Pension policy can be insidious. Seemingly small benefit changes turn costly over time. That’s why it makes no sense for lawmakers to tamper with established plans. But when they do, they should give themselves a clear out.
That’s what state legislators did with two pension enhancements adopted when the economy was more robust. Recognizing that the good times may not always roll, they included language reserving the right to amend or repeal the enhancements. When they exercised that right, public employee unions took them to court. While lower courts held for the unions, the state Supreme Court last week upheld the Legislature’s actions, saving the state billions of dollars in pension costs.
At issue were a “uniform cost-of-living adjustment” (UCOLA) and “gain-sharing,” an ill-conceived policy that increases benefits when then the pension system’s annual investment returns top a threshold over several consecutive years.
The UCOLA applied to members of the state’s oldest pension plans, closed to new members in 1977. It was established in 1995 and provided an annual benefit bump based on years of service. Although it replaced other cost-of-living adjustments, those increases were subject to the discretion of the state department of retirement systems and rarely granted. Determining that the pension programs had become underfunded, lawmakers repealed the UCOLA in 2011. The benefit enhancements already granted remained in place. The effect of repeal is entirely prospective. No future UCOLA adjustments will be made.
While COLAs may seem commonplace in some circles, gain sharing stands alone as a perversely one-sided compensation policy. Its nearly unanimous passage in 1998 reminds us that even smart people make bad decisions in a bubble.
It’s as if the croupier says, “I’ll share my winnings with you and pay all your losses.” Who wouldn’t come to the table for a deal like that? But eventually, the house runs out of money and closes the game.
That’s gain sharing. There were two distributions, in 1998 and 2000. Together, they increased state obligations by $924 million. Then came the lean years.
In the dry language of the court decision, “Because employee contribution rates … were fixed, it became necessary to increase employer contribution rates after gain-sharing events to accommodate years of poor investment returns.”
When they say “employer contribution rates” they mean taxpayer funding from the state budget.
Lawmakers saw the light and repealed the measure in 2007, adding replacement benefits for members of the affected groups.
The state Supreme Court heard the two cases together last fall.
Had the court found for the unions, the budget consequences would have been dire. According to the state actuary, the combined effect of reinstating the UCOLA and gain sharing would have increased state spending in the 2015-17 budget by $766 million. Local government would have had to increase spending $570 million. The long-term consequences compound into the billions.
On cue, leaders of public employee unions denounced the decision. The head of the Washington Education Associationclaimed the court was allowing the state to renege on promised benefits and “take away what educators had already earned.”
If that were true, the court would be wrong. But in these cases the unanimous court got it exactly right.
Attorney General Bob Ferguson summarized the outcome.
“Today’s decisions preserve the rights of public employees to receive the basic pension benefits the Legislature has promised, but make clear that the Legislature has the flexibility to add temporary benefits without being locked into providing them forever,” he said.
Right. To have ruled otherwise, the court noted in the UCOLA decision, “would strongly disincentivize (sic) the legislature from providing additional benefits beyond a basic pension.”
Applaud the rulings and amplify the disincentives. As long as lawmakers are in the pension benefit business, more mistakes are likely. Accepting short-term gain at the risk of long-term pain is not unusual in political environments geared to a two-year election cycle. The temptations are inherent so long as the state remains in the defined benefit world. Most private employers have moved to defined contribution systems — IRAs and 401(k) plans — allowing employees to manage their own retirement futures. To reduce political temptation and financial risk, the state should do the same.
Richard S. Davis is president of the Washington Research Council. Email rsdavis@simeonpartners.com
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