In Wisconsin, a model for pensions?
By MaryJo Webster firstname.lastname@example.org TwinCities.com-Pioneer Press
The 2008 stock market collapse, along with lackluster investment returns the entire decade, pushed most public pension plans in the U.S. — including those in Minnesota — into holes they are still trying to get out from.
But the Wisconsin Retirement System (WRS), which serves more than 500,000 working, retired and former public employees, remained nearly fully funded.
While the WRS weathered the storm quite well, Minnesota’s three statewide pension systems — which combined are about the same size as the WRS — are asking the Legislature this year for various remedies to increase money coming in and reduce costs in an ongoing effort to recover. This difference comes in light of the fact that both states offer roughly the same benefit levels and, up until 2009, provided retirees a share of investment gains as a way of ensuring benefits kept pace with inflation.
But Minnesota’s approach resulted in a deficit exceeding $5.7 billion, prompting legislators to scrap it four years ago. Wisconsin has reduced its unfunded liability, and the plan has been touted by at least two national studies as the most successful large public pension fund in the nation.
Many factors likely played a role in why one state’s approach worked and the other’s didn’t. But one key difference stands out: Wisconsin retirees are promised a minimum annuity, but the total they receive can go up when investments exceed expectation. That extra “dividend” also can be cut when times are bad. Under Minnesota’s former approach, the benefit could go up but never could be cut back.
Being able to take away $4 billion in dividends across the past four years is one of the key reasons the Wisconsin Retirement System did not take on additional unfunded liability when it took a huge loss in the 2008 stock market.
“While the system works hard to keep things in balance for the balance sheet, there’s some real pain for our members,” said Robert Conlin, secretary of the Wisconsin Department of Employee Trust Funds, which administers the pension system and other benefit programs for state and local workers.
This has been Wisconsin retirees’ first-ever taste of the downside to this system. Some have sought part-time jobs or moved in with children to adjust to the reduced income. It has raised questions about whether the system needs to be changed, but state leaders, including Gov. Scott Walker, say they don’t want to mess with something that’s not broken.
“A lot of our retirees are not happy about it, but they understand,” said Susan McMurray, a government relations representative for Wisconsin AFSCME, which represents about 150,000 active and retired WRS members. “They get it that this is part of the deal.”
Jim Palmer, executive director of the Wisconsin Professional Police Association, said any concerns raised about the Wisconsin pension system pale in comparison to what’s happening just over the border in Illinois. Pension funds there are estimated to have just over 40 percent of the assets required to cover their liabilities.
“I think we recognize how unique and special the Wisconsin Retirement System is,” Palmer said.
SHARING REWARDS AND RISK
The WRS, which pays out about $3.9 billion in annual benefits, has remained largely unchanged since 1982, when the state completed decades of arduous consolidation of various local and specialty pension plans.
It all started in 1945 when Wisconsin legislators decided that the “increasingly haphazard” public employee pension systems in the state were “resulting in an unwieldy and potentially financially unsound retirement fund structure,” says a report about the WRS.
All that work resulted in a system now referred to as a “trust fund” for public employees, with benefits considered relatively modest compared to pensions in other parts of the country but very similar to those in Minnesota.
The Wisconsin system has a couple of key components designed to ensure its fiscal integrity.
The first is that the pension can adjust the percentage of an employee’s pay that comes in — including a portion from the employer — to adjust for changing economic conditions. This prevents a contribution deficiency, a situation in which the money coming in is not sufficient to pay for that employee’s expected future benefits, plus administrative costs and necessary payments to reduce past unfunded liabilities.
Minnesota’s pension plans generally have to ask the Legislature to adjust contribution rates. Often, there is a lag between when the money is needed and when the Legislature approves the change, resulting in a buildup of unfunded liabilities. Recently, though, the Legislature gave the three largest plans authority to adjust contributions on their own if they have a deficiency meeting a certain threshold two years in a row.
The second component is that the WRS uses a “risk and reward sharing” system.
“It tries to do a better job of sharing the windfalls and the market downfalls,” said Jean-Pierre Aubry, assistant director of state and local research at the Center for Retirement Research at Boston College.
Retirees are promised a minimum benefit (or “floor”) that they will never drop below, and in subsequent years they are eligible for a dividend if the return on the pension fund’s investments exceed at least 5 percent. The gains from the stock market are spread across five years, so the retirees don’t see the full gain in a single year. These dividends compound over time, but the WRS can cut them back when the stock market does not meet expectations.
Since 2008, nearly half of the plan’s retirees have had their dividends cut back to their “floor.” Another round of cuts is coming in May, with some people expected to see up to 9.6 percent declines in their remaining dividends.
But dividend increases are expected to return the following year, barring another market downturn, Conlin said.
The dividends never went up high enough for a retiree to “get a whole lot of extra money or be at a much larger income level,” said Sue Conard, a retired La Crosse County public health nurse and president of an AFSCME retirees group in southwestern Wisconsin.
“But it was going along with the cost of living, so you didn’t have to worry about the cost of heating your home, paying utilities, food, medication and all those things,” Conard said. “Now you have to take those things into account … But the reality is that we know this won’t last forever.”
DOES IT NEED CHANGES?
The cuts coming in May will be bigger than previous years largely because the burden is being carried by fewer retirees — those who haven’t already hit their floor, said Keith Brainerd, research director for the National Association of State Retirement Administrators.
“This has resulted in a lot of talk amongst the members about what’s fair and who’s subsidizing who,” Conlin said. “This is pitting new retirees who haven’t seen their pensions reduced because they haven’t gotten any gains, against those who are seeing those gains eroded over time.”
Conlin said many retirees are asking whether some change should be made to keep this from happening in the future.
