Budget & Tax
Curtis Shelton | August 22, 2020
Rolling back pension progress is unhealthy
Every year millions of Americans will attempt to lose weight through dieting. Yet according to one report, “roughly 90 percent of people who lose a lot of weight eventually regain just about all of it.”
The failure to keep off the weight is not solely due to a lack of discipline or willpower. Many people don’t understand how an array of underlying health factors, such as our metabolic process or how our body functions, can affect our weight and overall health. For many people, the number on a scale is what matters most. Once they get that number where they want it to be, or at least moving in the right direction, they lose momentum or call it quits. Usually this happens before any lasting changes have been made to those underlying factors. While a person’s weight may be a valuable indicator, it is not a guarantee of whether that person is healthy or not.
The situation surrounding Oklahoma’s state pension system has a similar dynamic. Oklahoma’s state pensions were in dire shape for much of the early and mid-2000’s. In 2011 major reforms were enacted and the health of these pensions began to improve. Funding levels began to increase, moving from 56 percent in 2010 to 81 percent in 2019 for all pension systems. The Teachers’ Retirement System of Oklahoma (TRS), the state’s biggest retirement system, saw its funding ratio rise from 48 percent to 72 percent.
This rise in funding ratios was the rationale behind the idea of passing a cost-of-living adjustment (COLA) for state retirees. During the 2020 legislative session, lawmakers passed a COLA increase that would boost annual retirement benefits by two to four percent depending on how many years the employee has been retired. The cost of the COLA was estimated to be $776 million, lowering the funding ratios of each pension system between 1.2 and 2.1 percent.
All the hard work done to change the pension systems and improve funding ratios should be applauded. Moving from a statewide funding ratio of 56 percent to 81 percent is a substantial improvement. However, this improvement has led some to think the work is over. It has become a common arguing point for many that an 80 percent funding ratio shows a healthy pension plan that is actuarially sound. “Left unchallenged,” warns the American Academy of Actuaries, “this misinformation can gain undue credibility with the observer, who may accept and in turn rely on it as fact.”
In truth, every pension plan should have a goal of becoming fully funded, with assets equal to 100 percent of pension obligations. Using an 80 percent funding ratio as a benchmark for a “healthy” plan can undermine that goal and stall progress once that 80 percent is reached. Moreover, focusing solely on funding ratios ignores other important factors of a pension’s health. Some of these include contribution policies, investment strategies, and liabilities compared to the size of the plan sponsor. Additionally, publicly funded plans can change what it means for these factors to be healthy.
Oklahoma’s state employee pension systems rely heavily on state contributions as opposed to employee contributions, with a 3.5 percent contribution rate for the employee and 16.5 percent coming from the state in some form. While this combined rate is higher than most private-sector retirement plans, the employee rate is lower than the 6.8 percent in the average private-sector retirement plan.
Heavy reliance on state funding for retirement contributions can cause problems when the state faces economic hardships. If faced with the decision to lower contribution rates or raise taxes to keep the system afloat, the choice will nearly always be to protect the retirement system at the expense of the taxpayers, even if the taxpayers cannot afford it.
This overreliance on taxpayers can also become a problem when it comes to investment strategies. Because nearly all of Oklahoma’s public-employee retirees are on a defined-benefit plan, the state is obligated to provide a certain dollar amount in benefits regardless of how the market performs. In cases of severe or prolonged downturns, taxpayers will often be asked to support whatever gaps appear between pension obligations and market returns. In addition, public pensions will sometimes shift to riskier investments in the hopes of boosting returns to the promised rate.
Just as an individual making a diet change should not focus solely on weight but on establishing a healthy lifestyle, so too should the legislature seek to practice consistent fiscal responsibility. Good financial stewardship of public funds should not be a temporary fad, but rather a habitual practice.
Policy Research Fellow
Curtis Shelton currently serves as a policy research fellow for OCPA with a focus on fiscal policy. Curtis graduated Oklahoma State University in 2016 with a Bachelors of Arts in Finance. Previously, he served as a summer intern at OCPA and spent time as a staff accountant for Sutherland Global Services.