement plans and will pay lower annual retirement contributions than those paid today.

In order for California to truly address its ever-present-and growing-public pension crises at the state and local levels, true collaboration is needed. The Arizona experience showing unions can be part of the solution, and it should be a template to bring California’s legislators, employees, taxpayers and other stakeholders together to begin a dialog that focuses on reducing the risks of pension systems and creating plans to eliminate unfunded liabilities. Even the most unlikely allies can come together to agree on win-win reforms for taxpayers and public employees.

Leonard Gilroy is director of government reform at Reason Foundation. Pete Constant is director of Reason Foundation’s Pension Integrity Project and is a former San Jose councilman and police officer. This article was originally published in the Orange County Register on March 27, 2016.