Last September, the retirement boards that make up the WRS discussed the issue, addressing topics such as whether to allow the WRS to build up an unfunded liability, to increase employer contribution rates or to ask the Wisconsin Legislature for general-purpose tax revenue. The boards concluded that any “fix” must balance the interest of all participants and that it would be best to not make any changes, according to the WRS January newsletter.
“How often are we going to have a 2008 again?” Conlin said.
AFSCME’s McMurray says most pension fund members are more concerned about what Walker might do, considering he revoked nearly all collective bargaining rights for state employees and made comments about the pension plan that some think are a sign he intends to gut it.
“People are terrified that Walker is going to take money out of the pension fund or that he’s going to dismantle the pension system,” McMurray said.
In 2011, the Wisconsin Legislature eliminated a common practice in the state in which the employer paid the full pension contribution, usually in exchange for a reduced salary or lower raise for employees. This was a common tactic in collective bargaining. Now, as contracts are renegotiated, employees are having to take on their share — typically 50 percent — of the contribution amount.
Palmer said many police and fire unions, which still have collective bargaining rights, have been able to negotiate pay increases to offset the pension contributions now taken out of their paychecks.
Two years ago, Walker also asked for a review of the WRS that included studying whether it would be feasible to offer a defined-contribution (401(k)-style) plan or to give workers the choice to opt out of paying their share of the annual pension contribution.
The study, released last summer, rejected the ideas.
“We looked at those things, and the conclusion was that given the health of the system right now, there’s no reason to make those sorts of changes,” Conlin said.
Walker’s spokesman Cullen Werwie said the governor agrees and has no plans to “pursue alternatives right now” because the WRS is “on a path that is sustainable.”
“He’s always said he supports a strong and robust WRS system,” Werwie said. “One of the reasons he wanted the study was to make sure we can continue to provide the benefits that are promised today and provide them tomorrow and into the future.”
A SIMILAR SYSTEM WITH A CRUCIAL DIFFERENCE
Minnesota attempted to mirror Wisconsin’s system in 1969 by giving retirees a variable annuity, with a floor, that went up when the market did and was cut back when the market went down, according to Larry Martin, executive director of the Minnesota Legislative Commission on Retirement and Pensions.
But the plan had a fatal flaw: It didn’t help retirees’ benefits keep pace with inflation as intended. Market returns weren’t high enough and nearly everything the fund took in was required to be reinvested to ensure the fund was solvent.
In 1980, the Legislature replaced it with the Minnesota Post Retirement Investment Fund. Under this plan, benefits could go up but never down.
It had numerous flaws that were adjusted over the years, and by the early 1990s the system was set up so that retirees were promised at least an inflation adjustment (up to 3.5 percent), plus a portion of investment returns that exceeded the 8.5 percent expectation. Like Wisconsin, the gains were distributed over a five-year period, but they were added directly to the annuity rather than treated as separate dividends.
Then the stock market took off and retirees had a five-year span when benefit increases averaged 9 percent.
“The state was making significant, permanent adjustments in those retiree benefits,” said Jim Nobles, Minnesota’s legislative auditor whose 2006 audit of the pension system criticized this system.
But the funding of those retirees’ pensions — decades earlier — had not anticipated such huge increases. When the stock market started to slide in the early 2000s, the investment returns couldn’t keep pace with these higher benefit amounts.
“When you’re giving away the entire upside of the investments and you’re not saving anything for the downside, that leaves you with a funding problem,” Martin said.
Mary Vanek, executive director of the Public Employees Retirement Association, said she and the other fund directors realized this was a problem by 1999, and they asked the pension commission to consider a remedy.
“But we didn’t handle it right. We didn’t work with our constituent groups to get their buy-in,” Vanek said. “So we got pushed back.”
Vanek noted that things might not have been so bad if they had the ability to claw back the investment gains like Wisconsin does, or to even have some years where retirees got no increase (which happened in Wisconsin in 2002).
As a result, the post-retirement fund built up a $4 billion unfunded liability by 2006, and because it wasn’t solvent, the fund couldn’t pay out anything from investment gains. Retirees continued to receive 2.5 percent inflation adjustments.
Three years later, the Legislature started dismantling the system, choosing to replace it with an annual 2.5 percent cost-of-living increase for all retirees.
“The benefits that were paid would’ve been fine if the economy had stayed white hot, but it didn’t,” says Don Betzold, a former state senator from Fridley and a former chair of the pension commission. “Retirees understood that they wanted to save the system first, and that’s the most important thing we did.”
Minnesota’s pension plans are still grappling with the unfunded liability that developed as a result of the sizeable annuity increases granted during the booming stock market years, but they are generally in much better financial condition than other pension funds in the U.S. That’s partly because the pension directors and the Legislature have been quick to fix problems, such as aggressive reforms in 2010 that included freezes or reductions in cost-of-living adjustments that are still in place, according to national experts.
“Back in 2010, those plans got together with stakeholders and policymakers and came up with a reform proposal that was thoughtful and farsighted. And it’s working,” said Brainerd. “I think they deserve credit for not only being well-administered systems, but also having excellent oversight of the benefit structure.”
Would Minnesota consider going back to a model similar to Wisconsin’s?
“In any system, there’s going to be a problem with it,” Betzold said. “There’s no perfect system.”
State Sen. Sandra Pappas, DFL-St. Paul, chairwoman of the legislative pension commission, was intrigued upon hearing about Wisconsin’s success at staying fully funded and said that perhaps it’s something the commission could look into during their meetings after the Legislative session concludes.
Nobles said any significant change would be tough because the loudest voices in pension reform are always the current retirees.
“Once people have something, they don’t like to give it up,” Nobles said.
MaryJo Webster can be reached at 651-228-5507. Follow her at twitter.com/mndatamine.