New Jersey took an important step to improving the dire condition of the state’s public pension plans. But it will not close the funding gap.
On June 28, New Jersey Governor Chris Christie signed into law pension and health-benefit reform legislation aimed at increasing its state and local pension systems’ funded ratio from 62 percent to more than 88 percent over 30 years, with underfunding at $37 billion by 2041. It increases most employees’ contributions from the current 5.5 percent to 6.5 percent, with an additional 1 percent phased in over seven years. The legislation also eliminates automatic cost-of-living adjustments (COLAs) for retirees and raises the pension-eligibility age for many employees from 62 to 65.
The changes at least move in the right direction─if they last past the Christie regime, says Jeremy Gold, a consulting actuary at Jeremy Gold Pensions. “The bill is nowhere near a solution. But if they said, ‘We are inflicting all this pain and it is not even close to solving the problem,’ they could not have gotten anyone to vote for it,” he says. “It is sad but true that they achieved everything they could have achieved.”
New Jersey’s public pension plans have about $119 billion in underfunding currently, estimates Joshua Rauh, associate professor of finance at Northwestern University’s Kellogg School of Management. With these measures, he says, “New Jersey moved itself from the top of the list of the most-troubled states to a state in the top third, but not a standout.” To give a sense of the magnitude of its problems, if the state relied on employee contributions alone to reach full funding, that would require withholding 31 percent of employees’ pay, he says.
The COLA provision has not gotten much attention, but actually will achieve the biggest savings. “On a national level, we have calculated that a one percentage-point cut will reduce a plan’s total liabilities by 10 percent, and its unfunded liabilities by 15 percent,” Rauh says. “In New Jersey, we could see that provision potentially solve 40 percent of the unfunded-liability problem.” The law includes an option to reinstate the COLA after the system reaches 80 percent funding, and he wonders what will happen if the funded status hits that threshold for a short time.
If New Jersey had not passed the reforms and decided just to rely on taxes to close the funding gap, Rauh says, that would have required an extra $2,475 per-household, per-year tax hike for 30 years. Assuming the COLA truly has been eliminated, that hypothetical number drops to $1,500 to $1,750, he says.
The fact that the state often has skipped its own pension contribution plays a big role in the underfunding, Rauh says. “In recent years, New Jersey has been contributing on average around 35 percent of what its actuaries said they have to contribute to its pension systems,” he says. “It is an outlier in that regard.” The state reportedly has a plan to phase in making its ARC (actuarially required contribution) over seven years. Pulling that off “is going to require a substantial increase in the money going into the funds,” Rauh says, citing the state’s report that it contributed $3.6 billion in 2009. To reach full funding, he says, “in our measure, they would have to start contributing $11.9 billion per year now, for the next 30 years.”
That seems like an iffy scenario. And despite what some argue, a switch to defined contribution plans will not solve the state’s problem, Gold suggests. “You are still stuck with the legacy costs of the pensions, and you also are stuck with a system that does not meet the needs of employees and retirees,” he says. So the debate will go on for 20 years, he says: The damage is done, who is going to pay for it? “Ultimately, some employees will have to leave their jobs, and some taxpayers will lose services they need,” he says. “But that is what we get for violating the laws of finance, year after year after year.”
