Cost Sharing Among State Defined Benefit Pension Plans

Approaches to managing risk and cost uncertainty

Article January 18, 2017 By: Greg Mennis Read time:

Projects: Public Sector Retirement Systems

This analysis was updated on May 31, 2017 to reflect additional data provided by South Dakota describing the state’s cost sharing mechanisms.

A number of states with defined benefit, or traditional, pension plans have enacted policies that retain the core elements of the plans while sharing the risk of cost increases—as well as potential gains—between public employees and employers. These mechanisms for sharing costs can help reduce volatility and investment uncertainty while preserving the ability to pay promised pension benefits.

For most public sector defined benefit (DB) plans, the cost of providing these benefits fluctuates, depending on investment performance, inflation, salary growth, life spans, and workforce demographics. Cost volatility can strain state or local budgets or lead to underfunded pension plans if policymakers have not provided sufficient contributions.

In response to the budget strains and funding challenges, some states have looked to alternatives to traditional pensions, including defined contribution, cash balance, and hybrid plans. Still, most state and local governments continue to offer DB plans, though many now use cost-sharing mechanisms to reduce budget uncertainty. Employees continue to receive guaranteed lifetime benefits and in some cases see gains, such as higher cost of living adjustments (COLAs), from strong investment returns.

A formal cost-sharing policy distributes unexpected cost increases—costs that result from short- or long-term deviations from plan expectations—between employers and employees. Typically, the process is codified in state statute or policy, is transparent, and is set in motion by either investment returns or plan funding levels.

Approaches can include splitting some or all of the plan costs between the employer and the employee, or adjusting the employee contribution in response to investment returns. Alternatively, cost-sharing policies can modify COLAs or post-retirement benefit increases based on investment returns.

Further details on the 29 defined benefit plans in 17 states that use formal cost-sharing mechanisms to manage risk can be found in The Pew Charitable Trusts’ report Cost Sharing Features of State Defined Benefit Pension Plans.

This map and table highlight strategies used by large state pension plans to share cost increases with members. Looking at the benefits offered to new workers in 102 primary state retirement plans, Pew’s public sector retirement systems project identified 29 plans in 17 states that use formal cost-sharing mechanisms to manage risk.

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Source: State retirement system documents, including member handbooks, plan Comprehensive Annual Financial Reports (CAFRs), and retirement system websites.

Note: Based on 2013 figures, this analysis examines the largest defined benefit plans in each state and covers 90 percent of total state liabilities. A total of 102 plans were examined with up to four plans in individual states. We excluded alternative types of state plans, such as a cash balance, hybrid, or defined contribution, from our analysis.

