Eight Ways to Avoid a Crash

Here's a list of practical pension-related recommendations, gleaned from lessons of the GM implosion, that may help cities and states avoid the same fate.

1. Reduce retiree pension and health benefits.This is tricky for several reasons. Cutting benefits for existing employees usually is judged a breach of contract that would violate the Constitution’s ban on government seizure of property. Cutting benefits for new hires is allowed, but the lower costs won’t be realized until those employees start to retire a couple decades from now.

2. Increase employee contributions and/or raise the retirement age.Either move would require negotiations with unions, which are certain to mount stiff opposition, but ten states increased required employee contributions to pension and benefit plans in the past two years, according to a recent report by the Pew Center on the States. Others have raised the minimum retirement age. Now seems a good time for more states to follow suit.

3. Establish a VEBA trust for retiree health care.Here’s where states and municipalities can learn a positive lesson from the auto industry. Before 2007, retiree health care expenses were unlimited for automakers. But now Detroit has capped those expenses by establishing a Voluntary Employees’ Beneficiary Association trust for its hourly workers. Each company funds the trust at a predetermined amount. The funds are administered by the United Auto Workers union, which sets benefit levels at whatever the trust can safely afford. The system isn’t cheap, but it’s better than the previous, blank-check arrangement.

4. Switch to defined contribution plans.State and local governments ultimately might have to resolve their pension crises the same way that most private companies have: by switching from defined benefit pensions to 401(k)-type plans. A few governmental units have done this already, including about one in every three municipalities in Connecticut. Fixed pensions are maintained for existing employees in those towns, but new employees get defined contribution plans. Public sector unions will resist this change, but Connecticut’s budding success stands as proof that it can be done.

5. Adopt realistic accounting standards.States need to mark retirement plans to market, properly account for losses and be more realistic in their investment-return and discount-rate assumptions. Legislation to this effect should further require that the extent of any pension deficit be posted and clearly explained.

6. Sell pension obligation bonds.A logical but dangerous solution, especially if bond issuance itself becomes a liability, as it has in New Jersey and other states. Bonds should not be a substitute for a state’s contributions to employee pension funds.

7. Pay regularly into the system.Obligations need to be honored. State-mandated holidays or debt reprieves only delay the inevitable.

8. Improve portfolio management.Sensible diversification remains key to preserving capital in down markets.