Oklahoma Pension Plans: A House Finally in Order
Oklahoma’s pensions move towards financial sustainability: Oklahoma’s state pension funds, including its biggest plan covering Oklahoma teachers, have historically been among the less well‐funded in the nation. In the difficult financial circumstances since 2001, however, Oklahoma’s pensions have turned a corner, substantially outperforming typical state pension plans.
This progress relative to other state pension plans reflects the steps that Oklahoma’s legislature has taken over the past decade to ensure the long‐run sustainability of the state’s pensions:
- In 2006 and 2007, the state increased employer contributions to the Teachers’ Retirement System and enacted legislation that made it much more difficult to improve pension benefits.
- After a history of ad‐hoc cost‐of‐living adjustments (COLAs), the state in 2010 enacted a requirement that future COLAs be fully funded at the time of authorization, preventing the cost of COLAs being absorbed by the plans, and slashing nearly a third from their aggregate unfunded liabilities.
- Other changes provided additional dedicated revenue to the teachers’ pension plan, raised the normal retirement age for most new employees from 62 to 65, and increased employee contributions and reduced benefits for firefighters.
Many of these changes have required significant sacrifices by public servants – including current workers and retirees – such as the firefighters and police who put themselves on the line to make other Oklahomans safe, and the teachers who sacrifice higher private‐sector salaries for college educated workers out of their love for teaching and for Oklahoma’s children. For example, with COLAs ruled out for the foreseeable future, Oklahoma public employees who do not participate in Social Security – including many firefighters and police, and some rural teachers – no longer have any inflation protection in their retirement income. This makes these groups more vulnerable to inflation eating away their retirement income than the vast majority of other U.S. retirees, private and public. (Most U.S. workers enjoy full protection against inflation in at least the Social Security portion of their retirement income.)
The progress made on funding of state pensions is well recognized within Oklahoma, including by elected officials such as state Rep. Randy McDaniel and Senate Finance Committee Chair Mike Mazzei.
Oklahoma’s pension plans have now adopted best practices and have a cost for additional benefits earned each year (a “normal cost”) that equals only a small percentage of payroll. As a result of recent reforms, Oklahoma’s pension plans now exhibit the characteristics of best‐practice public pension plans highlighted recently by the National Institute on Retirement Security because they remained well funded through the financial market storms of the last decade. The best‐practice public pension plan features now in place in Oklahoma include:
- making actuarially required contributions, as Oklahoma’s plans began to do in 2011‐12;
- cost‐sharing between employees and employers – Oklahoma employees contribute more to their state pensions, on average, than workers in most states;
- not improving benefits or providing cost‐of‐living adjustments without paying for them in advance; and
- strong “anti‐spiking” protections, which ensure that the “final average salaries” used to compute pension benefits are not artificially inflated by promotions or overtime in workers’ final years before retirement.
By making Oklahoma’s defined benefit pension plans more financially sustainable, recent sacrifices by public sector workers have enabled the state to preserve the basic structure of defined benefit pensions. These pensions provide guaranteed benefits tied to final salaries and years of service, ensuring retirement security for long‐term career public servants. These pensions also have low costs, because they benefit from economies of scale, and high returns – for example, the state’s teachers’ pension plan has delivered investment returns of over 9%, on average since inception in 1943 and has been among the best performing plans in the nation in recent years.
Recent success stabilizing Oklahoma ‘s pension plans raises the bar for future reform proposals: given the low cost of Oklahoma pensions to taxpayers going forward and a credible path to full funding, it will be difficult for reform proposals to improve on the status quo. 401(k)‐type pensions: billions in transition costs plus “less bang for the buck.” The most prominent alternative pension approach under discussion would establish
401(k)‐style individual accounts for new employees, closing the existing defined benefit plans to new members. In place of defined benefits tied to final salary and years of service, employees would be guaranteed only the level of “contributions” made by employees and employers each year.
Research shows that defined contribution (DC) 401(k)‐type retirement plans earn lower investment returns than defined benefit plans, have higher fees, and also have high costs because of the high price for individuals to convert accumulated savings into a defined benefit (or “annuity”) until death.
Taking into account all the inefficiencies of defined contribution retirement plans, the plans cost 57% to 83% more in employee and taxpayer contributions to deliver the same level of retirement security.
A switch to individual defined contribution accounts for new employees would also lead to big increases in the unfunded liabilities of Oklahoma’s current pension plans, because it would lower investment returns on the assets of the current pensions. This happens because, gradually, those left in the existing pensions all retire or approach retirement. Lacking a balance between young, mid‐career, and retired workers, pension managers can no longer invest for the long term and also have to keep a larger share of pension assets in liquid form, ready to convert into pension checks. The shift to a more conservative investment strategy leads to lower investment returns. If investment returns now pay for less of pension debt, taxpayers have to pay more. In sum, a switch to defined contributions plans would increase the cost of paying off the existing defined benefit plans debt, currently estimated at $11.6 billion.
Cash balance: a new fad but less retirement security and potentially higher costs. A new pension favorite, now being promoted by the Pew Trust and the Arnold Foundation, is a “cash balance” (CB) pension. Similar to defined contribution plans, cash balance pensions do not guarantee a specific benefit tied to years of service. Instead they guarantee contributions from employees and employers each year plus at least a minimum annual interest rate on benefits (e.g., 4%).
- Although their impact depends on the specific features of the plan, cash balance plans would likely reduce benefits on average and even more deeply slash benefits for career employees who retire from public service.
- Since cash balance plans reduce the pension incentive to stay in public service but increase pensions for those who leave mid‐career, these plans could increase turnover among teachers, nurses, and other public servants. This could erode the quality of public services, and potentially requiring wage increases to increase retention.
- Cash balance plans risk lower investment returns – hence higher costs to achieve a given level of retirement security – because plan managers may choose to target only the interest rate guaranteed employees (e.g., 4% instead of the up‐to‐8% now targeted by Oklahoma’s pensions).
Hybrid pensions: mixing and matching flawed options. So‐called “hybrid” pension plans usually combine two types of pensions – the current design and a defined contribution or cash balance plan, or a mix of DC and cash balance plans. Given the almost limitless variations possible, detailed analysis of hybrid pensions is only possible once a specific proposal has been made. Nonetheless, to the extent that they include defined contribution or cash balance components they likely bring with them the limitations of these plan designs.
Oklahoma Pensions are not overgenerous and public employees earn less than comparable private workers. In the two biggest Oklahoma pension plans, pension benefits average about $19,000 and $18,000. These modest pensions compensate somewhat for public sector salaries that are substantially below private sector salaries for comparable employees (with the same level of education, experience, and other characteristics that impact salaries). In Oklahoma, moreover, teachers’ salaries trail those of equivalent private workers by even more than in the rest of the country. Thus today’s modest pensions are a critical offset against low salaries for the 78% female K‐12 teachers that hold Oklahoma schools together. If these pensions are further eroded, what incentive do teachers have to give their lives to educating Oklahoma’s children?
Don’t throw the Oklahoma pension house back into disorder. Given the progress made by Oklahoma pension plans over the past seven years, and the risks of defined contribution and cash balance plans, Oklahoma would be ill advised to shift its basic pension plan design.