All signs point to pension reform being a central issue in Oklahoma's next legislative session. Both Gov. Mary Fallin and Treasurer Ken Miller have said the state's unfunded pension liability, which market valuations estimate are as high as $33 billion, is the one of the final hurdles in the state's quest to regain its AAA credit rating.
With pension reform a possibility, though, the governor and legislators should focus on truly fixing the state's pension problems. They need to know what creating a defined contribution (DC) system for new hires does to reduce the existing unfunded liability: nothing. That move should be accompanied by reforms to the existing defined benefit (DB) structure. This dual approach is the only way to ensure that the growth in retirement obligations doesn't crowd out funding for vital public services like education.
The state should craft a plan to reduce the unfunded liability over a judicious yet fiscally responsible period. To get a more accurate picture of the hurdle presented by the unfunded liability, Oklahoma should immediately begin using lower, risk-free discount rates to value the amount owed in the future. This may mean higher costs today, but will put the state on a sounder financial footing in the future.
The burden cannot be placed solely on taxpayers. Sacrifices must be shared, whether that means increased employee contributions, adjusted benefit accrual rates or reduced cost of living adjustments.
The DB model is at the root of Oklahoma's pension funding dilemma, and a DC system offers a compelling solution. The difference between the two shows why leaders must avoid half-measures like an optional DC plan or “cash-balance” plan.
With benefits guaranteed, DB plans leave taxpayers on the hook whenever promised benefits outpace the ability of the fund to make payments. Public employers often fail to achieve expected investment returns and regularly skip their annual required contributions into the pension funds. Between 2002 and 2011, Oklahoma skipped $3.6 billion in these required payments.
In a DC plan, costs to employers remain consistent as a percentage of salary year in and year out, and employees know immediately if their employer doesn't make their pension contribution. With professional and prudent investment guidance, employees are able to guarantee themselves a secure retirement.
Merely an optional DC plan is inadequate. It would not put an end to the havoc wreaked on state finances by the existing retirement options. A “cash balance” plan would maintain the negative portions of the existing system while offering only a fictional nod to a DC system. In such an arrangement, a set benefit remains legally guaranteed and taxpayers are still left to foot the bill.
With a real chance at pension reform in the 2014 legislative session, Oklahoma's leaders need to prepare for meaningful pension reform. Without immediately addressing the unfunded liability and the question of how to offer a secure retirement benefit for future employees, the state will be left scrambling in future legislative sessions for the resources to pay existing obligations alone.
Williams is president of State Budget Solutions, a national organization dedicated to fiscal responsibility and pension reform.