Vermont Needs A Defined Contribution Plan--Now
Op-Ed from Don Turner
I’ve previously written about how our unfunded pension liabilities are Vermont’s sleeping giant. We owe our state employees and teachers about $4.5 billion more than we have in the bank. We’ve seen two credit-rating downgrades in one year. Our “funded ratio” (the ratio of assets to liabilities) is only about 64.3 percent, below the national average. We’ve lived through years of underfunding where, until 2008, the state made payments as low as 38.4 percent of what was recommended by professional actuaries. We’re forced to spend hundreds of millions on required principal and interest that would have otherwise gone towards higher education, child care, or any number of meaningful programs. And the projected rates of return on our pension investments are still far below actual returns. These are the facts.
It’s true that, over the past few years, we’ve taken modest steps to reverse these trends, including dedicating more toward paying down this enormous debt. But so long as we refuse to have a serious conversation about fundamental pension system reform, these investments are like trying to bail out a boat without addressing the leak. It won’t work. First, we need to plug the hole.
And to do that, we need to have a serious conversation about pension reform. Specifically, we need to look at switching the pension system for new hires to a defined contribution structure. Currently, most state employees are covered under a “defined benefit” program, which guarantees specific retirement payments and benefits. Defined contribution plans place invested contributions into an investment fund that the employee can control.
The problem is that defined benefit plans with generous benefit structures (like Vermont’s) can lead to expensive consequences that generate massive unfunded liabilities--which is exactly what we’re experiencing now. Let me be clear: I am not advocating for taking away the defined benefit plans guaranteed to Vermont’s state employees and teachers. All those in their current pension plans should be able to remain in them. We have an obligation to keep the promises we’ve made; not break them.
Rather, I’m suggesting we change the pension structure only for new hires. Additionally, existing hires should be given the choice to opt-into a defined contribution plan. This proposal has been endorsed by Vermont pension-guru David Coates, former Governor and Treasurer Jim Douglas (who oversaw multiple upgrades to Vermont’s credit rating), and has also been suggested by the Vermont Business Roundtable. Even the 2009 special pension commission chaired by Former Democratic Treasurer Jeb Spaulding reported that, while the majority of the commission did not want to implement a defined contribution plan at that time, “the majority did recommend further consideration of this issue in the future.” It’s been 10 years since then; today is the future.
Some, including Treasurer Pearce, stand in opposition to defined contribution plans. However, this stance remains in stark contrast to the growing number of states who are switching in-mass to defined contribution (or in some cases, defined benefit-defined contribution hybrid) plans. In a country that was once dominated by defined benefit plans, now over a third of U.S. states have moved away from them and towards full defined contribution or hybrid plans. Of the five states with the lowest funded ratios (according to Pew), four of them have moved to defined contribution or hybrid plans over the last 20 years in recognition of their need for structural reform. The only one that hasn’t is Illinois, whose pension crisis has progressively worsened, leading the state to near junk-bond status.
Additionally, the Treasurer’s assertions rely largely on some studies suggesting that defined benefit programs have better investment performance. But other studies suggest defined contribution plans’ annualized net returns exceeds that of defined benefit plans for the 10 years preceding 2016. Look at it this way: The State of Vermont already offers a defined contribution plan for some 600 or so exempt state employees. It’s unfunded liability? Zero. That’s pretty compelling next to a $4.5 billion unfunded liability for our defined benefit plans.
I’m not keen to rely on the Treasurer’s “expertise” on this matter. In fact, under Treasurer Pearce’s watch, we’ve seen our funded ratio decline, our credit rating get downgraded (twice), and our pension investment performances continue to struggle. Pearce also deployed and defended the disastrous “select-and-ultimate” rate system from 2012 to 2015, which drastically reduced General Fund support for the pension system. We need a new perspective; not the same failed policies that got us into this mess.
Contrary to what the Treasurer suggests, not only could a hybrid-defined contribution program save the state money, but it could also provide real benefits to plan participants. The vesting period (the amount of time an employee has to work before they’re eligible to receive all contributions) would be shorter. Workers would have easier portability of benefits. And employees would have more control over where their retirement funds are invested. Critics say that employees’ retirement funds would be left up to the whims of the market. But today, with ETFs, mutual funds, and government-guarenteed treasury bills readily accessible to even amateur investors, these claims are unfounded. Investment choice and control is especially useful for advocates of pension “divestment” from fossil fuels. If an employee has a moral objection to investing in a certain industry, they could choose to invest elsewhere with a defined contribution plan. Not so with today’s defined benefit program.
We have an obligation to have this debate in a meaningful way, without the draconian attacks that will undoubtedly be thrown. We need to do what’s right for the state: for taxpayers, workers, and other residents alike. Not what’s in the best interest of the union bosses. Down the road, we can invest millions more in areas of shared priorities, from broadband to child care, if we have the courage to stop the bleeding now. Let’s have this conversation, and make meaningful change toward the positive fiscal health of our state’s future.
Don Turner is a former Republican State Representative from Milton, former House Minority Leader, current Milton Town Manager and longtime member of the Milton Fire and Rescue departments. He was a candidate for lieutenant governor in 2018.