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Reforming State and Local Pension Plans
Richard W. Johnson

Retirement plan objectives
• Future benefits should be fully financed
• The plan should provide retirement security to all employees
• Benefit structure should help employers attract and retain qualified workers
• All employees should be treated fairly

Key questions for reform
• How can competing goals be reconciled?
• Improve financing and control costs
• Maintain adequate benefits
• Attract and retain qualified workers
• How should reform costs be distributed?
• Taxpayers
• Current retirees and employees
• New/future employees
• Who should pay for unfunded legacy costs?

California State Teachers’ Retirement System
Plan Feature
Coverage
CalSTRS 2% at 62 tier hired on or after
1/1/2013
5 years
CalSTRS 2% at 60 tier hired before 1/1/2013
Vesting 5 years
Years included in final average salary high 3 consecutive years high 3 consecutive years
Multiplier varies with age of first receipt
(1 year with 25 YOS) age 50 age 55 age 60 age 65
NA
1.16%
1.86%
2.4%
1.1% (with 25 YOS)
1.4%
2%
2.4%
COLA 2% per year 2% per year
Employee contribution 8% now; 9.205% by 2017 8%
Refund on contributions 4.5% 4.5%

Pension benefits increase sharply with years of service
Annual pension benefits at age 75, age-25 hires
$90,200
$28,000
$11,900
$3,500
10 20
Years of Service
30 40
Notes: Estimates are for the CALSTRS 2% at 62 plan for California teachers. Monetary amounts are in constant 2014 dollars.

Long-serving teachers can accumulate $1.3 million in lifetime benefits, mostly financed themselves
Value of teacher contributions and future benefits, age-25 hires
$1,400,000
$1,200,000
Lifetime pension benefits
$1,000,000
$800,000
$600,000
Value of teacher contributions
$400,000
$200,000
$0
0 5 10 15 20 25 30 35 40 45 50
Years of service
Notes: Estimates are for the CALSTRS
2% at 62 plan.

Relatively few teachers get anything out of the pension plan
Share of teachers whose lifetime benefits are worth more than their required contributions
53%
47%
35%
All At least 5
Years of service
At least 10
Notes: Estimates are for the CALSTRS 2% at 62 plan for California teachers.

16%
Employer contributions vary widely depending on when teachers are hired and how long they work
Career-average annual employer cost as share of salary
11%
6%
Hired at age 55
Hired at age 45
Hired at age 35
Hired at age 25
1%
-4%
0 5 10 15 20 25 30
Years of service
35 40 45 50
Notes: Estimates are for the
CALSTRS 2% at 62 plan

California teachers received higher annual benefits before the 2012 pension cuts
Value of lifetime benefits net of teacher contributions, age-25 hires
$800,000
$700,000
$600,000
CalSTRS 2% at 60
$500,000
$400,000
$300,000
$200,000
$100,000
$0
-$100,000
0 5 10 15 20 25 30
Years of service
35
CalSTRS 2% at 62
40 45 50
Notes: Monetary amounts are in constant 2014 dollars.

Before the changes, nearly half of teachers benefited from the retirement plan
Share of teachers whose lifetime benefits are worth more than their required contributions
CalSTRS 2% at 60 CalSTRS 2% at 62
72%
63%
53%
47% 47%
35%
All At least 5
Years of service
At least 10

Common reform options
• Change rules governing traditional pensions
• Increase employee contributions
• Reduce/suspend COLAs
• Trim multiplier, bump up retirement age
• Less commonly, adjust FAS for early separators, award longevity bonus to late retirees
• Move to hybrid or cash balance plan
• SAFE Retirement Plan

5%
Alternative benefit formulas and plan designs can distribute pensions more equitably
Career-average annual employer cost as share of salary
FAS, age-55 hire
4%
Cash balance, all ages
FAS, age-45 hire
FAS, age-35 hire
3%
2%
FAS, age-25 hire
1%
0%
0 5 10 15 20 25 30
Years of service
35 40 45 50

But for FAS plan, benefit formula is very complex
• Final average salary is based on top 3 earning years, but increases 7.5% each year separated employees wait to collect benefits
• Multiplier increases with years of service
• Annual benefits increase 4% each year that participants delay retirement past age 62
• COLA = percent change in CPI

