For Immediate Release
July 09, 2013

Pension Proposal Aims to Ease Burden on States and Cities

As states and cities wrestle with mounting pension woes, some even seeking refuge in bankruptcy, Washington has mostly stayed on the sidelines.

By law, the 50 states are sovereigns, so even though federal officials have regulated company pension plans for decades, they have had little interest in telling the states how to run theirs.

Now, one United States senator wants to change that. Orrin Hatch of Utah, the senior Republican on the Senate Finance Committee, has devised a way for states and cities to exit the pension business while still giving public workers the type of benefits they want. It involves a tax-law change that would enable governments to turn their pension plans over to life insurers.

Big players like MetLife and Prudential, to cite just two, might thus step into shoes now occupied by the likes of Calpers, California’s giant state pension system. Any such change would be voluntary, said Mr. Hatch, who plans to introduce enabling legislation on Tuesday. He and the Finance Committee’s Democratic chairman, Max Baucus of Montana, are committed to working on a tax overhaul package this year, and the public-pension change could be one part of that.

“America cannot continue sleepwalking into the financial disaster that awaits us if we do not get the public-pension debt crisis under control,” Mr. Hatch said. “The problem is getting more serious every day.”

Working with insurers would not suddenly make trillions of dollars appear, but Mr. Hatch said it would make costs more predictable and protect both retirees and taxpayers. The proposal “does not include an explicit or implicit government guarantee,” he said.

Aides said emphatically that insurers did not come up with this idea and talk the senator into promoting it. Mr. Hatch has been concerned about public pensions for some time, having issued his own study of their problems early last year. His report stated, among other things, that state pensions were a valid issue for federal lawmakers because of the likelihood that Washington would be called upon to bail one out at some point. Specialists working for the finance committee’s Republicans devised the insurance arrangement after extensive discussions with public-pension stakeholders, particularly unions that represent public workers.

In those talks, a committee staff member said, union officials were adamant about holding onto their members’ defined-benefit pensions, the type where workers receive a stream of predetermined monthly payments from retirement to death. In corporate America, many companies have been discontinuing such pension plans, not wanting to bear the investment risk they pose, especially as the population ages. Companies often give their workers 401(k) plans as a replacement, passing the investment risk to them.

Police unions in particular — an important constituency for Republicans — said their workers would not accept anything like that.

That is what prompted finance committee staff members to think about insurance companies. They, too, provide lifelong income to their customers — they just don’t call it a pension; they call it an annuity. Annuities can be devised in any number of ways, including precisely duplicating the terms of a worker’s pension. Senator Hatch’s staff eventually decided that shifting the states’ pension business to insurers was the only way to continue providing the monthly checks that public retirees want without forcing local taxpayers to come up with more money every time the stock market plunges. Life insurers would bear the investment risk, shielding both retirees and taxpayers.

Life insurers can also lose money over soured investments. But the states, which regulate insurance, have guarantee programs to protect policyholders in such cases. No backstop like that exists for public pensions, which is why benefits for older retirees in places like Prichard, Ala., and Central Falls, R.I., have been cut sharply after their municipal pension funds ran out of money.

Perhaps more important, state insurance regulators provide a kind of oversight unknown in the world of public pensions. They require insurance companies to meet capital requirements, taking into account the riskiness of their investments. Insurers are also required to hold more assets than they estimate they will need, and if they burn through their surpluses, state regulators can close them down.

Public pensions, by contrast, have no capital requirements and can make themselves look stronger by taking on more risk.

If Senator Hatch’s proposal were to become law, a local government that opted for insurance would hold competitive bidding once a year. The winning carrier would give each worker a contract, guaranteeing a retirement-to-death annuity amount for a year’s worth of work. Public employees’ unions would no longer negotiate the size of their members’ pensions; instead, they would negotiate how much the local employer would pay the insurer upfront. The annuity contracts would be portable, meaning workers would take theirs with them when they changed jobs.

This way, a worker retiring at the end of a 40-year career would have 40 annuity contracts, each representing the retirement income earned from a year’s work. An aide to Senator Hatch said an administrative body would have to be created to combine the contracts and issue a single check so the retiree would not receive 40 of them every month. But it would be not be a federal entity. The measure does not expand federal powers or impair states’ rights.

The real change would be in the federal tax code. The money that local governments set aside in public pension funds now clearly receives preferential tax treatment; money that it might pay an insurer does not. If a city or a state tried it, the Internal Revenue Service could say the money constituted income for the workers and require them to pay taxes on it.

If the bill became law, it would give the same tax preference to insurance premiums. Insurers and their trade associations have already sent letters telling Senator Hatch they support his goals and will work with him on the legislative proposal. So has the National Association of Insurance Commissioners and the trade association that represents the state guarantee systems. The biggest opposition is likely to come from public pension systems themselves. They now rely on contributions from workers to help close shortfalls and would lose some of that every time a local government shifted its business to the insurance industry. As envisioned by Senator Hatch, the annuity premiums would be paid solely by public employers; no employee contributions would be allowed.

View a full copy of the article here.