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Research & Commentary: Iowa Needs Pension Reform

December 15, 2017

In this Research & Commentary, Matthew Glans examines the need for comprehensive pension reform in Iowa.

Iowa’s pension system is accruing long-term debt at a rate the state may not be able to sustain, despite recent efforts by officials to curb the problem. According to the Des Moines Register, a recent actuarial study found Iowa currently faces $6.96 billion in total unfunded liabilities for all its membership groups. The main purpose of the report was to examine the effects of a reduction in the state’s annual average target for the Iowa Public Employees’ Retirement System investment returns, which was reduced from 7.5 percent to 7 percent. The report found the change in expected returns resulted in an increase in the pension fund’s long-term unfunded liabilities of nearly $1.4 billion. 

According to a new study published by the Reason Foundation, when a sounder method for determining pension liabilities is applied to state pensions, states’ liabilities appear far worse, but in actuality, they more closely reflect reality. Most states use inflated assumed rates of return as the discount rate when determining the value of future promised pension benefits; these estimations assume investment returns that are unrealistic and are unlikely to provide the funds expected to cover these liabilities in the future.

While lowering the rate of return is a positive step, 7 percent is still too high. If the rate of return consistently falls short of expectations in the near future, the state’s pension system may be in even more trouble than is currently thought. Pension experts recommend states use an expected rate of return between 2.3 percent and 3.1 percent – figures based on Treasury bond yields.

There are several reform paths states can follow to provide substantive retirement benefits to state workers while keeping costs and future liabilities under control. One option that has been around for decades but has recently become more popular is the hybrid model. A hybrid model combines defined-benefit and defined-contribution approaches for the same group of workers.

One hybrid pension model that could serve as a model for Iowa was created in Rhode Island in 2011. Rhode Island’s pension system had faced an unfunded pension liability of $6.8 billion and was less than 50 percent funded. The state passed the Rhode Island Retirement Security Act, introducing a hybrid defined-benefit/defined-contribution funding system, suspending cost of living adjustments for retirees, and increasing the retirement age. The plan also addressed the state’s labilities problem by extending the amortization rate from 19 years to 25 years. This made it easier for the Rhode Island government to handle pension debt payments.

Under Rhode Island’s hybrid model, employees and employers must contribute to employees’ retirement accounts, which grow over time through various investment strategies. If an employee leaves the public sector, he or she can withdraw the accumulated balance in the pension fund, which can then be used to purchase an annuity in the private sector.

While Rhode Island’s model is far from perfect, it demonstrates how a hybrid model must be paired with other common-sense reforms to succeed. Hybrid models do not eliminate all the problems of defined-benefit plans, but they do limit the rapid growth of liabilities in the future. 

Iowa policymakers should consider using hybrid plans as a viable model for reforming state workers’ pensions.

The following documents examine hybrid pension models in greater detail.
 

Iowa Legislature and Governor Need to Focus on Pension Reform
http://www.limitedgovernment.org/publications/pubs/studies/ps-13-6.pdf
Deborah D. Thornton of the Public Interest Institute examines Iowa’s pension system and argues for comprehensive pension reform. “If additional reforms are not considered and implemented by the Iowa Legislature, IPERS will remain at significant financial risk of under-funding in the future. The amounts owed to both current and future beneficiaries must be paid by future taxpayers — the younger workers of today and tomorrow. And many of these future taxpayers are already finding their financial future constrained because of a lack of jobs,” wrote Thornton.

Which States Are Hiding the Most Pension Debt
http://reason.org/news/show/states-hiding-pension-debt?utm_medium=email
Zachary Christensen of the Reason Foundation analyzes the actuarial valuations of the top 649 pension plans in the country to compare their reported value of unfunded liabilities to the pension debt calculated using a market value of liabilities. The results show many states are underreporting the liabilities they face.

Hidden Debt, Hidden Deficits: 2017 Edition
https://www.hoover.org/research/hidden-debt-hidden-deficits-2017-edition
In this study, Joshua D. Rauh of the Hoover Institution applies market valuation to pension liabilities for 649 state and local pension funds and says that despite the introduction of new accounting standards, the vast majority of state and local governments continue to understate their pension costs and liabilities by relying on investment return assumptions that range from 7 percent to 8 percent per year.

The Path to Public Pension Reform
https://www.mercatus.org/publications/path-public-pension-reform
In this Policy Briefing, Eileen Norcross and Olivia Gonzalez of the Mercatus Center at George Mason University discuss pension reform. They argue true reform must address “the inherent problems of public-sector accounting and management of pension funds and consider the benefits of defined contribution plans for public-sector workers. Reforms should be equitable for all generations, fund retirement benefits adequately, and have a plan for funding legacy obligations.”

Pension Reform Handbook: A Starter Guide for Reformers
http://reason.org/files/pension_reform_handbook.pdf
This paper by Lance Christensen and Adrian Moore of the Reason Foundation considers many of the problems that troubled pension systems often experience. The authors also outline several principles they believe should be used as part of any pension reform effort.

Not So Modest: Pension Benefits for Full-Career State Government Employees
https://www.heartland.org/publications-resources/publications/not-so-modest-pension-benefits-for-full-career-state-government-employees?source=policybot
Examining the benefits paid to state and local government employees, Andrew Biggs of the American Enterprise Institute argues drastic benefit reductions for current retirees would be unfair, but reforms to make public- and private-sector pensions more equitable should be on the table.

The State Public Pension Crisis: A 50-State Report Card
http://heartland.org/sites/all/modules/custom/heartland_migration/files/pdfs/27578.pdf
This Heartland Institute report examines problems facing public pension systems, including the enormous burdens public employee pensions pose in some locations. The report ranks each state according to the operation and relative disposition of the pension plans and suggests ways states might go about solving pension problems.

Keeping the Promise: State Solutions for Government Pension Reform
http://heartland.org/policy-documents/keeping-promise-state-solutions-government-pension-reform
This report from the American Legislative Exchange Council describes the variety of pension plans governments use today and the advantages and disadvantages of each plan. It also provides several tools legislators can use to ensure governments can affordably fund retirement benefits for their employees.

Defined Contribution Pension Plans in the Public Sector: A Best Practice Benchmark Analysis
http://heartland.org/policy-documents/defined-contribution-pension-plans-public-sector-best-practice-benchmark-analysis
This white paper from the TIAA-CREF Institute “addresses best practice benchmarks for the design of public sector primary (core) defined contribution pension plans. It includes an examination of the environmental conditions and factors affecting these plans as well as general principles for the design of effective defined contribution plans. Selected public sector core defined contribution plans are reviewed against identified best practices.”

 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website at https://www.heartland.org/publications-resources/newsletters/budget-tax-news and The Heartland Institute’s website at http://www.heartland.org.

Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on the topic, Heartland can assist you. If you have any questions or comments, contact Heartland Institute Director of Government Relations John Nothdurft at john@heartland.org or 312/377-4000.

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR