Barro calls Raimondo-Chafee pension ideas ‘very promising’

September 16th, 2011 at 2:35 pm by under Nesi's Notes

Josh Barro knows pensions.

Barro, a senior fellow at the Manhattan Institute in New York City, is an expert on state and local finances and the author of “Dodging the Pension Disaster.” We spoke in May about how Rhode Island’s leaders should approach pension reform; on Friday, Barro emailed his thoughts on the ideas Treasurer Raimondo outlined today:

Overall, the plan laid out by Treasurer Raimondo and Governor Chafee strikes me as a very good approach.

It is particularly important that the new system is for all accruals by workers in the future – not just for workers not yet vested or not yet hired. This is very important so that the state can start achieving real savings quickly and stop awarding pension benefits that are larger than necessary to attract and retain workers. As you note, this mirrors the process for changing pension benefits that is typical in the private sector (in compliance with ERISA), but it has not been typical in the public sector; most states, to their detriment, have been enacting pension benefit reforms that do not apply to the current workforce, meaning that meaningful savings will not be realized for years or decades.

It will be important that the state makes the right decisions in structuring the hybrid pension plan. They should go with a hybrid that is stacked vertically – that is, workers accrue a defined benefit in proportion to the first part of their salary up to $x, and then a 401(k)-style benefit on dollars earned above that. This is a progressive system, ensuring that everybody receives a defined benefit that serves as a safety net, while higher-income workers are expected to take more responsibility for managing their own retirement.

The size of the defined benefit (DB) should be larger for workers outside Social Security than for those who participate in Social Security. (If designing the system myself, I would offer the DB only to workers not in Social Security, but it seems clear politically that there will have to be some DB component retained for everybody in Rhode Island.) And the defined benefit should use a Cash Balance Plan structure, to avoid creating perverse retention and retirement incentives – Cash Balance Plans, unlike traditional DB plans, have smooth accrual of benefits through a career, so they do not disadvantage workers with short careers in government and do not push people out the door after 30 years even if they would like to continue working.

Other options – such as a horizontal hybrid, where workers accrue a defined benefit and a 401(k) side by side, like in the Federal Employee Retirement System – would not provide as many advantages.

I also agree with Treasurer Raimondo about reamortization. By itself, reamortization does not save money, it just kicks the can down the road. But as part of an overall reform that achieves real reductions in the cost of pensions in Rhode Island, it is acceptable to reamortize the existing unfunded liability to spread out the pain of paying it off.

I do not love the COLA freeze. I find it somewhat strange that COLAs (not just in Rhode Island but elsewhere) tend to be viewed as a different kind of thing than other aspects of the benefit formula, such as the retirement age and the wage multiplier. Fundamentally, the COLA is just one part of the formula that determines the value of a pension, and adjusting the COLA takes away vested benefits. Taking away vested benefits is appropriate in cases of insolvency, as in Central Falls, but should generally be avoided.

But I understand why leaders are drawn to the COLA freeze – as Raimondo notes, it seems to be a relatively palatable way to save money, and many of the options that I think would be more appropriate tend to be off the table politically. So, if it’s the way out of this mess for Rhode Island, that’s OK with me.

So overall, I think this looks very promising.

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9 Responses to “Barro calls Raimondo-Chafee pension ideas ‘very promising’”

  1. Al Moncrief says:

    Apparently Barro does not know pensions all that well. COLA is “pension.” Taking fully-vested, accrued, earned, contracted COLA benefits is outright, unabashed theft. Steal retiree’s pension income and you will be sued . . . . and you will lose. This will put you back aat square one a few years down the road.

    Instead, adopt prospective, legal, moral pension reform. Look at the hybrid plan adopted by Utah two years ago. They have begun to dig themselves out of their pension problem.

  2. Tough Love says:

    Interesting proposals from Mr. Barro, but I envision a huge problem with his … “hybrid that is stacked vertically – that is, workers accrue a defined benefit in proportion to the first part of their salary up to $x, and then a 401(k)-style benefit on dollars earned above that.”

    Union being what they are (Greedy) and politicians being what they are (incapable of not trading favorable votes on pension increases for campaign contributions and election support) …. there is no doubt the pressure to raise the “$X” salary limit … just as the CalPERS formulas were raised for many from 2% to 3% per year of service. And history being our guide, the increase in the $X will also be applied RETROACTIVELY undoing all the reforms currently being discussed.

    THE ONLY surefire reform approach is to end “traditional” form DB Plans completely. The “cash Balance” DB form is fine, as long as protections are put in place to prevent it from ever morphing into the “traditional” form at any point in the future.

  3. Tough Love says:

    There are 3 clear justifications why COLA changes SHOULD be on the table for reduction or elimination …. very simple and straightforward reasons:

    (A) Other than perhaps a few obscure and/or immaterial Plans, Private Sector Pension Plans NEVER incorporate automatic post-retirement COLAs.

    (B) The inclusion of post-retirement COLA increases is extremely expensive, typically increasing the cost (of an otherwise equivalent but non-COLA pension) by ONE THIRD.

    (C) Public Sector worker pension contributions together with all the investment earnings on those contribution throughout an employee’s career accumulates to an amount sufficient to buy at retirement 10-20% of the cost of the pension granted that employee. The Employer (meaning Taxpayer) contributions and the investment earnings thereon pay for the 80-90% balance. Why should Taxpayers pay 80-90% of the cost of a benefit provided to OTHERS that they almost NEVER get for themselves?

  4. Rlewis says:

    @Tough Love: You are completely wrong about who covers the cost of pensions for state wokers here in RI. It is the current employee who pays for 97% of the cost of his pension. The state contributes only 3%. This is fact and can be found in Raimondo’s own actuarial study.

    1. Ted Nesi says:

      RLewis, I’m pretty sure that ~95% figure was true until recently, but it isn’t quite as stark now.

      A union official told me last week the normal cost for current employees’ pensions increased as part of the new actuarial assumptions the Retirement Board approved in April, and current workers now cover closer to ~75% of the cost of their pensions with their 8.75%-per-paycheck contribution, down from that ~95% number.

      1. Tough Love says:

        A level annual 8.75% contribution from the employee would grow WITH INTEREST to an amount sufficient at retirement to buy less than 1/3 of the pension granted … it would be EVEN LESS, but RI’s formulas are not as generous as some other States.

        You clearly have no idea how a pension is funded.

  5. There is no alternative to a generous 401K for all private/public workers. Anything else that guarantees an unachievable rate of return at the expense of the next generation is unsustainable and unacceptable.

    We are in the midst of the largest transferance of wealth from younger generations to older of any society in history. The University of California, after making no contributions from employer nor employee for over twenty years, is now almost doubling tuition costs over the next five years from $12,000 to $22,000/year.

    After not making contributions for a generation, those retiring having not paid a dime into their retirement; are forcing the next generation to borrow money at 6.8% interest paid back over the next 25 years to cover their retirement. Students should be rioting in the streets.

    1. Tough Love says:

      No …. these grossly excessive pensions should not be paid.

      The promises were NOT made by those being called upon to pay the bill, but by politicians who willingly accepted campaign contributions and election support in exchange for favorable votes on pay, pensions, and benefits.

      And, there has never been anyone “negotiating” at a “bargaining table” who represented the TAXPAYERS.

      Taxpayers should renege on all of these outrageous “promises”. Taxpayer funding of these Plans should STOP innediately.

      Plans benefits must be reduced to whatever EXISTING Plan assets can buy …. and no more.

      Greed has consequences !

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