Public Pension Reform

January 14, 2014

Redesigning the public pension benefit structure is the key to developing a fiscally sustainable pension model, say Carl. A Hess, the global head of Towers Watson Investment, Thomas J. Healey, a senior fellow at Harvard University's John F. Kennedy School of Government, and Kevin Nicholson, a consultant at McKinsey & Company.

  • The nationwide public pension deficit is estimated at somewhere between $730 billion and $4.4 trillion.
  • In Detroit alone, the unfunded pension obligation is $3.5 billion, according to the city's emergency manager Kevyn Orr.

As calculated by Hess, Healey and Nicholson:

  • Increasing the retirement age to 65 reduces pension costs from 22.5 cents for every dollar of salary to 16.8 cents (a savings of 25.3 percent).
  • Changing the final average compensation base to the course of a career cuts pension costs from 22.5 cents to 15.1 cents (a savings of 32.8 percent).
  • Removing the cost of living adjustment reduces pension costs from 22.5 cents to 17.2 cents (a savings of 23.5 percent).

If all of these policy changes were implemented together, annual pension costs could be reduced by a full 62 percent, down from 22.5 cents to 8.4 cents per dollar of salary.

Several states and municipalities have implemented reform programs that illustrate that it is possible to tackle the problem of pension plan underfunding:

  • In Illinois, the state has reduced the cost-of-living allowance, increased the retirement age for younger workers and has imposed pension limitations on the highest-paid workers.
  • In the city of Atlanta, current employees are required to contribute an additional 5 percent of their compensation if they wish to keep their defined benefit plans. New employees are enrolled in a hybrid plan that uses a traditional pension as well as a plan similar to a 401(k).

More states and localities need to look closely at the many potential benefits of pension reform.

Source: Carl. A Hess, Thomas J. Healey and Kevin Nicholson, "Public Pension Reform: Benefit Design as the Key to Sustainability," Public Sector Inc., January 7, 2014.

 

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