State	Type of cost sharing	Details
Alabama	None
Alaska	None
Arizona	Employee contribution and COLA	Arizona State Retirement System Employer/Employee Cost Share: Employees and employers evenly split the total contribution rate, with each contributing half of the total annual cost . Public Safety Personnel Retirement System Employer/Employee Cost Share: For employees starting on or after July 1, 2017, employees and employers evenly split the total contribution rate, with each contributing half of the total annual cost. COLA: Employees starting on or after July 1, 2017, are provided a COLA between 1% and 2% if the funded ratio is 70% or more.
Arkansas	None
California	Employee contribution	Public Employees’ Retirement Fund Employer/Employee Cost Share: Employees contribute at least half of the total annual normal cost—the cost of new benefits earned over the last year, which does not include the cost of paying down unfunded liabilities . State Teachers’ Retirement Fund Employer/Employee Cost Share: Employees contribute at least half of the total annual normal cost—the cost of new benefits earned over the last year, which does not include the cost of paying down unfunded liabilities.
Colorado	COLA	Local Government Trust Fund COLA: Annual increase for benefit recipients is the lesser of 2% or the average of the monthly CPI-W (which focuses on spending of urban hourly wage earners and clerical workers) for the prior calendar year. In no case can the sum of annual increases exceed 10% of the divisional annual increase reserve . School Trust Fund COLA: Annual increase for benefit recipients is the lesser of 2% or the average of the monthly CPI-W for the prior calendar year. In no case can the sum of annual increases exceed 10% of the divisional annual increase reserve . State Trust Fund COLA: Annual increase for benefit recipients is the lesser of 2% or the average of the monthly CPI-W for the prior calendar year. In no case can the sum of annual increases exceed 10% of the divisional annual increase reserve.
Connecticut	COLA	Teachers’ Retirement System COLA: The COLA is tied to the Social Security’s cost of living adjustment with caps based on investment returns. If the investment returns are lower than 8.5%, the COLA is capped at 1%. If the investment returns are 8.5-11.5%, the COLA is capped at 3%. For returns over 11.5%, the COLA is capped at 5%.
Delaware	None
Florida	None
Georgia	None
Hawaii	None
Idaho	Employee contribution and COLA	Public Employee Retirement System of Idaho Base Plan Employer/Employee Cost Share: Employees contribute 60% of the employer contribution rate. COLA: Based on a cost-of-living factor reflecting the changes in the CPI-U (which focuses on urban consumers), subject to a maximum total increase or decrease of 6% in any year. If the CPI-U increases by at least 1%, a 1% COLA is provided. COLA may be increased up to 5% each year if the board finds that system’s assets are no less than its actuarial liabilities, including those created by the additional increase. If the CPI-U increases by less than 1% or decreases, the COLA is automatically equal to the change in the CPI-U. A decrease cannot be more than 6%. Member benefits cannot decrease below the amount at the initial benefit at retirement.
Illinois	None
Indiana	None
Iowa	Employee contribution	Public Employees’ Retirement System Employer/Employee Cost Share: Employees contribute 40% of the total contribution rate. The total contribution rate cannot be adjusted by more than 1 percentage point annually.
Kansas	None
Kentucky	None
Louisiana	COLA	State Employees’ Retirement System COLA: Granted when the Employee Experience Account contains sufficient monies to fund an increase. COLAs will be granted only every other year until the system is 85% funded and limited to the first $60,000 of benefit. The COLA amount is determined by the system’s funding level and rate of return, and subject t . legislative approval . Teachers’ Retirement System of Louisiana COLA: Granted when the Employee Experience Account contains sufficient monies to fund an increase. COLAs will be granted only every other year until the system is 85% funded and limited to the first $60,000 of benefit. The COLA amount is determined by the system’s funding level and rate of return, and subject t . legislative approval.
Maine	None
Maryland	COLA	Employees’ Retirement and Pension System COLA: Based on the CPI-U (which focuses on urban consumers) and capped at 2.5% when the system’s investment fund earns or exceeds its assumed actuarial rate of return and capped at 1% when the assumed actuarial rate is not met.Teachers’ Retirement and Pension System COLA: Based on the CPI-U and capped at 2.5% when the system’s investment fund earns or exceeds its assumed actuarial rate of return and capped at 1% when the assumed actuarial rate is not met.
Massachusetts	None
Michigan	None
Minnesota	COLA	General Employees Retirement Fund COLA: Provides a 1% COLA. If the funded ratio equals or exceeds 90% for two consecutive years, the COLA increases to 2.5%. If the funded ratio falls below 85% for two years or below 80% for one year, the COLA decreases to 1% . Public Employees Police and Fire Fund COLA: Provides a 2% COLA. If the funded ratio equals or exceeds 90% for two consecutive years, the COLA increases to 2.5%. If the funded ratio falls below 85% for two years or below 80% for one year, the COLA decreases to 2%. Employees who retire after June 1, 2014, receive their first increase two years after retirement . State Employees Retirement Fund COLA: Provides a 2% COLA. If the funded ratio equals or exceeds 90% for two consecutive years, the COLA increases to 2.5%. If the funded ratio falls below 85% for two years or below 80% for one year, the COLA decreases to 2% . Teachers Retirement Fund COLA: Provides a 2% COLA. If the funded ratio equals or exceeds 90% for two consecutive years, the COLA increases to 2.5%. If the funded ratio falls below 85% for two years or below 80% for one year, the COLA decreases to 2%.
