Study's Author Calls for Reform of Alabama Pension Plans

The once "sure bet" of a public pension has become a roller coaster ride for American governments, employees and taxpayers. Alabama is no exception; despite recent reforms, its pension plans are at risk of running out of money in the next 10 years. 

As I detail in Pension Reform in Alabama: A Case for Economic Accounting, released today by the Johnson Center at Troy University, if steps aren't taken to address the state's flawed accounting practices, the money that working Alabamians have been promised might not be there when they retire.

The news is full of examples of pension mismanagement from places like Illinois and New Jersey. Alabama is in better shape, but uses the same accounting sleight-of-hand that has led to financial ruin elsewhere: measuring pension debt—in effect, the amount the system must put aside now to pay retirees later—based on how plan managers expect these funds to do when invested in the market. In other words, pensions bet on their own investment prowess, rather than on steady annual contributions, to pay the bills.

Confusing what a plan owes retirees (a guarantee) with expected investment returns (an assumption) is a common practice across the United States, creating large and unrecognized pension funding gaps. Alabama's three retirement systems report a debt of $14 billion, which prompted the governor and the legislature to pass some minor reforms last year.

Alabama calculated that figure based on the assumption of an eight percent annual investment return. However, if the state used the guaranteed rate of return of a government bond (3 percent) for this calculation it would reveal Alabama's funding gap to be an eye-popping $59 billion.

There is another problem with this accounting train wreck: It leads plan managers to take on increasing investment risk. In some states, assets are heavily invested in hedge funds, alternatives and real estate to make up for losses during the Great Recession.

Alabama has taken its own unique course over the years. The state invests about 10 percent of its funds in ventures aimed at bringing jobs and economic development to the state. These include the widely acclaimed Robert Trent Jones Golf Trail, Raycom Media, Walmart and Community Newspaper Holdings.

This is a noble goal, but Alabama's retirees deserve to know their money is being invested to do one thing: secure their retirements. Pension funds are held in trust for the employee, not as lures for businesses or any other purpose.

When their favored projects go well, managers point to job creation, tourism and a growing economy. Yet these are subsidized by tax dollars and pension contributions. It also introduces a new risk—when the in-state investments falter, as they have in recent years, so does the pension fund.

The good news is Alabama has time to fix the problem. The first step is to accurately calculate pension debt so the state knows how much it must contribute to pay the bills. Next, reconsider the investment strategy. Ensure the plan is fully funded and hedge against the risks of changing wages, interest rates or inflation. Fretting over achieving high market returns is no way to fund a pension.

Lastly, offer workers more retirement options. A 401(k)-style plan, similar to what most private-sector workers have, can still include some of the low-risk features of the classic pension. This would give employees control and ownership over their savings, and options like investing in a life-cycle fund or converting savings to fixed payments.

Through my research, I've seen an unmistakable trend among states and cities that are currently underwater: they didn't address this problem when early warning bells were sounding. Alabama has a chance to set a positive new example for others to follow.