How public sector employers are reducing their pension liabilities
Public sector employers are struggling with the same problems that private employers are when it comes to pension plans. Rising costs associated with these plans have forced many municipalities, school districts and colleges and universities to get creative with their benefits to not only save money but still attract and retain good employees.
The cost of pensions increased in more than 70% of cities, and one in three cities identified these expenses as the largest expense affecting their budgets, a 2016 survey by the National League of Cities showed.
The survey found that between 2009 and 2016, 33% of public sector employers increased employee contribution rates; 22% changed plan design; 17% reduced benefits; 12% reduced the cost of living adjustment; 8% increased eligibility requirements and 7% increased the vesting period.
Many have adopted hybrid plans, which are a combination of a defined benefit and defined contribution plan. Anti-spiking provisions have also become more prevalent, meaning that plans are increasing the number of years used in the plan’s calculation to figure out an employee’s final compensation, lessening the impact of a single year’s substantial pay raise, according to the National League of Cities. Both of these options lower a plan’s costs.
Anita Yadavalli, program director for city fiscal policy in the National League of Cities Center for City Solutions, says that a recent survey found that the cost of employee/retiree pensions is the third largest cost for most cities following infrastructure and public safety needs and 81% of those surveyed said that pension costs increased in the last year.
She said in a recent blog post that from 2001 to 2015, aggregate public sector pension funding declined from 100% to 73%.
The California Public Employees Retirement System covers 90% of cities in California, but the program is underfunded. A handful of California cities are “trying to work with Section 115 Retirement Trust so they can set aside funds to cushion for a rainy day for funding pensions,” Yadavalli says. “This has been helpful for some cities that are able to have good forethought about what their pension payments will look like.”
A Section 115 Retirement Trust is a way for cities to put money aside right now to help offset additional costs in the future.
“Largely, the things I kept seeing in the State of Cities report was intergovernmental relations and how cities are trying to cope within the confines of the state retirement system,” she says. “Some of the cities are able to provide a solution within that scope, some cities in California are trying to save for the future through a Section 115 Retirement Trust Fund and Binghamton, New York created a savings fund where it can offset increases in health and pension costs.”
Memphis implemented a student loan repayment program to help attract and retain employees after a prior administration made changes to the city’s pension program.
Many cities are working with unions to renegotiate their pension contracts. The city of Hartford, Connecticut, and Hartford Fire Fighters Association signed a contract increasing pension contributions from 8% to 11%, instituting a four-year wage freeze, setting a fixed pensions cap and raising the years of service requirement from 20 to 25 for new hires, according to NLC’s State of the Cities report. In Salem, Massachusetts, the city worked with nine employee unions to ratify new contracts.
Other cities have put the question to their voters. Upper Arlington, Ohio, put an initiative before voters asking for additional funds to help pay for the city’s portion of the Police and Fire Retirement and Disability Fund, according to the NLC.
Many public sector employers are worried about breaking with tradition and taking defined benefit plans away from their employees.
“Quite honestly, with the expense of defined benefit plans and the flexibility of defined contribution plans, the participants or employees would be much better off in the DC plan environment,” says Troy Dryer, vice president of business development at Investment Provider Xchange in Denver.
In the last three years, many public sector defined benefit plans have been frozen to new hires and new employees are offered a defined contribution plan. This is very common in the K-12 and higher education realms, Dryer says.
In Texas, higher education employees have a choice between a DC or DB option. Participation in either plan is mandatory. Both plans are funded by the employer at the same level. The employer puts in 8% and the employee must put in 6.5%.
DC plans also can be more attractive to employees because they can choose when and how they want to withdraw funds from their retirement savings whereas DB plan participants are forced to live with their once a month check from the plan.
Maybe an individual wants to travel while they are younger and healthier, so they want to take more money out of their retirement savings early on and less later when they don’t have the ability to do the more active things they want to do, Dryer says.
“You don’t have that flexibility with a single check coming in from the DB plan,” he says.
Educating employees is a key component of any pension plan changes, Dryer says. Many of them have always worked in the public sector and they don’t know anything about the defined contribution world. It is up to employers to teach them about their different savings options.
He believes public sector employers should take a page out of corporate America’s book and start implementing plan design changes like automatic enrollment, automatic escalation and default investment options like target-date funds to help boost employee retirement savings.
“They need to look to the private sector side to see hey, what issues did they have? Where did they go? The private side is not as paternalistic about helping employees like governmental employers are,” Dryer says.
Today’s pension environment is tough for unions, but when they see that their city is going bankrupt, like Detroit, or their state pension plan is only 40% funded like Rhode Island, most unions are amenable to making changes to their collective bargaining agreements to make sure their members have access to a retirement benefit moving forward, he says.
Dryer points out that there are good and bad DC and DB plans. It all hinges on the governance of the plan and how the plan is designed.