Colorado’s budget faces a serious long-term threat from the unfunded liability in our state’s public pension plans.
If state leaders fail to make serious, substantive, structural changes in our public pensions, we will find ourselves choosing among breaking promises to our retirees, mortgaging our children’s futures, and cutting back on essential state services — or all three.
The Public Employee Retirement Association (PERA) admits to having $23 billion in obligations for which it has insufficient assets to cover. Using a more conservative discount rate, appropriate for a public pension obligation, the unfunded liability looks more like $57 billion, or $23,000 for every Colorado household.
To be sure, these are long-term obligations due over decades. Nobody is going to come to the door tomorrow and present the state of Colorado with a bill for $57 billion. However, as Detroit has shown, the always-future nature of public pension liabilities can make it easy to ignore them until it’s too late, and they become all-too present.
Colorado’s own relatively recent history provides much the same lesson. As recently as 2000, PERA was 105 percent funded. However, a combination of aggressive investments and generous benefits led to a precipitous decline in funding. By 2010, PERA’s defined benefit plan was only 65 percent funded.
With PERA’s inevitable failure obvious, the Legislature in 2010 passed Senate Bill 001. The bill included important reforms, such as increased contributions and a cap on the Cost of Living Adjustment for retirees at 2 percent per year.
Those changes brought PERA back to the path of being fully-funded – in 60 years. This year’s downward revision to an assumed 7.5 percent return has pushed that day even further out.
The assumption of a 7.5 percent return masks considerable risk and volatility. Although catastrophic market years such as 2008 have historically been rare, smaller routine losses are to be expected. Those losses can force an already-underfunded system to eat its seed corn by paying benefits out of assets that should be earning returns.
As a result, considerable risk exists that in the future, the state will still need to cut benefits to those who are already retired, to raise taxes, to cut services, or all three.
There is a way out.
First, in the interest of fairness, Colorado should gradually raise the retirement age to 67, and continue to have it match the appropriate Social Security retirement age. PERA seems to think that an average age of 61 for new retirees is old, but most of my contemporaries expect to work until they’re 70.
It is fundamentally unfair to ask the average taxpayer to work for an extra decade to fund the early retirements of their civil servants.
A higher retirement age is also probably the single actuarial change that will have the greatest effect on PERA’s solvency.
Second, Colorado should begin converting PERA from a defined benefit plan to a defined contribution plan. Defined benefit plans offer members a piece of a promise. A defined contribution plan assures them a piece of an asset, one they can know the value of at any time.
Such a conversion should not touch any vested benefits. It should be restricted only to benefits that are as yet unearned or unvested. Government employees who are nearest retirement will be affected the least; younger workers will have decades to adjust to fiscal reality.
It will also keep the unfunded liability from growing any larger, and indeed should reduce it over time, as benefits are paid off.
Public defined benefit pensions often assert that they produce higher returns at lower management cost than the private sector. Let them continue to do so. A switch to a defined contribution plan, such as the 457(b) plan that PERA already manages, shouldn’t mean throwing out PERA’s collective investment experience.
In the past, PERA’s happy talk and the political pressure of public employees concerned about losing their benefits have combined to stifle additional reform efforts.
Realization has grown around the state that something must be done, and state finances have started recovering. The next several years thus may offer the best time we will ever have to act, and brighten the prospects for Colorado’s future generations.
Joshua Sharf manages the PERA Project at the Independence Institute, a free market think tank in Denver. This op-ed originally appeared in the Greeley Tribune.