Recent Reductions in Public Pension COLAs
By Anna Petrini | Vol . 23, No. 38 / October 2015
Did you know?
- Cost-of-living adjustments, or COLAs, are meant to reduce the impact of inflation on retired public workers.
- At least 29 states have attempted to pare pension costs by reducing, suspending or eliminating post-employment COLAs since 2009.
- Courts have reached different conclusions about the constitutionality of cuts to public pension cost-of-living adjustments.
As the prices of goods and services increase over time, the purchasing power of retirement income decreases. Post-employment benefit increases—or cost-of-living adjustments known as COLAs—help to insulate retirees from the effects of inflation and are an important feature of most state and local government pension plans.
Many states embraced these benefits in their public retirement systems in the 1970s and 1980s in response to high inflation rates during that era. Social Security benefits have included an automatic cost-of-living adjustment since 1975, but between 25 and 30 percent of the state and local government workforce is not covered by Social Security. For these employees, including many public safety workers and teachers, a pension COLA may be the sole source of inflation-adjusted retirement income.
This valuable benefit comes at a cost. One study explored the costs of various COLA arrangements and found that offering a 3 percent compounded COLA adds 26 percent to the cost of the benefits paid out over the course of an average retirement.
Just how much a COLA costs and how much inflation protection it affords depends on how it is structured, and states have adopted a variety of COLA types and design features. The two broad categories of COLAs are ad hoc, which require active approval by a governing body (such as a legislature or decision-making board); and automatic, which do not require such approval. The latter are typically predetermined by a set rate (e.g., 3 percent) or formula. Many state and local government pension COLAs fluctuate with inflation, based on consumer price indices (CPIs) published by the U.S. Bureau of Labor Statistics. Other states link their cost-of-living adjustments to pension plan funding levels or investment returns.
At least 29 states have attempted to pare pension costs by reducing, suspending or eliminating postemployment COLAs for new hires, current workers or current retirees since 2009. Several states have revised their COLA formulas multiple times during this period. Many of the COLA changes have taken place in states that had guaranteed a fixed percentage pension COLA, regardless of inflation. The financial pressures of the Great Recession, combined with a relatively low-inflation environment, made reducing or eliminating these guaranteed rates or shifting to a different type of formula attractive to states such as Colorado, Hawaii, Florida, Kansas, Illinois, Minnesota, Montana, New Mexico, Ohio and South Dakota.
Several states either moved to CPI-linked COLA calculations or, if they already had such arrangements in place, lowered COLA caps or introduced other kinds of restrictions. For example, legislation in Maine in 2011 suspended COLAs for three years, capped future inflation-indexed COLAs at 3 percent rather than 4 percent, and applied that inflation-indexed percentage to a limited amount of the benefit (the first $20,000).
During this same period, some states—including Kentucky, Minnesota, Montana, New Jersey and Wyoming—tied their COLAs to pension plan funding levels, while others, such as Colorado, tied them to investment performance. Other types of cuts have involved skipping or delaying COLAs so they apply only after a worker has been retired for a certain period of time or reached a certain age. Some states, including Rhode Island and Louisiana, have developed complex COLA arrangements that combine several of these features.
Recent state cuts to pension COLAs have faced legal challenges, and courts have expressed a wide range of (sometimes conflicting) views on the constitutional issues involved. Reductions in cost-ofliving adjustments have withstood constitutional challenges in Colorado, Minnesota, New Jersey, New Mexico, South Dakota and Washington state courts, as well as in the First and Fourth Circuits of the U.S. Courts of Appeals. Similar reductions have been struck down in Arizona and Illinois and, in part, in Oregon.
Most states protect pensions for their public employees under a contracts-based approach, and the limits of states’ ability to change future benefits for current workers and retirees has formed the basis of several lawsuits. Whether legislative COLA cuts pass constitutional muster can depend on how courts view COLAs in the first place: Are they the same as, or different from, core retirement benefits entitled to state protection?