Changes to Pension Plans Since the Financial Crisis

Commentary

Changes to Pension Plans Since the Financial Crisis

Market losses since the financial crisis, unrealistic actuarial assumptions, and an aging workforce are reshaping the way public pension plans approach the funding of increasingly costly retirement benefits. What have state and local governments been doing about it? The answer is a lot of little things but very few substantive “reforms,” according to data collected by the Center for Retirement Research at Boston College (CRR).

Looking at over 200 state and local plans, CRR analyzed reform patterns and where the changes originated, specifically looking at reforms made just between 2009 and 2014. The results suggest that changes to pension plans tended to vary with union influence, and the strength of legislative protections for current employees’ core benefits. Also, the term “reform” is a broadly used phrase that is used in reference to changes that vary considerably in scope and influence on plan solvency.

Focusing only on whether a reform was made, the CRR study finds that since the 2008 financial crisis, 74% of sampled state plans experienced some type of change compared to 57% of sampled local plans. The majority of these reforms modified benefits for new employees; about 25% of reforms reduced benefits for current members.

Arguably, local pension plans are not in much better funding shape than the state plans — Omaha and Lincoln could attest to that, for example. Yet there has been much less activity at the local level than state level. One possible reason behind there being less local-level reforms is that those plans are much more likely to cover police and fire employees. This, in turn, might entail more intricate negotiations with unions that have strong political influence.

At the same time, the study also finds that prospective reductions or amendments to the benefits of existing employees occurred, on a percentage basis, more often in local plans than in state plans. This is arguably a more complex thing to do given the strong legislative protection of already accrued benefits. But we also know that some local plans have more flexibility to effectuate changes than others. A good example would be the troubled Dallas Police and Fire Pension System, which follows its own governing statute that essentially allows it to amend plan features itself, bypassing any official consent of the city council or taxpayers.

CRR’s research further shows that increases to employee contributions were the most common change for current employees, while more than 8% of sampled plans also modified COLAs. Prior research at CRR already revealed that, in many states, COLA provisions are not viewed as “core” benefits. As such, COLA reductions were one of the top reform choices, followed by changes to core benefits such as the multiplier, final average salary period, retirement age, and tenure provisions. For new employees, reductions to core benefits were much more typical. Meanwhile, 9% of state and 5% of local pension plans decided to create separate DC and Hybrid plans for new hires.

CRR also conducted a quantitative analysis consisting of two probit regressions, which allows measuring marginal effects of independent variables on the probability of an event (in this case of pension reform). In particular:

  • The first regression showed that plans with a higher Actuarially Determined Contribution (ADC) as a percentage of total government revenue were more likely to experience plan changes, being indicative of higher budgetary pressure and urgency of the reform.
  • The second regression focused on plans that have already made reforms, finding that among five plan characteristics, only the strong legal protection for pension benefits provided any meaningful results, implying that states are less likely to make changes to current employee benefits the stronger the protection.

To read the full report, go here.

Anil Niraula is a policy analyst at Reason Foundation.