To see all of our public pension research, visit www.urban.org/retirement_policy/pensionsproject.cfm

Social Security and State & Local
Government Workers:
How does the Pension Crisis Affect the Debate about Mandatory Coverage?
William Gale
Brookings Institution
Retirement Security Project
December 9, 2014
Very preliminary. Please do not circulate or cite.
This presentation reports on collaborative work with Sarah Holmes, Brookings, and David John, AARP.
We gratefully acknowledge financial support from the Laura and John Arnold Foundation via a grant to the
Retirement Security Project at Brookings.

•
1/4 of SLGWs are not covered by SS in their current job.
–
Some of those are covered under spousal provisions.
–
Some of those are covered under previous jobs.
•
Should SLGWs be brought into SS via mandatory coverage?
–
Focus on newly-hired SLGWs
•
Traditional arguments (focusing on SS) suggest that mandatory coverage would be a good idea
•
How does the pension crisis affecting states and localities influence this issue?
19

•
SLGWs were not included in original SS coverage in the 1930s because of constitutional concerns about whether the federal government could tax the states.
•
In 1950, states given the option of covering workers in SS.
•
Various extensions of coverage for SLGWs in the 1950s.
•
SS reforms in 1983 prohibited state and local governments from leaving SS once in
(and covered all new federal employees). Resulted from Texas counties leaving SS.
•
In 1986, all newly hired SLGWs covered by Medicare.
•
In 1990, SS coverage was mandated for all SLGWs not covered by a retirement program.
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•
Improves Social Security finances over the next few decades (closes 5 percent of
75-year gap) due to younger new hires joining system. Improvement largely disappears as they age and begin to receive benefits.
•
Improves inter-generational equity by having SLGWs contribute to paying SS legacy costs
•
Improves intra-generational equity by having SLGWs contribute to cost of income
•
Improves retirement benefits
– Security (by diversifying sources)
–
Level (probably, depending on SL response)
–
Quality (automatic full inflation indexing, dependent, survivor, spousal and disability) redistribution
–
In both cases, SLGWs are “free riders” currently
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•
Virtually all major commissions and a wide variety of major reform proposals over the last 20 years support mandatory coverage, despite massive differences in the overall proposed structure of SS.
–
SS Advisory Board (1997, all three groups)
–
National Commission on Retirement Policy (1999)
–
Domenici-Rivlin (2010)
–
Bowles-Simpson (2010)
–
Aaron-Reischauer (1998)
–
Shoven-Schieber (1999)
–
Diamond-Orszag (2004)
•
Exception was the Bush (2001) Commission
–
Co-Chair Moynihan indicated enormous political pressure on this issue.
22

•
SL pension problems highlight issues of retirement income security and quality and the risks that SLGWs face, suggesting mandatory coverage would be helpful.
•
But mandatory coverage would raise state costs without doing anything directly to deal with existing underfunding.
23

•
As noted, about one quarter of SLGWs are not covered by SS.
–
Some of those have coverage through spousal benefits.
–
Some of those have coverage through prior jobs.
–
Uncovered workers with benefits from spouses or prior job may be hit with reductions due to Government Pension Offset and Windfall
Elimination Provision.
•
Highest rates of non-coverage are in OH (97%), MA (96%), NE
(82%), LA (72%), CO (71%), CA (56%), TX (52%) and IL (45%).
•
Those eight states account for more than 70 percent of all uncovered SLGWs.
24

