A bipartisan pension reform plan signed into law Monday by Pennsylvania Gov. Tom Wolf could provide a model for other states with high pension liabilities to pull out of the fiscal sinkhole, pension experts say.
Under the plan signed by the state’s Democratic governor and passed by the Republican legislature, new employees hired by the state can choose a hybrid pension plan featuring a 401(k)-type defined-contributions account and a smaller defined-benefits component, or opt for a total defined-contributions account. Current state employees enrolled in the existing defined-benefits system, which had liabilities of more than $70 billion in 2016, could also opt into the new system.
“Because of this legislation, we removed 60 percent of the risk off the backs of taxpayers,” Pennsylvania Senate Majority Leader Jake Corman, author of Senate Bill 1, said.
Pennsylvania’s new hybrid pension plan could also be helpful to states like Illinois that have massive unfunded pension liabilities, according several authorities on state pension reform. Like Pennsylvania, Illinois also has a divided government – a Republican governor and Democrat-controlled legislature – and the hybrid plan’s features could have some appeal to both sides of the aisle, they said.
“What’s encouraging about Pennsylvania’s reform … is that it’s a compromise that slowly moves pension systems in the right direction,” Elizabeth Stelle, director of policy analysis for the Commonwealth Foundation in Harrisburg, told Watchdog.org.
Although Stelle said other states with mounting pension system liabilities should consider the hybrid model, she warned that what’s most important for states looking to enact such reforms is determination.
“It took us 10 years to get to this first step,” Stelle said, adding that many people were still denying a pension crisis existed in the state as late as three years ago.
Ivan Osorio, the Competitive Enterprise Institute’s editorial director and author of multiple papers on labor policy, said the adoption of a hybrid pension system in Illinois likely wouldn’t solve the entire problem, but it would help to move the state in a more positive direction.
“Closing underfunded pension plans to new entrants is essential,” Osorio told Watchdog.org. “That’s the first thing you have to do.”
The hybrid plan wouldn’t address current pension liabilities, but it would move the state toward a solution, he said. In the case of Illinois, the pension system has a stated liability of about $130 billion, but other estimates peg it as much higher.
“If you’re in a hole, as the old adage goes, the first thing you have to do is stop digging,” Osorio said.
Ultimately, he said, pension reform is not a partisan issue. “The need for Republicans and Democrats working together is essential,” Osorio said.
Others are more cautious about the idea of hybrid plans being a model for states. Alex Brown, research manager for the National Association of State Retirement Administrators (NASRA), said the number of states shifting to hybrid systems in recent years does not quite add up to a trend.
“Since 2009, we count seven states that have established hybrid plans, including defined-benefits and defined-contributions plans,” Brown said. Pennsylvania would be No. 8 on that list.
Brown underscored the idea that every state is different in terms of its finances, workforce needs and retirement system goals, so a one-size-fits-all solution really doesn’t exist for states plagued with pension debts.
NASRA itself does not endorse one type of pension plan over another. But the association emphasizes five components that it says should be part of any effective pension plan. Among them are mandatory participation by employees, shared contributions by employees and employers, and pooled investments to maximize returns. The other points NASRA emphasizes are providing retirees with income that reflects a percentage of their previous salaries and defining benefits as annuities that cannot be outlived.
Some research points to problems with transitioning away from defined-benefits retirement systems. The need to maintain two or more separate systems can be more costly than having just a single plan, according to a 2008 study by the National Institute on Retirement Security. And the reduction in pooled assets that comes with defined-contribution plans can reduce earnings potentials, the study said.
But Stelle said one key advantage of Pennsylvania’s hybrid system is that it will reduce the taxpayers’ exposure to financial risks by as much as two-thirds.
“It starts to move the politics out of pensions,” she said, noting that the Pennsylvania plan helps to prevent politicians from making poor financial decisions, such as deferring state pension contributions.
Those taxpayer protections, as well as providing public employees with a range of retirement choices, including a portable 401(k)-type option, should appeal to Republicans, Stelle said. Democrats, meanwhile, may see the hybrid system positively because it aims to fulfill the promises made to retirees and current employees.
“It’s really about choice,” she said. “It doesn’t mandate that current employees have to do anything differently.”