*This article was initially published in The Hill
Brazil has made international headlines with an exploding pension crisis that is wreaking havoc on public finances and threatening to take down the economy of Latin America’s biggest country. Our own Congress should take note, not only because of the potential ripple effect that would impact global markets, but also because of what is happening much closer to home: state and municipal pensions in the U.S. have unfunded liabilities topping more than $1.3 trillion that are continuing to increase at an alarming pace. Currently, these unfunded obligations constitute more than seven percent of our country’s gross domestic product, an eye-popping sum that signals the potential for an enormous fiscal crisis— and demands a federal solution.
Unfunded pension liabilities have been the main cause of default and bankruptcy in municipalities across the country — Stockton, Detroit, and San Bernardino — and have led to enormous debts in many of our largest cities, including Los Angeles, New York City, Chicago, and Houston. These localized crises are disruptive to the national economy and, with the problem only getting worse, a growing threat to the country’s stability.
Critically, many state constitutions and laws prohibit a decrease in pension benefits, making the need for a national approach obvious. Public sector workers in these states are legally guaranteed to be paid pension benefits equal to what was promised on their initial date of employment or on their date of vesting, which varies by state but generally kicks in after only a few years of employment. In contrast, private sector plans allow workers to vest only in the benefits earned at any point in time. Only those pension benefits are “guaranteed” and may not be reduced, but future benefits may be reduced.
The guarantee of future pension benefits is unique to the public sector and a fundamental cause of fiscal instability. Unlike the private sector, there is virtually no regulation of public sector benefits. In most cases, states and municipalities have wide latitude to set the amount they must contribute and there are few restrictions on how funds are invested. With interest rates at record lows, public pension funds seeking an 8 percent return have sought out increasingly riskier investments.
In addition, there are two more overarching issues: a) public pensions have no form of insurance against fiscal insolvency – public workers face the risk of their benefits being seriously impaired in the event of a municipal bankruptcy; and b) many public workers are not eligible to receive social security.
To address these problems while ensuring that pensions are protected for future generations, we propose that Congress establish a public Pension Benefit Guaranty Corporation (PPBGC) and regulate public pensions. An approach to resolving the pension crisis could involve the following:
- PPBGC would regulate and provide insurance to public pensions. If a public pension plan and its sponsor met specified termination standards, the sponsor would transfer the plan’s assets and liabilities to the PPBGC, which would then pay benefits to the plan’s participants and have a claim against the state or municipality for the plan’s shortfall.
- PPBGC’s operations and insurance fund would be financed by premiums to be paid by all municipalities and states with defined benefit pension plans. The premiums would be set at a level to ensure the solvency of PPGC, which would not have access to taxpayer dollars. Premium payments, termination liability, and investment earnings would be the agency’s sole financial support.
- Premium payments would be based on the size of a pension plan and its funding level, motivating public entities to minimize the size of their plans and transition employees to defined contribution plans. The best funded plans would pay the lowest premiums.
- The new law would provide for public pensions to be guaranteed only to the extent the benefits have already been earned. It would preempt state laws and constitutions providing otherwise. Future benefits not yet earned, including COLAs not yet in effect, could legally be reduced or eliminated in every State.
- The law would require that public pension plans be funded to a specified level – at least 80 percent – based on defined actuarial assumptions. Failure to reach the specified level of funding would result in higher premiums and – depending on the extent of the underfunding – benefit reductions. A transition period would allow states and municipalities not in compliance on the date of enactment of the law to come into compliance over a specified period of years.
- The law would require disclosure and reporting both to plan participants and PPBGC to promote the monitoring of regulatory requirements.
A national solution is needed to overcome local politics and state constitutions and laws that are roadblocks to significant reform. Fortunately, there is a way to set the country on a path toward fiscal stability, while at the same time protecting retirees and funding of pension plans. And all of this could be accomplished with no cost to the federal government. Congress should take action to implement a solution along these lines before the United States finds itself in similar straits to Brazil.