Best Practices in Pension Reform: Lessons Learned from Successful Reformers

This report assesses the lessons learned from various efforts to reform public employee pensions in jurisdictions across the United States. It draws on the experience of policymakers, officials and campaigners in Michigan, Alaska, Utah, Rhode Island, San Diego and San Jose to outline a series of best practices that will equip a willing and motivated pension reformer with the tools he or she needs to bring about substantive change. Click here to download (PDF).

Executive Summary

Ideally, state and local governments set aside a realistic amount of money every year to prefund their employees’ pensions using a range of assumptions about their labor costs and terms of service. But if these assumptions are off, even by a little, governments both small and large can find themselves mired in unfunded liabilities and debt obligations that consume an increasing amount of the annual budget. Many local and state governments are overwhelmed by unfunded liabilities right now, and looking for a way to bring pensions back into balance through reform. This document comprises the best practices and lessons learned in pension reform and is largely an excerpt from our Pension Reform Handbook: A Starter Guide for Reformers, published in July 2014. It also captures the experience of several jurisdictions that have successfully navigated reform, as spotlighted in our series of case studies, which can be found at Reason.org.

As illustrated by the experience of all of our reformers, the case for pension reform in most jurisdictions is grounded in applying a realistic assessment of the state’s unfunded liabilities and reversing a culture of underfunding the pension system. Simply blaming a jurisdiction’s public employee pension problem on a downturn in the stock market or a period of economic recession prevents an honest assessment of its long-term causes, which may be numerous and go far beyond the typical fluctuations of a dynamic economy. To lay the groundwork for reform, it is important to first identify a pension problem and then research it in a detailed, specific and deliberate way, realistically assessing liabilities and actuarial assumptions in a jurisdiction’s pension system. Actuarial assumptions should align with real performance. Would-be reformers should also examine the financial volatility of “other post-employment benefits” (OPEB), which often contributes to the problem. Most jurisdictions do not address OPEB unfunded liabilities, and, as a result, shortfalls in retiree health care funding likely outweigh those of the pension systems.

There are several pathways toward reform that may be worth considering before full-scale, comprehensive reform efforts are launched. An initial step is to professionalize the governance of the pension system. This will address conflict of-interest issues, provide transparency and improve oversight over benefit and investment decisions. A pension board should consist of professional finance and investment experts, and most members should be independent of the pension system.

One way to bring down the costs of pensions-without relying entirely on a political/legislative process-is to secure preliminary concessions in union labor contracts through the collective bargaining process. It is also important to understand that pension reform is more than just defined benefit reform. There are several options, including total defined contribution conversions, hybrid reforms or other plans-it all depends on the culture of the jurisdiction and appetite for reform.

If pension system stakeholders are hesitant or resistant to reform, even when the problem is clearly demonstrated, reformers should seek outside and independent legal counsel. Attorneys who have a personal interest in an existing pension system-no matter how defunct it may be-are less likely to form an objective opinion that would support reform efforts.

In order for any effort to be successful, there must be local and broad support. Forming coalitions to support and push for reform is essential. This may (and should) include elected officials, but it could well be led by concerned and engaged citizens. Coalitions can reduce the complexity of the legislative debate and create buy-in from various stakeholders in the jurisdiction.

It is likely that reform coalition partners have spent years creating reports and studies that could be very useful in building the case for reform, supplying evidence-based arguments backed up by statistics from reputable sources regarding the actual costs of pensions. Any competent pension system should be regularly reporting on its fund’s assets and liabilities. If that is not being done, reformers should agitate for more transparency and oversight with the legislative sponsor or pension board. It may require an independent entity to conduct audits or perform actuarial analysis by requesting annual financial reports through open records requests. Other applicable information can be found in public documents, reports, audits and actuarial reviews.

While the case for reform may be obvious to those advocating it, a well-organized coalition is essential to educate the public and help them understand the changes that need to be made. A coalition should present a straightforward case to the general public, emphasizing the fiscal impact on the budget and government services if the pension system is not reformed. This can be done by holding informational town halls to answer questions from the public. Active engagement with the community can sway even the most ardent union-dominated jurisdictions like Rhode Island or San Jose. A competent coalition will be prepared and vigilant in combating the common, but false, arguments opponents will make about the system’s health and fiscal impacts if reformed.

If lawmakers are not willing to make the requisite changes, reform may-in some jurisdictions-be taken directly to the voters through a ballot initiative. In this case, reform advocates should utilize competent political consultants, use polling to test ideas and arguments, and ensure that ballot language is vetted by knowledgeable attorneys. They should use the reform coalition strategically to line up funding and to counter labor union opposition tactics.

While it may be desirable to implement one broad and comprehensive reform measure, it is not reasonable to assume that such changes will be politically feasible until there is a felt need for change among both a majority of citizens and at least some elected officials. Attempting to pursue that one comprehensive set of reforms may be overly complex and, ultimately, counterproductive. It may require numerous narrow pension reform measures over the course of years to lay the groundwork for substantive reform. It takes some time to educate the public on the issues, thereby enabling reform proponents to overcome opponents’ negative messages and misrepresentations of the effects of the reforms.

Even if reform does happen, the work is not over. Implementation requires constant vigilance to maintain and sustain the reforms so that the retirement system is affordable, sustainable and secure for the employee and taxpayers. Defined benefit plans must continue to be fully funded as they close, based upon an amortization schedule that makes fiscal and budgetary sense.

Attachments

• Best Practices in Pension Reform: Lessons Learned from Successful Reformers