•
State pension benefit levels and SS coverage of SLGWs.
•
Munnell (2005) finds that states with lower SS coverage for SLGWs have higher benefit accrual rates in their pensions.
•
Our preliminary analysis using more recent data generates similar results. States that have lower SS coverage for SLGWs tend to pay higher pension benefits.
•
May be due to need to cover entire retirement benefit amount and offset loss of guaranteed Social Security coverage.
•
NOT a causal relationship, just a correlation.
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•
Pension underfunding and SS coverage of SLGWs.
•
Preliminary data work suggests that states that have lower coverage rates for SLGWs tend to have larger pension underfunding problems.
•
May be due to need to cover full costs of retirement benefits, but may also be due to local economic conditions & political decisions.
•
Again, we emphasize that we are not arguing that this is a causal relationship, just a correlation.
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• Depends on how state and local pensions react
• Munnell et. al (2014) find that if SL pensions react to preserve first-year retirement benefits, costs of new hires would rise by 6 percent of payroll. In addition, new hires would have to pay their share of the payroll tax.
•
This would be about 0.15 percent of state budgets over the next five years, rising to 0.9 percent in the long run
• The initial effect is small because
–
Labor cost is only part of state budgets,
–
New hires are a small part of labor costs, and
– Payroll taxes are a small part of the costs of new hires.
–
As new hires become a greater proportion of workforce, total cost would climb.
•
Preserving first year benefits would lead to greater lifetime benefits under the SS- and-pensions combination than under current pensions, because SS offers higher quality benefits as noted above.
• Note that costs would go up even if lifetime benefits are unchanged because some of the costs would be going to pay of the legacy burdens of SS.
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•
Ignore this slide. I am not a lawyer.
•
Issue is whether the federal government can impose taxes on the states.
–
In 1983, federal law prohibited states from leaving SS.
–
All SLGWs hired after 1/1/86 are required to be enrolled in Medicare.
–
In 1990, federal law required states to enroll workers without a pension into
SS.
–
All of those actions appear to impose federal mandates and taxes on state governments.
•
SS Advisory Council, GAO, Aaron-Reischauer believe there is not a problem. Most other SS studies do not address the issue.
•
Do not ever take legal advice from an economist. (And never take economic advice from a lawyer.)
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•
Virtually every SL government and every
SLGW group that has reported an opinion opposed mandatory coverage of SLGWs
–
Costs are the most common explanation
–
Fear of benefit reductions or complete system overhaul
–
What is the role of free-riding?
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•
Proponents emphasize the benefits of mandatory coverage.
•
Opponents emphasize the costs.
•
Both sets of arguments can be, and probably are, true simultaneously
•
Policy makers will have to balance these competing concerns
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Jean-Pierre Aubry
Assistant Director of State and Local Research
Center for Retirement Research at Boston College
LIVE WEBINAR:
State and Local Pension Reform:
Can We Cut Costs and Improve Retirement Security?
December 9, 2014

Two financial crises in a decade caused a drop in pension funding and an increase in costs.
60%
40%
20%
0%
120%
State and Local Funded Ratios, 1994-2013
100%
103%
94%
85%
80%
20%
ARC as a Percent of Payroll, FY 2001-2013
17.6%
17.1%
15%
12.5%
10%
6.7%
5%
0%
Sources : Public Plans Database. 2001-2011. Center for Retirement Research at Boston College and Center for State and Local
Government Excellence; and Paul Zorn. 1994-2000. Survey of State and Local Government Retirement Systems: Survey Report for
Members of the Public Pension Coordinating Council . Chicago, IL: Government Finance Officers Association.
33

Still, on average, pension costs as a percent of budgets remain around 5 percent.
Pension Costs as a Percentage of State and Local Own-Source Revenue, FY 2001-2011
6%
4.9%
4%
2.9%
2%
0%
Sources : U.S. Census Bureau. 2001-2011. Employee-Retirement Systems of State and Local Governments ; and U.S. Census Bureau.
2001-2011. State and Local Government Finances .
34

In the long term, the pension burden on states and localities will depend on:
1) Contributions;
2) returns on plan assets; and
3) the generosity of the benefit package.
35

On the contributions side, states and localities have started to increase the percent of ARC paid.
Percent of Annual Required Contribution Paid, FY 2001-2013
120%
100%
98%
93%
81%
83%
80%
60%
40%
20%
0%
Source : Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli. 2014. “The Funding of State and Local Pensions: 2013-2017.” State and Local Plans Issue in Brief 39. Center for Retirement Research at Boston College.
36

