ALEC’s Statement of Principles on Fixing State and Local Government Defined-Benefit Plans

ALEC’s Statement of Principles on Fixing State and Local Government Defined-Benefit Plans

Summary

To solve the funding crises in state and local defined-benefit plans for public employees {insert state} recommends that defined-benefit plans be replaced by defined-contribution plans.  However, should a state or locality choose to continue with a defined-benefit model, the following reforms are designed to fix the cost and labor market problems defined-benefit plans tend to create:

Primary Reforms

  • Cap employer cost to a maximum amount of salary state will pay towards employee benefits
  • Require the full ARC (or Normal Cost) of the plan to be paid each calendar year
  • Require the ARC (or Normal Cost) to be calculated using a realistic discount rate, such as the US treasury bond rate.
  • Smooth pension wealth accrual making it a constant % of earnings, such as a cash balance or constant accrual plan
  • Use Generally Accepted Accounting Principles (GAAP) rather than Governmental Accounting Standards Board (GASB) rules
  • Prohibit purchase of service credit unless it is made at full actuarial cost.
  • In accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 158, unfunded liabilities should be reflected on the financial statements of the employer.   The annual report of a pension plan should reflect the liabilities for each plan segment but states’ financial statements should only reflect the portion of liabilities attributable to state employees.  Liabilities pertaining to employees of local government entities and school districts should be reflected on the financial statements of their respective employers

Closing Loopholes

  • Eliminate double-dipping, whereby public employees retire and begin to take their pension, only to return to work for the government and begin earning a new annual salary along with the pension from their first job
  • Eliminate smoothing in the accounting for state and local pensions, whereby steep losses or gains in a given year are not immediately realized on that year’s balance sheet
  • Eliminate spiking, whereby public employees abuse overtime and other sources of compensation just prior to retirement in order to create an inflated benchmark for pension benefits
  • Include only base pay in the calculation of retirement pay
  • Cap retirement benefits at no more than 100% of final average salary
  • Increase the number of years used in final-average-salary calculation
  • Require any purchase of service credit to be at full actuarial cost or prohibit the purchase of service credit
  • Tie cost-of-living adjustments to the CPI (or eliminate them all together)
  • Benefits should be calculated on actual time employed and actual compensation paid.  Those working part-time should not receive credit for a full year’s service, including legislators.  Compensation should not be annualized and should not include any form of expense reimbursements, including subsistence allowances

Secondary Reforms

  • Increase employee contributions, retirement age, and vesting period as necessary to make pension systems sustainable in light of increased medical costs and life expectancies
  • Treat public pension benefits the same as private pension benefits for state income tax purposes in those states that tax pension income.  Employee contributions should be made pre-tax and all benefits should be taxable when received in accordance with each state’s income tax provisions.

 

Approved by ALEC Board of Directors, September 16, 2011