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BENEFITS BEAT
The Cost of Living Longer
It's time to reform retirement-age requirements.
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Actuaries in Washington State have made public a "dirty little secret" in the pension world: Retirees are living longer. While that seems like a statement of the obvious, it's not. Pension plans have blinders on when it comes to thinking about how long employees will live. Unless something is done about it, taxpayers alone will pay the price.
Even Congress has figured out that longevity has increased since FDR's New Deal, when the Social Security retirement age was set at 65. If you were born in 1960 or later, the eligibility age for normal retirement is now 67. Eventually, Congress will have to keep raising the threshold for normal-age retirement, to reflect ever-increasing longevity.
The problem is that public-sector pension plans, and now the new OPEB trusts, haven't even caught up with Social Security. Most public retirement systems allow normal retirement at age 65, and many of them even earlier if the employee has worked 20 or more years. For police and fire employees, the pension age is even younger.
These early retirement ages are unsustainable, as Americans live longer. In the case of public-safety employees, we already have a situation in which the retired life of the employee is equal to their period of service, if they start working at 22 and retire at 52. For those allowed the union-mantra "20 and out," the math is even worse — they can live 50 percent longer than their working career. There is simply no way that a savings system can put away enough money to make that workable.
There's a simple solution for now, and a longer-term solution for later. The first step that public retirement systems must take is alignment of their normal retirement age with the Social Security tables, which appear below:
Source: Social Security Administration
What this table illustrates quite plainly is that the actuarial reduction factor for early retirement is quite steep. For those born after 1960, the normal retirement benefit is reduced by 30 percent for early retirees under the Social Security system. In public retirement systems, the plan's actuary performs a similar exercise when an early retirement is taken under the plan document. But in most cases, public employees are able to exit the workforce with a "normal retirement" before reaching even age 65, and that is the problem.
If you make a simple mathematical projection of the above table, you'd see that for workers born after 1980 (now less than 29 years old), it would be reasonable to have a normal retirement age of 70. Ultimately, the reform of the Social Security system will require this age extension in order to avoid cutting benefits by 25 to 30 percent, which is what is now projected to occur after 2041 when the system's trust fund will otherwise be exhausted.
We've all heard about the "brain drain" that will result when aging Baby Boomers start retiring from public service. One of the immediate policy implications of this table is that by aligning normal retirement age with Social Security, governments can extend the working lives of valued senior employees. Of course, this will require amendments to labor contracts, and in some states it may arguably be unconstitutional to raise the age hurdle on incumbent employees — although I'd be happy to quibble with that point in most instances.
The cost of doing nothing is substantial. By deferring reality, the entire cost of paying pensions to recipients who keep living longer will fall to the taxpayers. As the news analysis of the Washington State report suggests, an adjustment to the actuarial assumptions could enable governments to assess higher employee contributions from those expected to live longer. This would be a change from current practice in which all employees pay the same rate regardless of how long they are expected to receive benefits given their probable longevity.
As with Social Security, this is one of those problems that retirement-plan administrators and public officials find easier to sweep under the rug and let the next guy worry about. The problem is that it's our children and grandchildren who will pay the price. Trustees of retirement plans and governing bodies of employers who fund retirement systems should make this an agenda item in their long-term strategic planning sessions, and they should emphasize sustainability in their plans' designs.
One way to start acclimating employees to the realities of extended longevity is to share with them the reality of the present Social Security age requirements and reduction formulas. It might be a wake-up call for many that their dreams of early retirement are just fantasies, unless they start saving more now while they are working.
A READER RESPONDS
Let me begin by stating that I applaud your efforts in providing Governing magazine with well thought out lucid commentary on the subject of public employee retirement. I think you have added greatly to public official understanding of the issues (or at least have provided those who are interested with valuable tools that will enhance their understanding). With that said, I respectfully disagree with a portion of your article on “The Cost of Living Longer” and thought there might be merit in explaining why.
First, regarding a national income redistribution program such as Social Security, I am in agreement with your conclusions. A constant retirement eligibility age established in 1937 (and modified only slightly since that time) makes no sense. Maintenance of such a program (even for a modest level of benefit) is dependent on there being a reasonable balance between producers (in the range of ages X to Y) and consumers (in the range of ages from birth to death). Reductions in mortality rates, bubbles in fertility rates, and migration from a labor based economy to a knowledge based economy since the inception of Social Security over 70 years ago have all served to make age 65 (or even age 67) retirement eligibility unsustainable at a reasonable level of cost to producers. Over time I expect this “third rail” will lose some of its voltage in terms of congressional willingness to touch it. (I say that only because I don’t see any alternative.)
On the other hand, I see a funded single employer arrangement being much different in terms of whether or not there is a need to increase retirement eligibility age. Starting with plan objectives, we hope to be able to (i) attract quality employees, (ii) make it worth their while to continue in service for an extended period and, finally, (iii) make it worth their while to leave. (This does not necessarily mean leave the work force but just leave the employer.) As you can imagine, there are a variety of personnel management objectives that make such an arrangement desirable. In our particular case, I believe that such a plan is sustainable for a long term employer cost of something less than 10% of pay with no employee contributions. This includes periodic adjustments to mortality expectations if supported by experience. (I believe that these adjustments should be based on experience rather than an expectation that there will be constant reductions in mortality rates simply because lethargy and obesity may reverse the historic trends.) There is, of course, always the issue of whether or not 10% of pay is reasonable.
Gary Findlay
Executive Director
Missouri State Employees' Retirement System
Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities. More biographical information.