Life, Liberty, Politics and Policy in the Land of Enchantment!

Fixing New Mexico’s $25.8 Billion Unfunded Retiree System

In the waning days of the 2010 legislative session, the need to reform the state's unfunded retiree system remains. The Rio Grande Foundation has produced studies that outlined New Mexico’s <a href="http://www.riograndefoundation.org/downloads/rgf_private_vs_public_compensation.pdf">state and local government over-employment</a> and <a href="http://www.riograndefoundation.org/downloads/rgf_ual_2.pdf">pension problems</a>.

In the latest installment of our ongoing effort to bring attention to this problem, we have released a four-point proposal designed to solve the $25.8 billion unfunded government pension problem. That study, “Fixing New Mexico’s $25.8 billion Unfunded Retiree System” is available here.

New Mexico’s defined benefit retirement system is massively underfunded. The pension system officially reports an unfunded liability of $4.6 billion; however, new analysis by two academic economists finds that the pension system is underfunded by at least $7.5 billion and may be as high as $22.9 billion—or three times greater than the state’s general obligation bond debt. The state Other Post Employment Benefits (OPEB) system, mostly health insurance, is underfunded by at least $2.9 billion.

If the unfunded retiree liabilities are not dealt with soon, the annual required contributions to the retiree system will crowd-out other state spending such as roads and higher education. Fortunately, there are solutions which can be summarized by this straight-forward four-step process:

Step 1—Fix the Public Sector Over-Employment Problem

In 2008, New Mexico’s state and local governments employed 25.3 people for every 100 people employed in the private sector versus the national average ratio of 16.72. If New Mexico’s state and local government ratio was reduced to the national average, then the workforce would be reduced by 56,970 people.

Step 2—Transform Defined Benefit System into a Defined Contribution System

Step 3—Continue to Increase Employee/Retiree Contributions to the Retiree Healthcare System

During the 2009 Legislative Session, the Legislature enacted HB 351 which increased the employer and employee contributions to the retiree healthcare system to 3 percent from 1.95 percent phased-in over 4 years. This is an important first step in correcting the unsustainable retiree healthcare system without resorting to tax increases or budgetary gimmicks. However, more reforms of this nature are needed since there are virtually no assets to offset the $3.1 billion unfunded retiree healthcare liability.

Step 4—Expand the Private Sector

States with larger private sectors will grow faster over time than states with smaller private sectors. Finding ways to help New Mexico’s private sector grow is a win-win for both the public and private sector. One low-cost, high impact way to help the private sector is to perform a thorough review and culling of out-dated regulations. In the end, a larger private sector will generate higher tax revenues which could be used to tackle New Mexico’s unfunded retiree system.

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Permalink Reply by Lee Kershner on February 10, 2010 at 5:05pm

Great subject and research however am unable to access either of the two websites you give us.

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Permalink Reply by Paul Gessing on February 10, 2010 at 6:14pm

Thanks for the note. The links are working now. My apologies!

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Permalink Reply by Thomas Molitor on February 10, 2010 at 9:53pm

Paul: Your second link went to "Server Not Found."

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Permalink Reply by Thomas Molitor on February 10, 2010 at 10:06pm

There are four steps to solving this problem:

(1) Create more private-sector jobs, (2) Reduce or freeze public-sector jobs, (3) limit the pension liabilities through a defined contribution system (see below for lengthy explanation), and (4) increase cost-sharing for OPEB benefits similar to HB 351.

Defined benefit pension plan vs Defined contribution plan

A traditional defined benefit (DB) plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. In the US, 26 U.S.C. § 414(j) specifies a defined benefit plan to be any pension plan that is not a defined contribution plan (see below) where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan.

Traditionally, retirement plans have been administered by institutions which exist specifically for that purpose, by large businesses, or, for government workers, by the government itself. A traditional form of defined benefit plan is the final salary plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the accrual rate. The final accrued amount is available as a monthly pension or a lump sum, but usually monthly.

The benefit in a defined benefit pension plan is determined by a formula that can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a Dollars Times Service plan design that provides a certain amount per month based on the time an employee works for a company. For example, a plan offering $100 a month per year of service would provide $3,000 per month to a retiree with 30 years of service. While this type of plan is popular among unionized workers, Final Average Pay (FAP) remains the most common type of defined benefit plan offered in the United States. In FAP plans, the average salary over the final years of an employee's career determines the benefit amount.

Averaging salary over a number of years means that the calculation is averaging different dollars. For example, if salary is averaged over five years, and retirement is in 2009, then salary in 2004 in 2004 dollars is averaged with salary in 2005 dollars, etc, with 2004 dollars being worth more than the dollars of succeeding years. The pension is then paid in first year of retirement dollars, in this example 2009 dollars, with the lowest value of any dollars in the calculation. Thus inflation in the salary averaging years has a considerable impact on purchasing power and cost, both being reduced equally by inflation.

This effect of inflation can be eliminated by converting salaries in the averaging years to first year of retirement dollars, and then averaging.

In the United Kingdom, benefits are typically indexed for inflation (known as Retail Prices Index (RPI)) as required by law for registered pension plans. Inflation during an employee's retirement affects the purchasing power of the pension; the higher the inflation rate, the lower the purchasing power of a fixed annual pension. This effect can be mitigated by providing annual increases to the pension at the rate of inflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent.

If the pension plan allows for early retirement, payments are often reduced to recognize that the retirees will receive the payouts for longer periods of time. In the US, (under the ERISA rules), any reduction factor less than or equal to the actuarial early retirement reduction factor is acceptable.

Many DB plans include early retirement provisions to encourage employees to retire early, before the attainment of normal retirement age (usually age 65). Companies would rather hire younger employees at lower wages. Some of those provisions come in the form of additional temporary or supplemental benefits, which are payable to a certain age, usually before attaining normal retirement age.