On pension overhaul, beware May surprises

The last weeks of Oklahoma’s legislative session often bring surprises as issues emerge seemingly from nowhere onto legislators’ desks. This year, one May surprise that should have legislators and the public deeply concerned is a a major but poorly-understood overhaul of public pensions.

The funding of Oklahoma’s public pension systems has been a simmering problem for years. As State Treasurer Ken Miller recently noted, “the root cause has been promising benefits and not paying for them.” Oklahoma has seven public pension systems – covering teachers, public employees, firefighters, police, law enforcement, judges, and wildlife – which together cover some 145,000 active and 75,000 retired workers. By the late 2000’s, the total unfunded liability in Oklahoma’s seven public pension systems had reached $16 billion. While some of the systems were in strong financial shape, others, in particular the Teachers Retirement System and Firefighters Pension and Retirement System, had a funded status (ratio of assets-to-liabilities) hovering at barely 50 percent.

In recent years, the legislature has taken important steps to stabilize the pension systems and ensure they could honor their obligations to current and future retirees. Any legislation to alter pension benefits must now include an actuarial analysis of the true cost, and the legislature may no longer increase benefits or grant cost-of-living adjustments (COLAs) without funding them. The retirement age has been raised for new teachers and state employees. These efforts were projected to reduce unfunded liabilities by over $5 billion and have helped improve the funded status of all seven plans. This year, a bill to direct all surplus revenues beyond the Rainy Day Fund maximum to a new pension stabilization fund is moving through the process.

Yet even as strong financial reforms have been put in place, efforts for more radical change are underway. Like in most states, Oklahoma’s public sector employees are covered by defined benefit plans, where retirees are guaranteed benefits based on their years of service and salary.  Defined benefit plans have considerable advantages, including more generous and secure benefits, lower administrative costs, and higher investment returns. They also serve as an effective recruitment and retention tool by helping to offset the lower salaries typical of the public sector and encouraging experienced public workers to remain in their jobs.

But as many private sector companies have sought to reduce costs and reduce links by switching towards other pension models, such as defined contribution 401(k) plans, there has been considerable pressure on state and local governments to follow suit.  National groups like the Pew Charitable Trusts and the Arnold Foundation, as well as Wall Street investment companies, have led the campaigns against defined benefit plans. In Oklahoma, talk of moving new public workers into defined contribution plans has been in the air for years, but the idea has never been pursued seriously, in part due to concerns over how to address the unfunded liabilities of the existing defined benefit pension systems once those systems are closed to new members.  

This session, legislation to give new members of the Public Employees Retirement System the option of selecting a defined contribution plan has been moving through the process.  Under HB 2077, the state would continue to contribute 16.5 percent of a public employee’s salary for pension benefits. For an employee selecting a defined contribution plan, a minimum of 3 percent and a maximum of 6.5 percent of the state’s contribution would go to match the employee’s contribution, with the remainder dedicated to the legacy defined benefit plan.

At the same time, Treasurer Miller has been leading private discussions exploring other options, including a pension model known as cash balance plans, which combine features of defined benefit and defined contribution plans. The Treasurer has indicated his intent to enact legislation this session that would make cash balance plans mandatory for new employees in at least some of the pension systems, but thus far the specifics of his proposal have not been released publicly or shared with stakeholders. Treasurer Miller has warned unions and associations representing public workers that if legislation is not enacted this session to convert to cash balance plans and to consolidate administration of the seven pension systems into a single entity, they should expect the issue to be put to a vote of the people in 2014.

Although supporters of strong public pensions are likely to prefer cash balance to defined contribution plans, no reasonable assessment can be reached without careful study and understanding of the details of any proposal. Critical plan design features include the guaranteed investment provided to retirees and the amount of employer and employee contributions. These decisions will have a decisive impact on employee retirement security, the state’s ability to recruit, retain and reward future employees, and  the impact on the legacy pension systems serving existing public workers. Even if the state funds the new systems at existing levels, it will be extremely difficult for any plan to achieve all the various goals that pension reform supporters are seeking.

Treasurer Miller and others have pointed to the recent adoption of cash balance plans in Kentucky and Louisiana to suggest that Oklahoma should move in the same direction. However, Kentucky acted only after a cash balance proposal was subject to extended public analysis and debate, while Louisiana’s plan was struck down by the courts this January. In Oklahoma, should legislators be presented with a last-minute pension proposal, there will have been no thorough actuarial study conducted, no committee hearings, and no opportunity for legislators and the public to provide input or offer amendments.

Major changes that are unveiled at the last minute without careful vetting by legislators and the public rarely yield good policy.  Any overhaul of the state’s pension system needs to be done right, not quickly.