WASHINGTON — Defined benefit pension plan promises in the public sector are not as secure as many had thought before the financial crisis, given that courts have largely upheld states' cuts to cost-of-living adjustments, a recently released report said.
"At this point, the legal hurdles to cutting COLAs appear to be quite low," the Center for Retirement Research at Boston College said in its report.
Most public plans provide retirees with COLAs to mitigate the effect of inflation on their income, CRR said.
Between 2010 and 2013, 17 states with a total of 30 plans enacted legislation that reduced, suspended or eliminated COLAs. Some of the states cut COLAs only for current employees and new hires, but many of the states also made changes to COLAs for current retirees, the report said.
The cuts to COLAs were surprising because the general assumption was that public plan participants had greater benefit protections than private plan participants, CRR said.
Many states cannot modify their current employees' or retirees' core pension benefits, either because of court rulings or provisions in their constitutions, the report said. But courts have viewed cuts to COLAs more favorably.
Twelve of the states that changed their COLAs have been challenged in court. In all but one of the cases where courts have ruled so far, the cuts to COLAs have been upheld. The main reason why judges have allowed the cuts is that COLAs are not considered to be a contractual right, the report said.
"The courts clearly view COLAs very differently than core benefits," it said.
There are four main types of COLAs: 1) increases that are a constant percentage or dollar amount not linked to the consumer price index, 2) increases tied to the CPI, 3) increases set by legislatures and revised on an ad-hoc basis, and 4) increases linked to a financial metric such as plans' overall funded levels or the level of assets in special COLA funds. As of 2009, about 75% of public plans provided COLAs that fell into the first two categories, the report said.
Reducing or eliminating COLAs can reduce unfunded liabilities since plans' existing liabilities represent benefits already earned, including promised COLAs. By contrast, reducing benefits for new hires or future benefits for current employees decreases future pension costs but doesn't impact the existing liabilities, the report said.
"Cutting COLAs is an extremely attractive option to plan sponsors, because it is virtually the only way to make large reductions in a plan's unfunded liability," CRR said.
The states' COLA changes fall into three groups, CRR said. Three states basically eliminated COLAs for the foreseeable future: New Jersey, Rhode Island and Oklahoma. Eight states — Colorado, Florida, Illinois, Minnesota, Montana, New Mexico, Ohio and South Dakota — reduced, eliminated or suspended fixed guarantees of 2.5% to 3.5% that compounded annually. And six states with CPI-linked COLAs made cuts or suspended COLAs: Maine, Maryland, Oregon, Washington, Wyoming and Connecticut.
The extent to which cuts to COLAs hurt retirees depends on whether state and local workers are covered by social security, the report said.
Four states that cut COLAs — Colorado, Illinois, Maine and Ohio — have plans where the workers don't have social security coverage. Most employees in those states won't be seriously hurt by COLA changes as long as inflation remains low. However, if inflation increases to 3% or 4%, they will see the real value of their retirement income decrease, CRR said.
