Pension Reform Hurts Public Sector Competitiveness

A new report exploring the effects of pension reform on state and local government competitiveness in the labor market has found that pension benefit cuts have hurt governments’ ability to attract new employees. 

“It is well known that pensions are a significant component of public sector compensation,” said the report, which was published by the Center for State and Local Government Excellence, a non-partisan, non-profit organization. “Hence, without offsetting wage increases, recent pension cuts may make public sector employers less competitive in the labor market.”

After the stock market crash of 2008 decimated the funded status of pension plans, many state and local governments enacted pension reform that reduced the benefits for new and current workers. The report tracked the number of benefit cuts made by the largest 160 pension plans on the Public Plans Data Website between 2005 and 2014, which are the plans and years for which data on benefit cuts were available.

“Cuts were relatively uncommon before the stock market crash of 2008,” said the report, “but quickly became more prevalent as plan sponsors realized the extent of the deterioration in their funded ratio.”

According to the report, common changes included increasing the normal retirement age, reducing the monthly benefit that workers will receive when they retire, requiring employees to contribute more to the pension fund, and reducing post-retirement cost-of-living adjustments. It also found that most of the cuts applied only to new hires because many states consider future accruals of pension benefits for current workers to be contractual obligations that can’t legally be reduced.

The cuts aimed at newly hired workers typically increased the normal retirement age and reduced the final-average-salary and benefit multiplier. And because cutting benefits for current employees is more difficult, both legally and politically speaking, cuts for this group generally entailed lower cost-of-living adjustments, and requiring higher employee contributions.

The report also noted that another change made by some pension plans was to add a defined contribution (DC) component to the traditional defined benefit plan.

“Unlike the other reductions, it is unclear whether these new hybrid plans qualify as benefit reductions since workers—particularly the young and mobile—might prefer portable savings accounts to traditional pensions,” said the report. “Still, because plans often reduce defined benefit multipliers when adding a DC component, they may be viewed as cuts in many cases.”

Overall, the report found that the research results imply that the public sector had trouble hiring and retaining the same type of workers it used to after a benefit cut

“While future research should continue to explore the effect of pension cuts,” said the report, “states and localities should at least consider how benefit cuts might affect worker recruitment and retention.”