Public pension systems need to reduce debt and modernize design for today’s workforce

A recent RAND Corporation research brief discusses the complexity of the state and local government pension crisis and proposes a process for stakeholders to work within when addressing it. This summary of public pension funding challenges is a useful framework for understanding the causes of pension debt and some potential solutions to the large and growing problem for state and local governments.

However, the RAND brief comes up short in identifying common limitations in public retirement plan design. When addressing the ongoing funding challenges posed by public pension plans, policymakers must also seek modernized approaches to retirement policies that address the larger retirement crisis.

The RAND paper breaks the integral contributors of the crisis down into specific categories, with “assumptions,” “institutional setting,” and “poor governance” topping the list. The paper also identifies specific steps in a process to address the problem. In its list of solutions, RAND prescribes better defining the issues, understanding the causes of public pension underfunding, and implementing pension reforms to address the pressing underfunding of the pension systems.

There is nothing in the study to disagree with. It is clear and logical in its approach to addressing the issue. Importantly, it provides a useful framework for tackling public pension underfunding and debt, which is a complex and crippling economic issue for many states and municipalities. However, the blind spot of the RAND study is the lack of a broader discussion on the type of retirement benefits that should be offered and how they can best serve public employees.

Oliver Wendell Holmes Sr. once said, “For the simplicity on this side of complexity, I wouldn’t give you a fig. But for the simplicity on the other side of complexity, for that I would give you anything I have.”

The RAND paper sees the state and local government pension crisis as a funding crisis. They are not wrong, but a deeper study reveals that public retirement plans need more than additional funding. To find the simplicity on the other side of complexity, it is necessary to define the crisis by what else it is—a retirement crisis. The traditional pension system still used by most state and local governments no longer meets the needs of most workers or employers.   

Yes, many traditional pension plans are dangerously underfunded, and states and cities have declined to implement proper solutions for various politically expedient or fiscal reasons. The bottom line is that even if the funding crisis were to be solved, the retirement crisis—and all its inherent issues for employers and employees alike—would still exist. Instead of focusing purely on funding, policymakers need to adopt a two-step process that addresses the retirement crisis and a plan to address underfunding.

1. Cap the well: Limit the accrual of any future unfunded liabilities by putting new public employees (and possibly non-vested current employees) into a retirement plan that better meets their needs, addresses the more significant retirement crisis, and cannot accrue unfunded obligations.
2. Accept your pension obligations to current employees and retirees and make all necessary funds available to meet your promises. You must pay these pension benefits, accept these costs, and build them into budgets and long-term financial plans.

Policymakers have come to terms with limiting and addressing the extant funding problems (no small task), but they must also address the retirement crisis. Employees, plan sponsors, pension boards, legislators and other policymakers, labor unions, and citizen groups need to recognize that the legacy pension plans still in use in so many jurisdictions today simply no longer meet the needs of primary stakeholders. The basic premise of these plans is that as new workers enter the workforce, they will be drawn to state and local government employment, in part, by a pension plan, and that they will remain with that employer for an entire career. But this has not been the case for at least a generation and continues to be less true as time goes on. Most employees in the modern workforce will have multiple employers throughout their careers. Government employers must recognize this fact in their retirement plan designs if they hope to recruit and retain quality employees from the broader pool of talent.

Only when these parties acknowledge the reality of existing unfunded public pension obligations and take steps to stop the bleeding while understanding the truth about the modern workforce can they design and implement a retirement plan that meets both employer and employee needs without putting further strain on taxpayers and the government’s financial position.

Fortunately for state and local government retirement plan stakeholders, there are a variety of retirement plan designs and working examples that provide the improved flexibility in retirement benefits that the modern workforce needs. Defined contribution (DC) plans do not have to operate like supplemental 401(k) supplemental tax-sheltered savings plans. DC plans can, and do, operate as true risk-managed, income-focused retirement plans in many instances in both the public and private sectors. They do this through the use of annuities and other tools. More retirement-focused DC-based designs are emerging to better meet the needs of the modern workforce and their employers.

The Pension Integrity Project at Reason Foundation has iterated on this approach with the Personal Retirement Optimization Plan, or PRO Plan, which focuses explicitly on customizability and adequate lifetime benefits.          

The RAND study defines the public pension crisis as a funding crisis, which is correct but incomplete. While there is unquestionably a debt and funding crisis in public pensions, policymakers must also recognize that traditional pensions are becoming less compatible with the needs of modern workers and government employers. That is the simplicity on the other side of complexity: modern employment in the public sector requires flexible, employee-specific benefits in a risk-managed framework.