Reform for Connecticut’s pension system

Recently I wrote about the difficulty, even impossibility, of funding Connecticut’s ever-growing pension liability. The article elicited a number of comments, and all agreed that something must be done. Here are my own recommendations for reform.

First, a relatively small but significant first step in reforming the system would be to freeze pension benefits for all existing state employees not covered by union contractual obligations. These employees would include non-union members and employees of the state’s executive, legislative, and judicial branches. It would also include all administrators in the University of Connecticut system.

In the future these employees could participate in a defined contribution or 401k-type plan. This reform would still provide them with a retirement income, consisting of the vested value of the current plan as well as the accumulated value of the new defined contribution plan. This combination would still be superior to what is available to ordinary citizens in the private sector.

Removing legislators and other political appointees from participation in the state pension plan does not involve breaking any sacrosanct union contracts. Not only will such a reform help to reduce the state’s unfunded pension liability, but also it should provide legislators and other officials with an incentive to reform.

Under the present system members of the state government were always on the same side of the table with the public service unions when it came to pension negotiations. Everything they gave to the unions also benefited them since they were participants in the same plan.

Secondly, the lion’s share of the huge unfunded pension liability is the extremely generous contractually binding retirement benefits enjoyed by members of the various public service unions. The benefits are extremely generous because the retirement income is based on the average of an employee’s highest three years pay (Final Average Pay).

Most state employees start at relatively modest salaries and their pension contribution is a percentage of that amount. Someone who starts at $30,000 is required to contribute about $2,000 per year to the pension plan. That contribution will never be enough to adequately provide a pension 30 or 35  years later of 70 percent of one’s highest pay. For example, teachers starting today at $40,000 will certainly be earning over $160,000 by the end of their careers, and be eligible for pensions in excess of $100,000.

Even though many public service employees gripe about their pensions, a simple comparison with Social Security will point out the disparity between the benefits that this minority enjoys and those enjoyed by the rest of us who are covered under Social Security. The pension benefit in Social Security is based on an average of earnings over a 30-year period, and not on the highest three years. Teacher union leaders like to point out that Connecticut teachers are not covered by Social Security, but they react with horror at any suggestion that their pension plan be replaced by Social Security.

So, how is it possible to reform the pension system without starting a Greek style revolution among our public service employees? Their pension benefits are guaranteed by law and contract. Any solution must be agreed upon by union members. Unless a moderate solution is found, the state faces economy-busting tax increases, or even bankruptcy. I suggest that it might be possible to get the unions to agree to a modification of the benefit formula that would be phased in gradually.

For those retiring in the next three years “Final Average Pay” would still be the average of their highest three years pay. But for those retiring after, “Final Average Pay” would be the average of the number of years of service from the present to their actual date of retirement. For example, the pension of an employee retiring in five years would be based on the average of the five last years of service: for those retiring in ten years the pension would be based on the average of the last ten years of pay, and so on. Ultimately, final average pay would be based on the average of an employee’s pay over an entire working career.

The adoption of this new formula would not hurt anyone close to retirement. Those further away from retirement would still enjoy retirement benefits superior to anything available to citizens in the private sector. In addition, they would be able to supplement their retirement income by contributing to tax sheltered retirement plans available to public employees.

The new pension formula would allow the state’s pension actuaries to get a much better handle on the actual size of the unfunded liability. After all, how is it possible to really estimate the figure when no one can tell how much an employee will be making in the last years of service? This reform would also put an end to the nefarious but little known practice called “spiking,” whereby employees find ways to dramatically increase their salaries in the last three years of service.

A sweetener could be offered to the unions to help gain their consent to this modification of the pension benefit formula. Once the actuaries determine the savings resulting from this change in pension benefits, a pay raise could be offered to all consenting unions. I would suggest 15 percent for employees earning under $50,000; 10 percent for those earning between $50,000 and $100,000; and 5 percent for those earning over $100,000. Many union members might want to choose higher current pay in exchange for a modest reduction in future retirement benefits. They have already agreed to do this for future state employees.

The enormous unfunded pension liabilities of the State of Connecticut must be an issue in the November gubernatorial election. Whoever is governor after the election will inevitably have to reform the state’s employee pension plan or face the real possibility of bankruptcy.

Francis P. DeStefano, Ph.D., of Fairfield, is a writer, lecturer, historian and retired financial planner.