And plan sponsors are gradually reducing the assumed return used to calculate liabilities.
Average Discount Rates for Public Plans, FY 2001-2013
8.5%
8.0%
8.1%
7.9%
7.7%
7.5%
7.0%
6.5%
6.0%
5.5%
Sources : Various actuarial valuations; and PPD. 2001-2013. Center for Retirement Research at Boston College and Center for State and
Local Government Excellence.
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On the benefit side, sponsors have cut back on excessive COLAs.
States Eliminating, Suspending, or Reducing COLAs for Current Workers and/or Retirees
Eliminated COLA or lowered CPI cap
Reduced COLA guarantee
Source : Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli. 2014. “COLA Cuts in State/Local Pensions.” State and Local Plans
Issue in Brief 38. Center for Retirement Research at Boston College.
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And recent changes in plan design have emphasized risk-sharing through hybrids or cash balance, not DC.
Introduction of State Defined Contribution Plans, by Year, 1947-2013
Source : Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli. 2014. “Defined Contribution Plans in the Public Sector: An Update.”
State and Local Plans Issue in Brief 37. Center for Retirement Research at Boston College.
39

To get a better sense of the impact of recent reforms, the CRR analyzed the long-term costs for 32 plans in 15 states.
Sample States and Number of State-Administered Plans
Source : Author’s illustration.
40

First, the CRR did a detailed analysis at the plan level.
Pension Costs as Percent of Payroll for
Ohio Public Employees Retirement System: 2011-2046
25%
20% 9%
15%
10%
2%
5% 5%
6%
3%
4%
2%
10%
Increased age/tenure; cut
COLA; increased avg. salary; reduced service-related benefit factor.
5% 10% 10% 10%
0%
Pre-crisis:
2007
Post-crisis:
2011
Post-reform partial impact: 2028
Post-reform full impact: 2046
Employee contribution Employer normal cost UAAL payment
Sources : Author’s projections based on plan actuarial valuations and Public Plans Database. 2009-2012. Center for Retirement Research at Boston College and Center for State and Local Government Excellence.
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29 of the 32 plans responded to the crisis by reducing their benefit package.
Sample Plans Making Pension Changes, by Type of Change
30
24
New employees
All employees
20
18
15
14
9
10
3
0
Age/tenure requirements
Average salary period
Benefit factor COLA Contribution rate
No changes
Sources : Actuarial valuation reports; National Conference of State Legislatures. 2008-2012. “Pensions and Retirement Plan
Enactments.” Washington, DC; and National Conference of State Legislatures. 2011. “State Pensions and Retirement Legislation: 2011.”
Washington, DC.
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And, generally, plans have taken actions that are calibrated to their circumstances.
10%
8%
Employer Normal Costs as a Percentage of Payroll, Pre-Crisis and Post-Reform
By Plan Funded Status
7.8%
Pre-crisis
Post-reform
8.5%
10%
8%
9.2%
By Plan Generosity
Pre-crisis
Post-reform
7.6%
5.6% 6%
4%
6%
4.3%
4.5%
3.3%
4%
2% 2%
0% 0%
Poorly funded Well-funded Generous benefits Low to average benefits
Source : Alicia H. Munnell, Jean-Pierre Aubry, Anek Belbase, and Joshua Hurwitz. 2013.“State and Local Pension Costs: Pre-Crisis, Post-
Crisis, and Post-Reform. State and Local Plans Issue in Brief 30. Center for Retirement Research at Boston College.
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Often for poorly funded plans, benefit cuts more than offset increased costs.
Extent of Reforms Compared to Impact of Crisis Based on ARC as Percent of Payroll, by Plan Funded Status
10
8
7
Poorly funded
Well-funded
8
6
6
4 4
4
2
2
0
Offset Not enough to offset
More than enough to offset
Source : Alicia H. Munnell, Jean-Pierre Aubry, Anek Belbase, and Joshua Hurwitz. 2013 .“State and Local Pension Costs: Pre-Crisis,
Post-Crisis, and Post-Reform.” State and Local Plans Issues in Brief 30. Chestnut Hill, MA: Center for Retirement Research at Boston
College.
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Then, the CRR projected costs at the state level.
Ohio Employer Pension Costs as
Percent of Budget: Pre-Crisis, Post-Crisis, and Post-Reform
10%
8%
6%
4%
2%
0%
2006
Pre-crisis (pensions)
Post-crisis (pensions)
Post-reform (pensions)
2016 2026 2036 2046
Note: Budget = general own source revenues of all Ohio state/local governments. Retiree health costs assumed pay-as-you-go.
Sources : Author’s projections based on plan actuarial valuations and Public Plans Database. 2009-2012. Center for Retirement Research at Boston College and Center for State and Local Government Excellence.
45

