PERA’s Automatic Adjustment Provision a Case Study for Pension Risk Sharing

A recent paper from the National Association of State Retirement Administrators, In-Depth: Risk Sharing in Public Retirement Plans, looks at how different public retirement plans have incorporated a variety of risk-sharing features into their plan designs. Colorado PERA is included as a case study for its use of automatic changes to contribution rates and benefit levels.

Why risk sharing

As the paper notes, a primary objective of any retirement plan is to provide income during retirement by moving a portion of compensation from the working to the retirement years. And while a variety of factors impact the effectiveness of a retirement plan, a few things are especially important: adequate contributions and investment returns, as well as predictions of inflation and the life expectancy of plan members. There are risks – meaning there is a chance of a financial loss compared to what is expected – with each of these factors.

Long-time
readers of PERA on the Issues will be familiar with the following formula:

C+I=B+E

Which stands for: Contributions + Investment earnings = Benefits + Expenses.

The revenue a retirement plan receives must, over time, equal the cost of the benefits and expenses the plan pays. If the assumptions underlying any of those factors change over time – if contributions decrease or investments earn less than expected, or if benefits or expenses grow faster than inflation – another factor of the equation must shift or the plan gets out of balance.

Who bears the impact of those changes – who takes on the risk and when those changes should occur – must be addressed. As the paper notes, “Nearly every state in recent years enacted reforms to [their] pension plans…. As a result, although most public employers in the U.S. have retained [Defined Benefit] plans, in many plans, more risk has shifted from employers to employees.”

In different states, cost-of-living adjustments have been reduced, employees have been required to work longer or to a higher age, employee contributions have been increased, and employers have paid higher costs.

The paper focuses on risk sharing plans that do two things compared to traditional Defined Benefit or defined contribution plans. First, they distribute risk among both employees and employers. And second, they articulate who bears what risk and how, before the loss or gain actually occurs.

Plans in which either the employees or the employers bear all the risk may experience bad outcomes. “Plans in which risks are strategically and optimally assigned…may be found to be more sustainable,” the paper notes.

The paper points to the automatic adjustment feature of Senate Bill 200, approved in 2018, as an example of risk sharing based on the relationship between contribution rates, which are set by the Legislature, and the rate determined by the actuarial experience of the plan’s level of funding (the actuarially-determined contribution, or ADC). Put simply, when the actual rate of contributions to PERA is less than 98 percent of the ADC, the statute requires that employer and employee contribution rates go up by up to 0.5 percent in any one year, not to exceed an additional 2 percent total increase. Conversely, if the rate of contributions were to reach 120 percent or more of the ADC, the contribution rates would decrease. A direct payment to PERA from the state as well as changes to retirees’ cost-of-living adjustments are also triggered.

The paper notes that it is unusual for such contribution and benefit increases or decreases to be contingent on the ratio between actual contribution levels and the ADC, and that they are projected to eliminate PERA’s unfunded liability by 2047.

Read more about PERA’s Automatic Adjustment Provision here.

Automatic adjustment provisionA provision of Colorado law that automatically changes PERA contributions (from employers, employees, and the state) and annual benefit increases based on PERA’s funding progress.Unfunded liabilityThe difference between the projected amount of money needed to pay benefits earned to date and the amount of money currently available to pay those benefits.Defined benefitAlso known as a pension, this is a type of pooled retirement plan in which the plan promises to pay a lifetime benefit to the employee at retirement. The plan manages investments on behalf of members, and the retirement benefit is based on factors such as age at retirement, years of employment and salary history.Defined benefitAlso known as a pension, this is a type of pooled retirement plan in which the plan promises to pay a lifetime benefit to the employee at retirement. The plan manages investments on behalf of members, and the retirement benefit is based on factors such as age at retirement, years of employment and salary history.Defined contributionA type of individual retirement plan in which an employee saves a portion of each paycheck (along with a potential employer match) and invests that money. The employee’s retirement benefit is based on their account balance at retirement. A 401(k) is a type of defined contribution plan.