A Look at Pension Reform

Scott Mooneyham, Director of Political Communication and Coordination

Over the past several years, local governments in North Carolina have seen their pension fund contributions escalate drastically to keep the Local Government Employees Retirement System on a sound fiscal footing.

In 2022, the total employer contribution to the North Carolina pension fund—including LGERS, the Teachers and State Employees Retirement System and a handful of smaller public employee funds—was $3.75 billion, more than double the total employee contribution. That comes after years of equal employer and employee contribution rates of 6% of salary.

The $111 billion fund paid out roughly $7 billion in benefit to retirees, according to the National Association of State Retirement Administrators (NASRA).

The rising rate of employer contributions by local governments, now 12.85% of salary, as well as a lack of cost-of-living-adjustment increases for retirees, is largely a result of investment gains not keeping pace with benefit needs. And those contributions now account for 2.33% of all state and local government general operations spending.

With that in mind, this article explores ongoing pension reform in other parts of the country and looks at general shifts in public pension fund stability as a result of economic downturn.

State Reforms

According to NASRA, every state since 2009 has made meaningful changes to pension plan benefit structures, financing arrangements, or both. Some states have made more than one change to its system during that timeframe.

“There has been no broad shift to defined contribution plans as the primary retirement plan, with most states electing instead to retain a reformed defined benefit plan either on its own or as a component of a combination (DB+DC) hybrid plan. Common types of reforms—some of which faced legal challenge—include higher employee contributions, lower benefit levels, increased eligibility requirements, and COLAs that were reduced, suspended, or eliminated.”

Thirty-nine states have increased employee contribution rates to at least one of their pension plans since 2009, according to NASRA. North Carolina is not among those states.

“Most increases applied to current workers as well as new hires, but in some cases higher rates applied to new hires only. Some higher employee contribution rates were temporary, but more were permanent or indefinite,” according to the organization.

The NASRA study also found that a majority of states had automatic COLA increases (North Carolina was not among them), and of those, most had reduced, altered or forgone those increases in some years since 2009.

While all of these changes occurred with existing defined benefit plans, some states have adopted broader reformers. Eleven states adopted either hybrid defined benefit/defined contribution plans, or a cash balance plan, with the changes typically applying to new hires only.

Other studies looking at changes involving shifting new hires to defined contribution plans, including one in North Carolina in 2010, concluded that the change would do little to reduce costs for decades. Meanwhile, public employers continue to view defined benefit plans, with vesting schedules of five years like North Carolina’s, as a strong employee retention tool.

Economic Troubles, Pension Troubles

It is important to note that, in many states, pension costs have only become a fiscal challenge in recent decades, with the 2001 recession and concurrent monetary changes causing returns on the bond components of plan portfolios to decrease significantly, according to a 2017 National League of Cities study.

“Pension funding took an even bigger hit as the Great Recession in 2008 materialized. The recession had an added component, beyond its depth and length, that previous recessions did not: a nearly decade-long period of exceptionally low interest rates. This feature of the recession resulted in lower expected returns and therefore higher pension funding requirements,” that study said.

That resulted in North Carolina and other states lowering assumed rate of returns, which had typically been at 7% or above in most states. Once those assumed rates of investment returns are lowered, the formulas that are used to examine future system needs end up recommending higher contributions into the systems, as also occurred in this state.

While the North Carolina system’s funding remains strong relative to its peers, it has not been at or above 100% fully funded, using the Government Account Standards Board criteria, in a number of years. More recently, the fund’s investment gains have also not kept pace with most of its peers. (You can find comparisons of those fund returns s at the following link: https://www.pionline.com/section/returns-tracker.)

Although some studies project that defined benefit pension demands will ease within a couple of decades, that will do little to change the fact that taxpayer funding could continue to escalate until then, and that shifts to defined contribution plans for new workers also will not ameliorate those effects.

Instead, reforms that would save taxpayers and lower employer contributions, such as higher employee contributions or changes to benefits, are likely to be politically difficult.

But as the NASRA study shows with its review of previous state reforms, fiscal reality can force changes even if politically challenging.