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South Carolina lawmakers have undertaken reforms to address some of the serious issues with their state’s pension system, but major changes are still needed to prevent future budget problems.
In 2012, the state increased employee and employer contribution rates for the South Carolina Retirement System (SCRS), the state’s public pension fund. The increase affected current members as well as new hires. The 2012 reforms also reduced the expected rate of return for pension investments and reduced the minimum cost-of-living benefit increase. In 2000 and 2002, the state created optional defined-contribution plans for existing and new state and local government employees and teachers.
While these steps toward improving South Carolina’s pension system were much-needed, the state’s pensions still remain in dire need of further reform. According to a report on SCRS released in 2015 by the South Carolina Legislative Audit Council (SCLAC), South Carolina’s five state-run pensions were only about 60 percent funded in 2014 and carried a combined unfunded pension liability of $19 billion.
Due to the generous rate of return estimate used by the state in its pension projections, state Rep. Jeffrey Bradley, R-Hilton Head, says the problem is now even worse than the SCLAC report indicated. In an editorial in the Island Packet, Bradley says over the past 10 years, the rate of return on the fund’s investments has averaged 5.06 percent. This, Bradley insists, is a significant problem, but why?
In November 2014, State Budget Solutions released a research report that found if the state used a fair market valuation in its pension projects — one based on a more reasonable discount rate of 2.743 percent — South Carolina’s pension system would only have a funded ratio of 32 percent in fiscal year 2013, meaning every South Carolinian would have to pay $13,280 to make the system whole.
The high cost of defined-benefit pensions caused most private sector companies to abandon them in the 1990s for 401k-style defined-contribution plans, but state and local governments, using the hard-earned money of taxpayers, continue to promise these outdated and unsustainable benefits to public workers. We have already seen municipalities such as Detroit and Stockton, California literally bankrupted by these defined-benefit plans. When these plans fail, not only are taxpayers hurt, the public sector workers who were promised these benefits suffer as well.
In 2010, South Carolina received a grade of “F” in The Heartland Institute’s 50-state public pension report card. The state was one of the lowest graded in the nation, and it remains so today. In the report, the state scored low in its efforts to avoid pension spiking, its failure to tax pension benefits, and because of the poor solvency of its pension fund, among other things.
These problems have been compounded in recent years by the South Carolina Retirement System Investment Commission’s decision to take on additional risky and expensive investments for the pension funds. According to the Post and Courier, since 2007 — when the state eased rules on how pension funds could be invested—more investments were made in stock and hedge funds. The SCLAC report found the state did not see improved returns as a result of this decision, and its investment returns trailed those of most other states. The state also paid high fees for the investments.
“Due to South Carolina’s increase in stocks and ‘alternative investment’ holdings, such as hedge funds, from 2005 to 2014, annual expenses rose from $22.4 million to $467.3 million,” wrote David Slade and Gavin Jackson in the Post and Courier article. “In 2005, expenses amounted to less than one-tenth of a percent of the pension assets—.09 percent, the same as the Vanguard fund. The state’s expenses rose to 1.57 percent by 2014.”
To protect taxpayers and public workers, South Carolina should follow the private sector’s lead and switch its pension plan offerings for new employees to a defined-contribution pension plan system. A defined-contribution system would give retirees direct control over retirement and make it possible for them to move in and out of the private sector without losing their accrued pension benefits. This would also allow governments to budget more accurately, because the benefits would be paid directly to the employee and are set each year, rather than changing along with benefit costs.
Defined-contribution plans benefit taxpayers as well, because the pension plan burden does not rise automatically due to cost of living adjustments and because the defined-contribution model is more transparent, making it harder for government officials to utilize the accounting gimmicks governments currently use to hide liabilities.
Moving state workers into a defined-contribution model would put South Carolina on a path toward more-sustainable budgets and give public employees improved flexibility, a win-win solution to the state’s growing fiscal crisis.