Colorado’s proposed pension reform is a missed opportunity

In November of 2016, Colorado’s Public Employees Retirement Association Board (PERA) realized it had a problem. Not only did the state’s public pension system have a current unfunded liability of $50 billion, but overly-optimistic expected returns and overly-pessimistic mortality tables would leave the plan at less than 20 percent funded in a couple of decades – and that was if it met its expected returns.

Thus began a year-long quest for a reform package, the fourth such effort since 2004, to shore up the plan’s finances. PERA and Gov. Hickenlooper’s office each produced plans, and after months of consultations, Senate Republicans and House Democrats produced a bipartisan bill of their own, Senate Bill 18-200, a heavily amended version of which recently passed out of a Democrat-controlled House of Representatives committee. The bill as amended represents a missed opportunity that would only double down on the worst aspects of public pension finance.

{mosads}The version of the bill that passed out of the Republican controlled senate contained a number of solid provisions revising the funding and benefits formulas, and it also increased legislative oversight, added independent voices, and expanded the defined contribution (DC) option for new employees.

But it also missed an opportunity for even more far-reaching and substantial reforms.

First, all new employees should be in a DC plan. While that would still leave the unfunded liability of $50 billion for the current defined benefit (DB) plan to be dealt with, it would keep matters from getting worse. Current PERA members should also be able to go to the DC plan. Members could take their own contributions and the actuarial value of their vested benefits with them; PERA would be able to set the price, making the transition cost-neutral to PERA.

Barring that, we would have preferred an entirely new, more conservative DB plan with no employee contribution above the normal cost, and separate accounting for employer contributions going to the normal cost and the unfunded liability.

The bill implements neither of those reforms. Therefore, the defined contribution plan should be the default option for all new members, rather than the defined benefit. Not only is it fiscally sounder, the default option also tends to be “sticky” – people tend to stick with what they’re put into as a default. Making the DB the default will tend to minimize DC participation, leaving the door open to yank the DC option altogether.

Second, a permanent legislative oversight committee with independent, non-voting experts appointed by the State Treasurer is the minimum of governance reform we should expect.

But this bill doesn’t reform the board, nor does it prevent the board from using public money to lobby the legislature for or (mostly) against additional proposed reforms. Allowing the board to lobby against additional reforms raises the stakes for this bill, which is bad, but also increases the likelihood that we’ll end up back in the same place in a few years. If that happens, the current crop of legislators will have failed the citizens of the state and PERA members alike.

In addition, the board should be reconfigured with more appointed and fewer elected members. Academic studies have shown that independent boards are associated with higher credit state credit ratings and sounder funding policies.

Finally, PERA needs to ask multiple investment firms to estimate returns on its current portfolio. It should also decouple its discount rate from its rate of return, using something like the Muni 20 Index. It will only do these things if required by law. For those who dismiss these requirements as details, we should remember that the current crisis was initiated when PERA lowered its expected rate of return from 7.5 percent to 7.25 percent.

For the knobs and dials of benefit and contribution changes to mean anything, the discount rate and rate of return need to reflect reality as well as they can. Otherwise, it’s like trying to fly a plane into the mountains using a chart of the eastern plains. Just as the mountains don’t care what chart you have, the markets couldn’t care less what your estimated rate of return is.

Unfortunately, the House Democrats chose to weaken what reforms there were, eliminating independent experts from the new oversight committee and keeping teachers locked into the unsustainable defined benefit plan, along with other changes that hide the magnitude of the problem. What had been a missed opportunity is now worse than useless, doubling down on the failed defined benefit model.

Instead of looking forward to the next crisis and response, the legislature should scrap this effort and start over with the intent of avoiding the next crisis altogether.

Joshua Sharf (@JoshuaSharf) manages the Public Employees Retirement Association Board Project at the Independence Institute (@i2idotorg), a free market think tank in Denver.