On the whole, cuts should reduce pressure on sponsor budgets to below pre-crisis levels.
Pension Costs as a Percentage of State and Local Own-Source Revenues,
Sample Average, Pre-Crisis through Post-Reform
8%
6.5%
6%
5.3%
4.1%
4%
3.3%
2%
0%
Pre-crisis:
2007
Post-crisis:
2011
Post-reform Post-reform partial impact: 2028 full impact: 2046
Source : Alicia H. Munnell, Jean-Pierre Aubry, Anek Belbase, and Joshua Hurwitz. 2013 .“State and Local Pension Costs: Pre-Crisis,
Post-Crisis, and Post-Reform.” State and Local Plans Issues in Brief 30. Chestnut Hill, MA: Center for Retirement Research at Boston
College.
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Cutting benefits is not costless, because they are a key part of total compensation.
Total Compensation of State and Local and Private Sector Workers, as a Percentage of Private Sector Wages, 2010
160%
148.1%
147.0% 142.3%
138.2%
120%
100.0%
90.5%
80%
40%
0%
Private sector State and local sector
Wages ECEC benefits
Pension adjustment Retiree health
Source : Alicia H. Munnell, Jean-Pierre Aubry, Joshua Hurwitz, and Laura Quinby. 2011. “Comparing Compensation: State and Local versus Private Sector Workers. State and Local Plans Issue in Brief 20. Chestnut Hill, MA: Center for Retirement Research at Boston
College.
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Reducing compensation will reduce the quality of new hires.
Figure 3. Effect of a 1-Percentage-Point Increase in Normal Cost on the Quality Gap
2.0%
1.5%
1.0%
1.0%
0.7%
0.4%
No controls
With controls
0.0%
-0.1%
-0.3%
-1.0%
-0.9% -0.9%
-2.0%
-3.0%
7.5
10 12.5
15
-1.7%
-1.5%
-2.5%
-2.2%
17.5
20
Note: Striped bars are not statistically significant. Sources: Authors’ calculations from U.S. Census Bureau,Current Population Survey Outgoing Rotation Groups, 2000-2013; and Public Plans Database (2001-2012).
48

Conclusion
• Two financial crises in a decade hurt public plans and increased costs to state and local governments, but pension spending is still a modest share of budgets.
• Many plans responded by cutting pension benefits for new hires. This, along with a return to paying the ARC, should put plans on the path to sustainability over the long-term (if assumed returns are realized).
• But, benefit cuts can have consequences for the quality of state and local workforce that should not be ignored.
49

• The Center for Retirement Research at Boston College http://crr.bc.edu
• State and Local Pension Costs: Pre-Crisis, Post-Crisis, and
Post-Reform http://crr.bc.edu/briefs/state-and-local-pension-costs-pre-cris is-post-crisis-and-post-reform/
Jean-Pierre Aubry
Assistant Director of State and Local Research aubryj@bc.edu
23

Retiree health spending is projected to rise but is still relatively modest share of budget.
Retiree Health Costs as a Percentage of State and Local Own-Source Revenues,
Sample Average, Pre-Crisis through Post-Reform
2.0%
1.7%
1.6%
1.5%
1.3%
1.0%
0.8%
0.5%
0.0%
Pre-crisis:
2007
Post-crisis:
2011
Post-reform Post-reform partial impact: 2028 full impact: 2046
Source : Alicia H. Munnell, Jean-Pierre Aubry, Anek Belbase, and Joshua Hurwitz. 2013 .“State and Local Pension Costs: Pre-Crisis,
Post-Crisis, and Post-Reform.” State and Local Plans Issues in Brief 30. Chestnut Hill, MA: Center for Retirement Research at Boston
College.
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