IE 11 is not supported. For an optimal experience visit our site on another browser.

Government workers feeling pension pressure

State and municipal workers — and the unions that represent them — are fighting to retain the treasured benefit of a fixed monthly pension, something that is rapidly disappearing from the corporate world. By's Martin Wolk
/ Source:

The promise of a lifelong monthly retirement check, with all the security that implies, has always been one of the biggest attractions of government service, from sanitation workers to members of Congress.

Now police officers, teachers, public health workers and the unions that represent them in many states are scrambling to defend the treasured benefit — one that the vast majority of them still enjoy but is rapidly disappearing from the corporate world.

For the most part they are winning, arguing successfully that providing a traditional pension plan for public workers is a cost-effective investment of taxpayer dollars, helping to attract and retain a higher-quality workforce.

But the stock market runup of the late 1990s and its subsequent collapse has left some state pension funds badly underfunded, opening the door to free-market advocates who want to see public workers funneled into defined contribution pension plans similar to the 401(k) accounts that have come dominate the private sector.

Officials of unions representing public-sector workers describe the battle over the future of retirement as one of their top two priorities, along with health-care costs.

“It is a very hot issue,” said Rich Ferlauto, director of pension investment for the  American Federation of State, County and Municipal Employees. The movement to privatize pensions “really threatens the middle-class lifestyle of people who have worked all their lives,” he said.

In Alaska, lawmakers last year voted to stop offering a "defined-benefit" pension plan, which provides monthly checks for the lifetime of each retiree. Current teachers, police officers and other state and local government employees will keep the benefit, but new hires will be required to participate in a "defined-contribution" plan similar to a 401(k).

Under the new plan employees will contribute 8 percent of their pretax pay into an individual retirement savings account, which their employer will partly match with a 5 percent contribution, with additional contributions for health care and death and disability benefits. The funds will be invested in any of 10 stock or bond funds as allocated by the employee.

Oregon recently shifted to a hybrid that adds elements of an individual account. But elsewhere the idea has been rejected, most recently in California and Colorado.

In essence, the debate over President Bush’s plan to privatize Social Security is being played out on dozens of smaller stages as managers of state and municipal pension plans grapple with the fallout of the 2000-2002 bear market, compounded in some cases by mismanagement, reckless political choices and possibly fraud.

Free-market activists say public-sector employees should shoulder more of the burden for their own retirement security, putting money aside in personal accounts that would get some government matching funds but would be managed by each individual.

That would mirror the trend in the private sector, where only one-third of new employees at larger companies are covered by a traditional pension, compared with 80 percent just two decades ago. By contrast 90 percent of government workers still have a defined-benefit pension plan, according to the Employee Benefit Research Institute.

The push to defined-contribution plans is a worrisome prospect to people like Doris Sutherland, 78, of Grand Junction, Colo., who retired from her job as a secretary for a state agency in 1988 and now lives mostly on her $2,300 monthly pension. Sutherland gets no Social Security benefit from her many years of public service because state and local government workers in Colorado, along with several other states, are exempt from the system.

Sutherland contributed up to 11 percent of her pay into the state's public-employee pension plan over the years and now is vigilant against any attacks on it, acting as an advocate for retirees in her union, the Colorado Association of Public Employees.

"I think for most of the people that are retired right now, their benefit is pretty secure," she said. "But I don’t want new hires to have nothing to look forward to. If they don’t have a sound retirement (plan), they won't stay any length of time."

Sutherland supplements her income with work as a gift-wrapper and with a small 401(k) from a brief stint in the private sector, but she is skeptical about investing her retirement savings in the stock market. "I don’t think it's that sound of an investment," she said.

The debate over the future of pensions for government workers has been pushed along by the deteriorating financial condition of many state and municipal retirement funds. In fiscal 2000, the average state pension plan had assets equal to 107 percent of their liabilities, according to Wilshire Consulting, which surveyed 125 big plans with total assets of nearly $2 trillion. By fiscal 2005 that figure had dropped to 85 percent. Unfunded liabilities totaled $242 billion as of fiscal 2003, the last year for which complete figures were available.

In some states, the picture is far bleaker. In Illinois, the state pension plan has assets valued at only 60 percent of its liabilities, and in West Virginia the figure is 44 percent, according to a report issued this year by Standard & Poor’s.

Parry Young, a credit analyst with Standard & Poor’s, said the main reason funding levels have dropped so low at some state pension funds is that the bull market of the 1990s emboldened state legislators to take contribution "holidays" and in many cases to increase benefits.

Most of the state plans were created in the 1920s and 1930s and were never fully funded until the 1990s stock bubble made every fund manager look like a stock-picking genius. “By 2000, with the strong bull market, on average they got up over 100 percent, so everyone was feeling very confident,” Young said.

Because of actuarial accounting methods that smooth out changes in asset values, the full impact of the bear market did not become apparent until several years after the market peaked. And then in some states, the loss of assets triggered a crisis.

In Colorado, the crisis came to a head this past spring with a pitched battle over the future of the state's pension plan, but unions defeated a movement to switch the system to a defined-contribution type.

California Gov. Arnold Schwarzenegger also learned the perils of trying to take on the pension benefits of government workers.

Last year, in his state of the state address, Schwarzenegger proposed moving to a defined-contribution plan, saying the state’s pension system was a train on a “track to disaster.” He endorsed a constitutional amendment that would have eliminated defined-benefit pensions for new employees.

State employees, including police, firefighters and public health nurses quickly mobilized, focusing on a provision in the proposed ballot initiative that would have scrapped death and disability benefits. Schwarzenegger’s popularity plummeted, partly as a result of intense union opposition to the plan. The governor ultimately withdrew his support.

Elsewhere, though, advocates of the individual approach to retirement plans have scored some successes. Michigan has been using a mandatory defined-contribution plan since 1997, after a reform bill narrowly passed the state Legislature and was signed into law by then-Gov. John Engler.

While the plan has been in effect for more than a decade, it will take “many, many years” to determine which is better for taxpayers and workers -- the defined-benefit or the defined-contribution plan, said Chris DeRose, the state’s director of retirement services.

State agencies “certainly have more certainty about the contributions they need to make for the defined-contribution employees,” he said. But about half the employees are still in the defined-benefit plan, which has enjoyed strong market returns over the past three years, he said.

Advocates of defined-benefit plans say they operate at a lower cost, which increases returns over the long run, and that individuals generally do a poor job of managing their retirement savings, investing either too aggressively or too cautiously.

They point to the example of Nebraska, which switched to a defined-contribution plan in the 1960s and then switched back to a traditional pension plan several years ago largely because of the low returns being earned in individual accounts.

Experts say there is no easy answer to the question of what is the best retirement plan but generally agree that for a secure retirement, workers should have the traditional “three-legged stool” of a fixed pension like Social Security, tax-deferred savings and ordinary savings.

“If you ask a pension professional what is the best type of pension plan to have, a defined benefit or defined contribution plan, you ordinarily will get the same answer,” said Mark Iwry, a non-resident senior fellow of the Brookings Institution and a senior adviser of the Retirement Security Project.

“The answer is both,” he said. “You want a combination of the attributes of the defined benefit plan on the one hand and the defined contribution plan on the other.”