The Heavy Burden of Increasing Your COLA Base

A white paper has found an increase in unfunded liabilities in Massachusetts’s already underfunded public pension plans when raising their COLA base.

(October 24, 2013) — Raising the cost-of-living adjustments (COLA) base in state pension funds would massively increase unfunded liabilities and appropriations over the next 20 to 30 years, according to a paper.

A white paper by the Pioneer Institute for Public Policy Research found that due to a series of regulations passed that allowed Massachusetts pension funds to increase the COLA base in increments of $1,000 up to a maximum of $18,000, state and local pensions could face significant rise in liabilities, of more than $1 billion, which could be detrimental to already underfunded plans.

COLA bases were designed to ensure retirees’ benefits remained consistent to the rate of inflation over time, the authors said. However, the Massachusetts public pension system’s COLA does not adjust for inflation—instead, it allows each retirement board to increase up to a maximum of 3% annually, only to a $12,000 base.

This system made the real value of future benefits uncertain, according to the paper, depending on the rate of inflation and pension size. Most likely, Massachusetts’s pensioners found their purchasing power decreasing over time as the COLA failed to adapt to inflation—losing up to 50% during their lifetimes.

“There is no clear answer about whether the [Massachusetts’s] COLA system is unfair to employees and retirees,” the report said. “However, it is clear that changing the COLA to track inflation more closely would cost state and local governments.”

Massachusetts’s retirement funds’ unfunded liability equaled more than $6 billion, or only 58% funded, research found.

The paper concluded that if every local system in Massachusetts increased the COLA base to $13,000, liabilities would increase by $2,300 per pensioner, resulting in a total rise of about $203 million. However, since most pension plans do not have enough money invested, they would result to spreading the payments over a 20-year duration, amounting to $470 million.

If every state retirement system in Massachusetts raised the COLA to $18,000, the paper calculated an estimate of $1 billion increase in liability—an appropriation of an extra $2.5 billion over the next 20 years.

Despite such exorbitant impact on plans’ liabilities, the study said 45% of local retirement boards have already raised the COLA base as of 2013.

These changes in Massachusetts’s legislature and movement in COLA base stood out among a sea of other American public pensions’ decisions to lower COLA.

aiCIO reported in August that Illinois’ legislators have proposed to cut the automatic 3% annual increases in COLA and instead link the raises to inflation, to settle its serious underfunding. The state also suffered a downgrading by the ratings agency Fitch from “A” to an “A-“.

Rhode Island pensions plans also made headlines when the state treasury identified COLA as “the most expensive aspects of the current pension system (continuing to pay out COLA may deplete the pension und if the 7.5% investment return assumption is not achieved).”