5 Things to Watch When Cutting Public Pensions
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By Mark Miller,
June 20, 2012

The message from voters about public pension plans is clear: They're ready to cut the retirement benefits of police, firefighters, teachers and other state and municipal workers.

The latest indicators include the failed recall of Gov. Scott Walker in Wisconsin – which started with his efforts to cut pensions – and referendums in San Jose and San Diego, where voters overwhelmingly backed pension reform measures. A recent study by the U.S. Government Accountability Office found that 35 states have reduced pension benefits since the 2008 financial crisis, mostly for future employees. Eighteen states have reduced or eliminated cost-of-living adjustments (COLA) – and some states have even applied these changes retroactively to current retirees.

RELATED: Labor Regroups After Drubbing in Wisconsin

This week, the Pew Center on the States reported that states are continuing to lose ground in their efforts to cover long-term retiree obligations. In fiscal year 2010, the gap between states' assets and their obligations for retirement benefits was $1.38 trillion, up nearly 9 percent from fiscal 2009. Of that figure, $757 billion was for pensions, and $627 billion was for retiree health care.

Pensions are, no doubt, consuming a larger share of some state and local budgets. The bill has come due for years when plan sponsors did not make their full plan contributions; in the years leading up to the 2008 financial crisis, many papered that over by relying on strong stock market returns. Many plans also took major hits in the 2008 crash, and returns have since been hurt by low interest rates.

But before we continue swinging the axe, here are five things to keep in mind about public sector pensions:

1. Pensions Aren't Simply a Gift from Taxpayers.
They're an integral part of total compensation, along with salary, health benefits and vacation. Unlike private sector defined benefit pension plans, most state and municipal workers contribute hefty amounts from their salaries. For those who aren't participating in Social Security, the median contribution is 8.5 percent of pay; for those who do contribute to Social Security, the median contribution is 5 percent and rising, according to the National Association of State Retirement Administrators.

Investment earnings account for 60 percent of all public pension revenue, NASRA reports; employer contributions cover 28 percent and employee contributions account for 12 percent.

2. Many Workers Don't Get Social Security.
Thirty percent of state and municipal workers work for states that have not opted into Social Security. That means pensions are their only source of guaranteed lifetime income in retirement. Social Security comes with automatic cost-of-living adjustments to protect retirees from inflation - a feature that is on the chopping block under many public sector reform plans.

3. Pension Underfunding Isn't As Bad As You Think.
It's true that funding in some states has dropped to frightening levels. Illinois, for example, which failed to make the necessary plan contributions for years, has a funded ratio of 43.4 percent. But nationally, the story is more positive. Aggregate asset/liability ratios have been rising. The funding level for all state plans combined was 77 percent last year, up from 69 percent in 2010, according to Wilshire Consulting.

Most public sector pension plans have a target funding ratio of 100 percent. However, ratings agencies consider a ratio of 80 percent to be adequate. By comparison, private sector pension plans are considered at risk of default if their funded ratios fall below 80 percent.