The Tip of the Iceberg? June 14, 2013

One of the less glamorous, but very expensive actions taken by the Iowa legislature prior to adjournment has to do with public pension funding.

Ninety-one million dollars was appropriated to shore up the most poorly funded of the state public pension plans, the Police Officer Retirement (POR) system.  According to actuaries, the system’s assets are only about 62 percent of what they should be in order to eventually cover benefits that have already been earned.  And that’s assuming an 8 percent return on investment, on average, for the next 26 years.  The appropriation is designed to improve the funded status to 80 percent, which is often deemed to be the level below which a “sound” pension fund should never fall.

The Judicial Retirement Fund will also receive a nearly $19 million injection with the same goal.  Between the two, $110 million is proposed to shore up these systems.

So what’s wrong with this picture?  Isn’t the legislature doing the right thing?

These actions should serve as a wake-up call about the risk inherent in the kind of defined benefit retirement plans that, while having largely disappeared from the private sector, are still in place for most public employees.

The POR is one of the State’s smallest plans with relatively few active members (618) covering peace officers in the Iowa Department of Public Safety.  It allows employees to retire at age 55 and receive up to 88 percent of their highest three-year average salary, for life, plus generous cost of living increases.   According to the California Public Employee Retirement System (CALPERS), the average life expectancy for a public safety occupation is no different than any other, so today’s retiring employees will receive an average of $68,000 per year (plus cost of living increases) for another 25-30 years.

Sadly, the $110 million solves only about half the funding shortfall.  The rest is being shifted to future taxpayers, many of whom have not even been born yet.

Like the canary in the coalmine, these examples from the smallest systems should alert us that our current defined benefit retirement model is simply not sustainable for taxpayers, or for employees.  In the political process, when times are good, benefits are enhanced.  When times are poor, these higher costs still have to be covered even if there are less investment earnings, or even losses.  Inevitably, the accumulation of benefits over time results in a system that cannot be sustained; even with an 8 percent return assumption.  The problem is compounded by demographics, where the ratio of active to retired members is shrinking every year.

One hundred and ten million dollars is a lot of money.  It could provide $1,500 in tuition assistance to every single one of the 74,000 students attending the state’s public universities.  It is more than the annual budget of the whole Department of Public Safety, which includes the State Patrol, the Division of Criminal Investigation (DCI), and many other public safety functions.   It could fund the entire Department of Cultural Affairs for 22 years.  But as large as it is, $110 million is just the tip of the iceberg.  The total unfunded liability associated with the POR is less than one-tenth the size of the debt associated with the state’s largest public pension plan.

Iowa shouldn’t wait for the next market downturn – which has the potential to create a nearly insurmountable liability – to take a hard look at the structure of our plans and ask what is truly an acceptable level of risk.  In order to assure we can honor promises that have already been made to public employees and to be fair to current and future taxpayers, fundamental reform is needed.  As the bill comes to his desk, Governor Branstad would be wise to carefully consider whether it is appropriate to ask taxpayers to place another $110 million into these – or any – defined benefit pension plans, without first insisting on such reform.

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