Securing the future or undermining it? Both are possible outcomes from the Legislature’s recent reform to the state pension system serving most state employees.
In the closing week of the 2014 legislative session the Legislature approved HB 2630 — the so-called “Retirement Freedom Act” — which would change the pension system for most new state employees from a defined benefit plan to a defined contribution plan. The bill exempts state employees served by other public pension funds including teachers and public safety officers.
Under the proposal, most new state employees would be required to contribute a minimum of 3 percent of their new salary to a fund similar to the 401(k)-type funds commonly used in the private sector. The state would match the employee’s contribution (up to 7 percent). Once vested, new employees would have access to 100 percent of these funds plus investment earnings if they leave their state job. In exchange, they would forego the retirement benefit that current employees will receive upon their retirement.
In the private sector, such transitions have been happening for decades. Why? There are two reasons. First, in the long run it is less costly for employers to operate a defined contribution plan than a defined benefit plan. Second, it gives workers more control over their funds and more security that funds will be there when they need them.
Essentially, traditional pension funds are plagued by the same dynamics that trouble the nation’s Social Security system. Current workers pay into a system, with the expectation that they will receive a promised benefit when they retire. In the meantime the control of the funds rests with the pension and not the employee. Everything works great as long as the workforce is growing and people aren’t living longer. However, as we’ve seen over time, workforces don’t always grow and advances in health care mean people live much longer than they used to. Notice that both effects are working to weaken the long-term solvency of the pension fund.
There are two straightforward ways to resolve this problem — reduce benefits being paid or increase the amount current workers are asked to pay. Neither step is popular and so often both are avoided for as long as possible. This leaves pension fund operators with a third choice — pursue larger investment returns on the funds they collect. If the investment returns are large enough (and sometimes that is a very big if), then the pension can continue to meet its obligations indefinitely.
Since some of the workers paying into the system will not be retiring for decades, the pension fund’s investment managers can afford to make more risky investments and achieve those higher returns. But the passage of HB 2630 threatens to change this dynamic and for the worse.
By taking new public employees out of the system, over time the mix of employees still in OPERS will age, thereby shrinking the investment horizon. As this shrinks, the fund must make less risky (and lower return) investments to ensure payments will continue to be available. In other words, the fund won’t be able to pursue the higher investment returns it needs to remain viable. In short, shifting to a defined contribution plan will necessarily weaken the ability of the defined contribution plan to meet its obligations.
This does not necessarily mean the passage of HB 2630 was bad policy. In fact, much like we’ve seen with the private-sector pension plans, this move was inevitable. Furthermore, in an era when workers are concerned that the nation’s promised Social Security benefits will not always be fulfilled, the new state retirement plan would give workers ownership of some of their retirement funds. In a very real sense, this move helps secure the retirement futures for new state employees.
However, we must also never forget the promises our state has made to the thousands of current and retired state workers — those who devoted their careers to building a better Oklahoma, and those whose retirement security is still in question.
MICKEY HEPNER is the dean of the College of Business Administration at the University of Central Oklahoma. Hepner serves on the Executive Committee of the Board of Directors for The Oklahoma Academy.