When trying to get out of a hole, the first thing to do is to stop digging. When the hole is a state pension deficit, it’s also a good idea to throw away the shovel. The shovel in this case is defined benefit (DB) pensions, which are structured in a way that makes deficits likely.
Defined benefit pensions depend on a combination of investments and contributions from employers and employees for funding to pay obligations to retirees. Investment returns vary from one year to the next, so a period of underperforming investments can lead to a shortfall in a pension plan’s assets relative to its funding projections.
This happens surprisingly often because many pension plan managers calculate their contributions against discount rates based on unrealistically high year-on-year investment return projections. And they have an incentive to use discount rates based on high projected returns, because that means lower employer contributions.
Now many states face huge public pension shortfalls because of years of their kicking the can down the road like this. State lawmakers are reacting in different ways, not all of them for the better.
To date, Illinois lawmakers’ reaction to their state’s pension crisis has been like that of someone in a hole who keeps digging. A recent — thankfully failed — legislative proposal would have left the state’s defined benefit model in place and put taxpayers on the hook through the creation of a pension payment “guarantee.”
By contrast, an example of someone trying to throw away the shovel can be found in Virginia, where the Speaker of the House of Delegates has proposed shifting state employees from defined benefit to defined contribution retirement plans, such as 401(k) accounts.
Government employee unions are their legislative allies are certain to fight such a change, and their opposition is bound to be fierce. But lawmakers who are serious about securing the Old Dominion’s fiscal future should not be deterred from pursuing far-reaching pension reform, which is a fight worth having. Other states’ lawmakers should watch and follow suit.
For more on public pensions, see here.