Mississippi	None
Missouri	None
Montana	Employee contribution and COLA	Public Employees’ Retirement System—Defined Benefit Retirement Plan Employer/Employee Cost Share: The employee contribution rate is reduced from 7.9% to 6.9% when the pension debt amortization period falls below 25 years. COLA: The guaranteed annual benefit adjustment is capped at 1.5% and is reduced when the system’s liabilities are less than 90% funded. The benefit adjustment will be zero if the plan’s amortization period is 40 years or more . Teachers’ Retirement System Employer/Employee Cost Share: The board can increase employee contributions up to an additional 0.5% if the system is below 80 funded and the debt amortization period is 20 or more years. COLA: Guaranteed annual benefit adjustment varies from 0.5-1.5% based on the retirement system’s funded status.
Nebraska	None
Nevada	Employee contribution	Public Employees’ Retirement System Employer/Employee Cost Share: For members of the Employee/Employer Contribution Plan, the employee and employer split the total contribution rate. For members of the Employer Pay Contribution Plan, the employer pays the total contribution.
New Hampshire	None
New Jersey	None
New Mexico	COLA	Education Employees’ Retirement System COLA: If funded ratio is 100% or more, COLA is equal to the CPI up to 2%. If the CPI is more than 2%, the COLA is equal to the greater of half of the CPI or 2%, up to 4%. If the funded ratio is 90-100%, the COLA is reduced by 5-10%. If the funded ratio is 90% or less, the COLA is reduced by 10-20%.
New York	None
North Carolina	None
North Dakota	Employee contribution	Teachers’ Fund for Retirement Employer/Employee Cost Share: The employee contribution rate decreases from 11.75% to 7.75% when the funded ratio of the actuarial value of assets reaches 100%.
Ohio	None
Oklahoma	None
Oregon	None
Pennsylvania	Employee contribution	Public School Employees’ Retirement System Employer/Employee Cost Share: Employee contribution base rate of 7.5% or 10.3%, depending on which class members opt in to. Every three years, the plan’s actual investment returns for the last 10 years are compared with the assumed rate of return over the same period. If the investment return is less than the assumed rate by more than 1 percentage point, the employee contribution increases by 0.5 percentage point If the investment return is equal to or more than the assumed rate, the employee contribution rate decreases by 0.5 percentage point. In addition, if the fund is fully funded, the employee contribution rate will revert back to the base employee contribution rate. The potential increase is limited to 2 percentage points in total, so the rate cannot be more than 9.5% or 12.3% . State Employees’ Retirement System Employer/Employee Cost Share: Employee contribution base rate of 6.25% or 9.3%, depending on which class members opt in to. Every three years, the plan’s actual investment returns for the last 10 years are compared with the assumed rate of return over the same period. If the investment return is less than the assumed rate by more than 1 percentage point, the employee contribution increases by 0.5 percentage point. If the investment return is equal to or more than the assumed rate, the employee contribution rate decreases by 0.5 percentage point. In addition, if the fund is fully funded, the employee contribution rate will revert back to the base employee contribution rate. The potential increase is limited to 2 percentage points in total, so the rate cannot be more than 8.25% or 11.3%.
Rhode Island	None
South Carolina	Employee contribution	Police Officers Retirement System Employer/Employee Cost Share: If the current employer and member contribution rates are insufficient to maintain an amortization schedule of 30 years or less, the board will increase the employer and member contributions by an equal amount (keeping a differential of at least 2.9 percentage points between the employer and member rates) as needed to maintain a 30-year funding period. The employee and employer contribution rates may not decrease until the plan is 90% funded . South Carolina Retirement System Employer/Employee Cost Share: If the current employer and member contribution rates are insufficient to maintain an amortization schedule of 30 years or less, the board will increase the employer and member contributions by an equal amount (keeping a differential of at least 2.9 percentage point between the employer and member rates) as needed to maintain a 30-year funding period. The employee and employer contribution rates may not decrease until the plan is 90% funded.
South Dakota	COLA	South Dakota Retirement System COLA: COLA is based on the CPI-W and plan funding status, ranging from a minimum of 2.1% to a maximum of 3.1%. The maximum amount decreases as the funded level falls. Starting in fiscal year 2018, the COLA will be based on CPI-W with a minimum of 0.5% and a maximum of 3.5% when the funded level is 100% or greater. When the funded level falls below 100%, the COLA maximum will be restricted in order fully fund plan.
Tennessee	None
Texas	None
Utah	None
Vermont	None
Virginia	None
Washington	None
West Virginia	None
Wisconsin	Employee contribution and COLA	Wisconsin Retirement System Employer/Employee Cost Share: Employees contribute 50% of the total contribution rate. COLA: The annuity benefit is based primarily on the investment returns of the plan’s trust funds. Actuarial factors, such as mortality rates, also affect annuity adjustments. Adjustments can be both positive and negative. Plan members can decide whether to participate in a fund that takes on greater risk for potentially higher returns.
Wyoming	None