Interested Party Testimony on Public Pension Reform for the House Health and Aging Subcommittee on Retirement and PensionsAug 15, 2012
By Greg R. Lawson
Thank you Chairman Schuring, Ranking Member Hagan and members of the committee for providing the Buckeye Institute this opportunity to discuss how Ohio can best reform its public pension systems. My name is Greg R. Lawson; I am the Statehouse Liaison at the Buckeye Institute for Public Policy Solutions.
The Buckeye Institute is a non-profit, non-partisan, free-market think tank. To that end, we believe that a low tax, limited regulation environment best attracts business, fosters job growth, and results in stronger, more vibrant communities.
This testimony is substantially similar to that what was previously presented before the Senate, but we felt it was imperative to put this debate into an appropriate context.
Public pension reform is a multi-billion-dollar issue that affects all Ohioans—from the government employees who rely upon these programs for retirement income to the private-sector taxpayers who help fund them. Reforming these systems will undoubtedly have a significant impact in Ohio’s fiscal health years and decades into the future. Thus, the stakes are high for getting things right and for making sure that all issues surrounding our state pensions are fully vetted.
Let me make it perfectly clear at the outset that OPERS is an extremely well run public pension system when compared to those of many other states. If the status quo of a defined benefit system is the goal, then many of the changes made by the Senate, as well as the further recommendations from the Ohio Retirement Study Council report, accomplish this.
However, the guiding principle of reform should be more than attempting to ensconce the status quo. It should be to establish public retirement systems that not only provide reasonable retirement benefits, but do so at a permanently sustainable cost to taxpayers.
We would not be here if Ohio did not face a serious pension dilemma. Unfunded pension liabilities from Ohio’s five public pension funds total roughly $70 billion—an amount equivalent to 126 percent of the biennial budget. While there are clearly major differences between the pension systems and the types of personnel they serve, collectively those pension funds are roughly only 67 percent funded. (A funding ratio above 80 percent is generally considered to be fiscally sound.) According to the latest comprehensive annual fiscal reports of each pension system, three of the funds are well beyond the statutorily required 30-year amortization window. Clearly this trajectory is unsustainable.
While the need for reform is obvious, the path forward is less clear. In recent year, over 40 state legislatures have enacted significant pension reform legislation. The degree of reform has ranged from small adjustments to existing plans to the whole restructuring of the defined-benefit system.
While the reforms currently on the table in Ohio, and outlined in the recent Retirement Study Council report, are superior to the status quo this debate offers a unique chance to be bold and move Ohio to a system that better fits the imperatives of the 21st century.
The Buckeye Institute is generally supportive of several of the recommended reforms under consideration. The anti-spiking provisions, the longer look back period, the increased retirement age and increasing discretionary power of the pension boards are all positive. Nevertheless, these changes are tactical and do not make our systems as flexible as needed in a vibrant, ever changing global economic environment.
As the Buckeye Institute makes clear in our report Hanging by a Thread, a transition away from the status quo defined-benefit system to either a mandatory defined-contribution plan or defined-benefit/defined-contribution hybrid would be a significant and bold move.
Defined-contribution and hybrid reforms are wise for at least three reasons: lower costs, less risk, and greater portability.
A debate on cost savings through public pension reform must begin with a discussion of overall equity between the public and private sectors in terms of retirement income. By many measures, the retirement benefits receive by government workers in Ohio, on average, are more generous than those received in the private sector. A good method to compare the generosity of retirement plans is to compare contribution rates.
The average Ohio government employee receives a 14 percent contribution of salary from his or her employer, in this case, taxpayers. That contribution will then be matched by a 10 percent employee contribution. (Public employees do not participate in Social Security in Ohio.) Meanwhile, the average private-sector worker in Ohio receives a 6.2 percent employer contribution toward Social Security and an average 4.0 percent contribution to a 401(k), totaling 10.2 percent of pay.
The resulting 14 to 10.2 percent differential provides government employees with a significant financial advantage over private-sector workers. To see how this difference benefits career government employees at retirement, please visit the Buckeye Institute’s retirement comparison calculator.
Our calculations indicate that Ohio could save $3.3 billion over the course of 30 years by establishing a defined-contribution plan equivalent to private-sector standards. Additionally, defined-contribution systems accrue no unfunded liabilities, which would begin to wind down Ohio’s pension debt once and for all.
Equally important to cost saving is reducing risk exposure to taxpayers. Again, both defined-contribution plans and hybrid models are superior to defined-benefit systems.
Under the current defined-benefit pension plans, government, employees face zero risk in securing their retirement income. Regardless of financial market performance, retiree benefits must be paid, as required by law. The responsibility to pay these benefits falls squarely into the laps of taxpayers.
Private-sector workers face substantially more risk in securing their retirement income. While Social Security payments to private sector retirees are guaranteed (although serious questions about the program’s long-term fiscal viability are well known), the investment risk of 401(k) plans fall on the individual.
While a full-blown defined contribution plan would be the gold standard to avoid any potential taxpayer risk, a mandatory hybrid pension plan would still be a better reflection of the risk that private-sector workers face than the current system. Under a hybrid system, public employees would be provided a smaller, taxpayer guaranteed defined-benefit pension and an accompanying defined-contribution account to provide the remainder of retirement savings. Risk is spread more equitably and unfunded liabilities are limited.
