If you wondered why there has been so much emphasis on eliminating the Alabama Deferred Retirement Option Plan (DROP) program, it can be summed up fairly simply…it is part of an effort to pull the state of Alabama back from the brink of fiscal insolvency.
Despite the misguided attacks launched by Alabama Education Association (AEA) lobbyists and AEA-backed legislators who supported DROP, the Legislature has taken a needed step toward reforming the state’s benefits and pension plans to make them affordable and sustainable.
Opponents of eliminating the DROP program have argued that eliminating the program is essentially an attack on teachers and other state employees. The fact is eliminating DROP saves the state of Alabama millions of dollars each year that can be directed toward saving teachers’ jobs, used in classrooms and to fund essential public safety and other state personnel.
At the present time, these pension and benefit funds are in serious trouble. In fact, a 2010 study by Joshua Rauh of the Kellogg School of Management at Northwestern University and Robert Novy-Marx of the University of Chicago Booth School of Business estimate that Alabama’s pension fund will run out of money in 2023.
This problem is not limited to Alabama. The estimated unfunded liabilities for all state pensions range from $1 trillion (Pew Center on the States) to over $5 trillion (Novy-Marx & Rauh). Even using the most conservative estimate, a trillion dollar shortfall is cause for major concern.
These unfunded liabilities are partly due to massive investment losses caused by the second worst economic meltdown in the last one hundred years. However, a larger part of the problem has to do with how generous the plans are for state employees.
While the majority of non-government (private sector) workers are in defined contribution plans, most state employees are in defined benefit plans. There is a big difference between the two.
In a defined contribution plan, the employer and the employee pay into the plan, but the employee directs how the money is invested, typically through options provided by the plan administrator. At retirement, the employee draws a pension from accumulated funds. These plans usually do not include additional payments by the employer, such as cost-of-living adjustments (COLAs). Since defined contribution plans are funded at the front end, future unfunded liabilities are avoided.
On the other hand, a defined benefit plan guarantees a benefit payment based on the number of years of employment and the employee’s salary and includes periodic COLAs. The last COLA of seven percent, which was approved by the State Legislature in 2006, increased Alabama’s pension costs by over $62 million per year and added over $817 million to the state’s long-term pension obligation.
The problem with a defined benefit plan is compounded by the fact that state employees are allowed to retire much earlier than workers in the private sector. In Alabama, there is no minimum retirement age, so state employees can retire when they have worked 25 years, regardless of their age. Because of longer life expectancies, this means that some retirees could draw a pension for more years as a retiree than they actually worked as an employee. As Marc Reynolds, Deputy of the Retirement Systems of Alabama (RSA), said in the October 2009 edition of the Advisor, the RSA’s monthly publication, “Twenty-five year retirement at any age makes no sense for a pension program.”
Reynolds is right. Not only does Alabama need to increase the number of years worked and set a minimum retirement age, the state should also consider ending the defined benefit program and implementing a defined contribution plan, much like private sector pension plans.
Nationally, 84 percent of state and local government employees are in defined benefit plans compared to 21 percent of private sector workers. Unlike private sector retirement plans, states with defined benefit plans are legally obligated to pay the pension, regardless of whether or not there have been sufficient earnings from pension plan investments to pay them. In that case, the taxpayers must pay for the pensions directly.
Since 2001, 39 states have enacted some level of reform to their state employee benefit and pension plans, and reforms will be considered this year in at least eight more states. Despite the protests from the AEA, with Alabama spending close to $2 billion dollars this year just to keep the health benefits and state employee pensions funded, the bottom line is that the Alabama Legislature must address overall pension reform.
About the author: Gary Palmer is president of the Alabama Policy Institute, a non-partisan, non-profit research and education organization dedicated to the preservation of free markets, limited government and strong families, which are indispensable to a prosperous society.
This article was published by the Alabama Policy Institute.
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Gary Palmer keeps earning his keep. His outfit is one of the numerous policy shops funded by right wing philanthropists, trade associations, and corporations. He and his reliably advance that which the American Legislative Exchange Counsil (ALEC) and the State Policy Newtwork (SPN) advocate.
ReplyDeleteThat Guv Bentley put this man on his "Alabama Commission on Improving State Government" truly frustrated me and yet people who fall for the ideas advanced by Palmer and his API are surely running our show. Then again, they've hardly been lacking in Alabama.
I've asked on various venues how the state will save money when DROP contributions are made by retired employees of money they've already earned. Letting Dr. Bronner and his crew play with that money, even at 4%, is till likely a decent outcome. I just don't understand from where these alleged savings flow.
It was rather generous for Mr. Palmer to even acknowledge that his blessed unfettered markets caused this mess. He and his sort preach deregulation and worship the wisdom of financeirs and other elites. The last three decades have seen the results as wealth has accumulated at the top and regular folks have barely held even or in some cases backed up.
Then again, Gary Palmer glosses over the fact that the market has only recently rebounded. I wonder if the study he cited holds as much sway given recent prosperity of the market. While I hardly use the market as the measure of success, that it has done so under the guidance of the new administration I would anticipate troubles Mr. Palmer.
As for his (and pretty much the whole of movement conservatism) idea of reeling in the public sectors' defined benefit plan, the times are right to employ "pension envy." Folks with 401Ks are surely hurting and they can resent the teacher or ... down the street much easier than the Wall Street swells that screwed things up.
It's undeniable that there's a war against public sector workers and also that some on the right would love to hand some serious money to financiers to scrape fees off the top as they invest on behalf of folks.
Cons like Gary Palmer have called the shots for far too long. It's time to reject their narrow view and try a Progressive, sustainable approach. John Gunn