US Politics Mega-thread - Page 1071

A lack of inflation linking savaged the benefits of British pensioners, particularly in the 1970s. Even at 4% inflation, prices will double within 18 years, within the life expectancy of males and females retiring at 65. In other words, living standards will halve in such a scenario.

Most national govenment pensions (including the US's Social Security) try to offer inflation-linking to offset this risk. But around 25-30% of state and local government workers are not covered by the Social Security system, so the loss of this benefit could lead to substantial hardship, particularly in later years.

The problem for states and local governments is that defined benefit (final salary) pensions are easy to promise but expensive to deliver and the full bill takes decades to come due. A combination of buoyant equity markets and generous accoutnig assumptions made the promise seem fairly cheap in the 1980s and 1990s. And offering better benefits was a way of rewarding workers without pushing up the immediate pay bill (a move that might require higher taxes).

Cutting pensions is hard work. Many states have switched new employees to defined contribution plans, where the cost is strictly limited (there is no pension promise, and thus no shortfall to make up). But that does nothing to cut the cost of promises that have already been made. And courts have tended to rule that the benefits of existing employees are protected under contract law and thus cannot be reduced; join the workforce at 18 and the promise made by the employer must still be enforced at age 90.

One might think that such legal protection might apply to COLAs, but it seems not. The CRR says that of the 17 states that have reduced COLAs, 12 have been challenged in court. The courts have ruled in nine cases and have upheld cuts in all but one case. The CRR writes that

The main rationale for allowing the COLA cut is that COLAs are not considered to be a contractual right. For example, in Colorado, where the decision is currently under appeal, the judge found that the plaintiffs had no vested contract right to a specific COLA amount for life and that the plaintiffs could have no reasonable expectation of a specific COLA amount for life given that the General Assembly has changed the COLA formula numerous times over the past 40 years
Some changes in the COLA were surely overdue. Eight states had COLAs that were fixed at 2.5-3.5% a year regardless of the rate of inflation; in low inflation years, such as this one, that means a real increase in pension entitlement. Three of the states linked future COLA increases to the CPI, a perfectly sensible reform. Other states have COLAs linked to the CPI but with a cap; some have reduced the cap. At current low inflation rates, that won't hurt pensioners much (although, by the same token, it won't help the funding status of the plan much).

Some states have eliminated the COLA for a set period or for the forseeable future. These include New Jersey where a committee will be formed to determine whether the COLA can be brought back if the plan becomes 80% funded. As the CRR drily remarks

Since the state has allowed funding to decline since the legislation, the prospect of 80% funding is very unlikely
Cutting the COLA out completely can help a lot. The CRR estimates that eliminating a 2% COLA reduces lifetime benefits by 15-17%. And states probably need cuts of this magnitude. It takes a while for the figures in state pension plans to get updated (and the accounting is all wrong as mentioned before). But one can get an idea of the funding pressures from the private sector. After a good year in 2013, a lot of ground has been lost, largely because bond yields have fallen. According to Mercer, the pension plans of S&P 1500 companies have risen from $103 billion to $360 billion so far this year, leaving a funding ratio of 84%.

But is this the fairest way of cutting pension costs? The main worry is about people on low incomes, particularly those in state plans without social security. Better to have people retire later and to move to career average benefits, particuarly as final salary benefits mean that a few employees get huge and very costly retirement incomes (see the 12,200 Californians with six-figure pensions). But such approaches may not be legally possible; COLA cuts are the only weapon states can use.