Rhode Island Analysis Shows Benefits of Pension Risk Management Strategies
Careful assessments and commitment to risk management practices are helping the state make sustainable policy choices
Rhode Island policymakers took important steps in 2024 to address cost-of-living concerns for retired public sector workers while maintaining critical pension funding targets and plan design features that mitigate risk. A recent actuarial analysis of the state’s retirement systems shows that changes enacted last year have been effective in balancing economic security for certain retirees with Rhode Island’s long-term fiscal sustainability goals.
The New England state’s experience offers important insights for policymakers in other states that may be revisiting previous reforms or considering benefit improvements, while demonstrating the value of successfully-used risk management tools.
Careful analysis ensures manageable strategies to address reforms
The changes adopted in Rhode Island were supported by analysis produced for the state’s Pension Advisory Working Group, which was established in 2023 to examine reforms to the pension systems made in 2011. Under those reforms, policymakers had replaced the traditional defined benefit plan with a hybrid approach, linked future cost-of-living adjustments (COLAs) to investment performance, and significantly reduced annual retiree COLAs until the retirement system reaches a funding threshold of 80%. In addition, lawmakers charged the group with providing options for improving retirement benefits.
In testimony and a letter to the working group in 2024, The Pew Charitable Trusts highlighted the importance of maintaining plan design features implemented in 2011 as an essential tool to mitigate risk. Pew encouraged the working group to incorporate assessments of the manageability of increased costs, liabilities, and risks associated with proposed benefit improvements to help policymakers ensure workers’ retirement security—without undoing fiscal sustainability gains.
The changes adopted by lawmakers in the state’s fiscal 2025 budget reflect those recommendations by allowing retirees to receive full annual COLAs sooner than originally anticipated. Those who retired before July 1, 2012, will have full COLAs restored immediately, while all other retirees will begin receiving full COLAs when the retirement system is 75% funded. At the same time, future post-retirement benefit increases will continue to be linked to actual investment experience, with half of the annual COLA calculated based on the five-year average of Rhode Island’s pension plans’ investment returns. This feature preserves efforts to ensure long-term stability for the state’s retirement systems even as some retirees collect full COLAs going forward.
The December 2024 actuarial assessment of the system shows the value of these carefully considered reforms. The analysis indicates that the additional costs of the 2024 changes will delay pension funding progress slightly—by just one year—with funding expected to improve rapidly over the next decade. That should keep Rhode Island on track to achieve critical fiscal sustainability goals. Ensuring that funding targets are not significantly affected is critical to meeting the state’s retirement security goals, since restoration of full annual COLAs for beneficiaries who retired after fiscal 2012 is contingent on these funding improvements.
In addition, the report includes critical investment risk analysis that assesses the potential impacts to plan funding and required costs if investment returns fall short of expectations and that shows that funding progress is expected to hold, even if long-term investment returns underperform plan assumptions. Key elements of the 2011 reforms still in place to help manage investment risk—including the hybrid design and a COLA formula that adjusts based on investment performance—will continue to help stabilize employer pension costs.
Risk management features help balance competing concerns
As in Rhode Island, many states made changes to public employee retirements systems after the 2007-09 Great Recession that reduced, delayed, or eliminated retiree COLAs. State policymakers have recently revisited these changes in response to concerns that sustained higher inflation is eroding the purchasing power of benefits. At least 17 states have adopted ad hoc COLA increases since 2020, with many approving more than one hike over time. Although ad hoc increases can restore a portion of lost purchasing power, they do not offer a sustainable path to providing retirees with inflation protection while ensuring affordability and predictability of costs for the state.
In contrast, policies that provide an actuarially funded annual COLA can help to better maintain the purchasing power of retiree benefits over time while reducing the need for policymakers to consider ad hoc increases that boost unfunded pension liabilities. Successful retirement systems can also use COLAs as part of their toolkit to manage risk by connecting increases to plan funding or investment performance. For example, variable COLAs—like the one established and maintained in Rhode Island—adjust based on actual investment return experience and are effective at mitigating risk while balancing retiree economic security.
Policymakers considering improvements to COLA policies should also take advantage of actuarial analyses, such as those produced for Rhode Island’s Pension Advisory Working Group, to evaluate the effects of proposed changes on plan balance sheets and government costs and ensure that any new liabilities associated with planned benefit increases are affordable.
Lessons learned
The actions taken by Rhode Island policymakers demonstrate that states can look to increase benefits or undo past cuts responsibly, if they adequately assess the actuarial costs of doing so and ensure that they are willing and able to pay that amount. The changes made in 2024 will improve the effectiveness of COLAs for beneficiaries who retired before July 2012 to maintain buying power and protect against inflation. They also keep important provisions that allow investment gains and losses to be shared between employer and retiree and keep the state on target to reach its pension funding goals.
Managing risk is a long-term challenge for states, even those at or close to full pension funding. In addition to risk-sharing plan design features, investment risk reporting tools such as pension stress tests can simulate economic volatility to help governmental plan sponsors manage risk. The actuarial reporting that shows the impact and sustainability of Rhode Island’s 2024 COLA changes importantly includes risk analysis assessing how investment experience can affect state government costs and retiree access to COLAs. Making such assessments part of regular pension reporting for states can help policymakers monitor their progress on legacy pension challenges while proactively managing future challenges before they become crises.
Stephanie Connolly is an officer and David Draine is a principal officer with The Pew Charitable Trusts’ state fiscal policy project.
People
