Pension plans are still recovering from the enormous losses suffered in the wake of the Great Recession. According to the Federal Reserve, state and local pension fund asset values fell from $3.2 trillion at the end of 2007 to $2.1 trillion in March 2009, increasing pension costs at a time when state and local governments faced severe losses in revenue. More recently, the California Public Employees Retirement System (Calpers), the country’s largest public pension fund, announced in December 2016, that it was lowering expectations for future investment returns.

Calpers lowered its target rate of return from 7.5 percent to 7 percent by 2020, which will force the state of California to contribute an additional $2 billion a year for state workers. Given Calpers’ size and influence in the investment industry, the move will likely encourage other pension funds throughout the United States to lower their targets.

Adding to these pressures is the fact that the Baby Boomer generation has entered their retirement years, and many retirees are living longer. Virtually all public pension funds are now operating in a “cash flow negative state,” meaning that each year the funds pay more in benefits to retirees than they receive in contributions. Recognizing that these economics were unsustainable, nearly every state has passed meaningful reforms to one or more of its pension plans in the years following the Great Recession. In June 2016, the National Association of State Retirement Administrators (NASRA) published a report detailing the reforms undertaken in each state. The most common reforms include the following:

• Employees are required to pay more. Nearly every state requires that employees contribute a portion of their earnings toward the cost of retirement, and most of those states increased their member contribution rates. For states where the retirement plan provides a benefit in addition to Social Security, the median employee contribution rate has risen from 5 percent to 6 percent of salary. In states that provide a public benefit instead of Social Security, the median employee contribution rate is 8 percent.
• Benefits lowered. Pension benefits are typically paid based on a formula that provides a percentage of salary for every year worked for the employer. For example, a worker that retired after 25 years of service with a final average salary of $50,000 in a plan that provides 1.5 percent of salary for each year worked would earn an annual benefit as follows: 25 x $50,000 x 1.5 percent = $18,750 per year in retirement
Benefit reductions have included the following adjustments: 1) an increase in the period used to calculate average salary (usually resulting in a lower average salary upon which the benefit is based; 2) a reduction in the retirement multiplier (i.e., a smaller percentage of income per year worked); and 3) reducing or eliminating cost-of-living adjustments. A recent study by NASRA found that benefit reforms could reduce the retirement benefit of new employees by between 1 percent and 20 percent compared to pre-reform benefits.
• Employees are required to work longer. The vesting period (the number of years for an employee to become eligible to receive retirement benefits) for new employees was increased for many plans, with nine states increasing the vesting period from five years to 10. To begin drawing a benefit, an employee must reach a second level of eligibility, generally expressed as a number of years of employment, a certain age or both. Twenty-nine states increased retirement eligibility, with a median increase to the retirement age of two years, and a median increase to required service of five years.
• Most states retained traditional pension plans, but not all. While most states retained traditional pension plans, some have created hybrid plans that have combined a defined benefit (typically with a more modest benefit level) with participation in an individual account plan. In most cases, changes in plan design applied only to newly hired workers. Two states—Arizona and Oklahoma—closed their traditional pension plans and placed new employees into individual account plans.
In this era of chronic funding deficits, low interest rates and increasing numbers of retirees, it’s a brave new world for pension fund administrators. Fortunately, many pension funds have taken proactive steps which will help ensure the long-term solvency of their plans, and in turn, the financial security of their members. Will there be more changes to come? You can bet on it.

Full Content: Daily Business Review

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