It should also be noted that each of Ohio’s pension funds assumes a rate of investment return (between 7.75 and 8.25 percent) that may deem to be overly optimistic. When returns fall short, as they have over the past decade, liabilities increase, putting an even greater burden on taxpayers. And to achieve these high investment goals, the pension systems have devoted larger portions of their portfolios to higher risk investments such as hedge funds, private equity investments, and real estate. Yes, it is possible for those rates to potentially be accomplished over a 20-year plus time period, but global instability raises questions about long-term market prospects. Consequently, continuing to assume these rates is risky.
Ohio’s pension funds should adopt more conservative investment assumptions—Indiana recently lowered its investment assumption to 7 percent. Doing so would put taxpayer investments on firmer fiscal footing and less subject to volatile and unpredictable financial markets.
Finally, defined-contribution and hybrid plans offer workers greater control and ownership of their retirement and greater portability. The current system is designed for workers to join the system and retire 30 years later. Today’s economy is different. Today’s college graduates are entering a workforce where in-demand skills change rapidly—as such, multiple career changes have become more commonplace. There must be enough flexibility built into the systems to allow easy access in and out of public service. Public sector retirement plans must adapt to this new economic model; the best way to do that is with defined-contribution and hybrid reforms.
Perhaps the greatest evidence of the benefits of defined-contribution and hybrid plans is the states. A growing number of states have either passed comprehensive pension reform legislation or are actively debating such proposals today.
Washington, DC transitioned to a defined-contribution plan in 1987. Michigan closed its defined-benefit pension plan to state employees in 1997, offering a defined-contribution plan, and has saved the state upwards of 2.3 billion. Utah ended its defined-benefit plan in 2010, offering the choice of either a defined-contribution plan or a hybrid model. In late 2011, Rhode Island overwhelmingly passed, on a bipartisan basis, mandatory hybrid legislation for its state employees. And just last month, Virginia established its own mandatory hybrid plan for state employees.
Additional legislation that moves states away from the defined-benefit structure is almost certain to come in future years. California Gov. Jerry Brown has proposed a hybrid plan to address his state’s well0kniwn pension crisis. Aggressive reform legislation is also currently being debated in Kansas and Louisiana.
To be fair, many of these states have, quite frankly, poorly managed their pension systems and have brought on a financial apocalypse as a result. Ohio does not face that catastrophe. Yet, we should not forget that a mere three years ago both STRS an OP&F were pushing plans that would have increased the taxpayer funded employer share of the contribution. STRS wanted to go from 14 percent to 16.5 and O&F was suggesting a gradual phase in to up to 25 percent to shore up their systems. Clearly there is an appetite in some circles to force taxpayers into what amounts to bailouts when market returns decline. While that argument has failed for the time being, a different political contest could easily yield different results that could be detrimental to taxpayers.
The current reforms being envisioned stall such a possibility from re-emerging in the near term, but they do not permanently prevent it. Why not strike now while the moment is ripe and the debate is open?
Even if the General Assembly believes a mandatory defined-contribution or hybrid is a bridge too far, perhaps, the default presumption for new employees should shift from the defined-benefit pension to one of the others. This would still give all workers the opportunity to opt for the defined benefit plan, but would likely shift a significant number to more sustainable and more flexible models over time.
The Buckeye Institute is familiar with many of the arguments against these ideas. These include: risk adjustments and diffusion of costs that traditional defined-benefit plans have, the transaction costs of fully defined contribution plans, the potential lack of investment sophistication of many state employees, and the dreaded “transition cost” associated with closing a defined benefit system. These are legitimate points. But they are points made to perpetrate a comfortable status quo in a time of great change.
For many years Ohio could afford its defined-benefit pension plans. Under perfect circumstances, it might still be able to. But with a rapidly changing economy, this assumption cannot be guaranteed and taxpayers should not be the ones asked to take on the heightened risk of providing guaranteed pensions to government employees that exceed what most in the private sector receive.
Not only is it questionable whether the days of guaranteed high market returns are gone, but the issue of fairness confronts us quite clearly. It is time to be forward thinking, to change before events force our hand, and establish a retirement system that reflects the economy of the 21st century.
Thank you for your time. I would be more than willing to answer any questions you may have for me.
1. “State and Local Government Pension Plans, Current Structure and Funded Status,” Testimony before the Joint Economic Committee, Government Accountability Office, GAO-08-983&, July 10, 2008. http://www.gao.gov/assets/130/120599.pdf
2. Snell, Ronald. “Pensions and Retirement Plan Enactments in 2011 State Legislatures,” National Conference of State Legislatures, 4 May 2012.
3. Mayer, Matt. “The Grand Bargain is Still Dead,” The Buckeye Institute for Public Policy Solutions, 7 May 2012.
4. McCleary, Mary. “The Impact of Shifting Ohio State Workers from Defined Benefit Plans to Defined Contribution Plans,” The Buckeye Institute for Public Policy Solutions, 4 May 2012.
5. Dreyfuss, Richard. “Estimated Savings from Michigan’s 1997 State Employees Pension Reform Plan Reform,” Mackinac Center for Public Policy, 7 May 2012.
6. Steve Wartenber, “Pension Plans Outline Reforms,” Columbus Dispatch, September 10, 2009, at http://www.dispatch.com/content/stories/local/2009/09/10/PENSION_MEETINGS.ART_ART_09-10-09_A1_OPF1BFJ.html (September 4, 2011).