Scoppe: How to fix the State Retirement Systems
05/30/2012 12:00 AM
05/30/2012 9:53 AM
THE PROBLEM facing the State Retirement Systems is fairly straightforward: The Legislature has promised employees more benefits than the system will be able to pay.
Depending on which assumptions you accept, it would take anywhere from 37 to 51 years to pay the benefits that the state will owe once all its current employees retire. The drop-dead number, at which a system is considered unsound, is 30 years.
Looked at another way, the $25 billion pension system is projected to collect $15 billion less over the next 30 years than it will need to meet its obligations.
How we got into this mess is likewise straightforward: Back in the early 1990s, when the pension system was cash-flush, the Legislature increased benefits. The two biggest changes — reducing the early retirement requirement from 30 years to 28 and the companion TERI program that allowed employees to draw their regular pay and also bank their retirement benefits during the final five years on the job — increased the unfunded liability from two to 27 years. That’s the number that needs to stay below 30.
If the Legislature was determined to increase pension benefits, and it was, it couldn’t have come up with a worse way of doing it. The work-fewer-years rules crashed head-on with increasing lifespans.
That collision put our state into the unsustainable and indefensible position of having to pay people longer not to work than we pay them to work.
Contrary to popular belief, our long-delayed decision to get into the stock market will make it easier to pay those benefits than if we had stuck with cash and bonds. But part of the reason we’re in trouble now is that we didn’t anticipate the Great Recession, and so kept making decisions based on overly optimistic assumptions about the investment portfolio.
Even the general approach for solving the problem is straightforward.
Defaulting on our obligations isn’t an option. That leaves four options, or a combination thereof: The taxpayers have to pay more, employees have to pay more, retirees have to receive less, or we have to get better returns on our investments.
We’ve gotten about as aggressive as we safely can with the investment portfolio, and the taxpayers already are contributing 10.6 percent of employee pay, up from 7.7 percent just six years ago. So the solution has to involve state employees giving more and getting less.
This is where things get complicated.
Once you settle on how much more state employees have to contribute — and the competing plans passed by the House and Senate (H.4967) aren’t far apart — it’s not at all obvious which combination of benefit reductions is smartest and fairest to current and former employees.
And lawmakers can’t consider the pension system in a vacuum. A lot of the proposals would encourage state employees to stay on the job longer. That helps the retirement system, because they pay into it for more years and draw out of it for fewer years, and because veteran employees tend to make more than employees who would replace them, so their contributions are larger.
Obviously we have to move in this direction, but how far? Encouraging people to retire early helps the state budget, because higher-paid, older workers can be replaced with lower-paid, younger workers; that’s one reason the Legislature passed laws that encouraged people to retire sooner. It also could help our economy, because giving some people a pension instead of a paycheck means the state can give other people a paycheck. Some would even argue that encouraging faster churn leads to better, more efficient government, though others would argue the opposite.
Regardless of how we feel about all that, though, there’s another consideration that trumps them all: What’s constitutional?
This isn’t just a matter of legal niceties. Get it wrong, and we not only get the new law invalidated and have to start all over, but we have to pay damages.
Many state courts have ruled that pension benefits are a contractual right, protected by the Contract Clause of the U.S. Constitution. Courts do sometimes allow states to violate constitutional rights if it serves a compelling state interest — such as preserving the solvency of a pension system — but it’s risky trying to guess just how far a court will let you go.
That means it’s always dangerous to reduce the benefits for current employees and retirees.
How all this gets sorted out is one of the most important questions confronting the General Assembly as it heads into the final days of this year’s legislative session.
On one of the biggest-dollar provisions, the Senate has the smarter solution. While the House reduces benefits for current employees, by calculating “average final compensation” based on the final five years’ pay, rather than the final three in current law, and ending the practice of adding unused vacation and sick time to that figure, the Senate applies those changes only to new hires. Another smart Senate provision requires new hires to work eight years, rather than the current five, before they’re vested in the pension system.
In contrast, it is the House plan that closes the Teacher and Employee Retirement Incentive only to new employees, while the Senate shuts it down as of 2018. Although I have always opposed the ill-conceived TERI program, which lets people essentially give themselves a raise, I’m not sure that the Senate’s more aggressive approach is worth the legal risk it poses.
Both plans allow current employees to keep the 28-year retirement option, while requiring new employees to work longer if they want to retire early. While the House requires new employees to work 30 years before retiring early, the Senate adopts the “rule of 90,” meaning that the years worked added to the employee’s age must equal at least 90. I’d prefer a rule of, say, 95, but I think this approach will do more than the House’s to reduce the number of years we pay people not to work.
The Senate plan also would cut off pension benefits in any year that a retiree returns to work for the state and makes more than $10,000. This will either reduce the burden on the pension system or encourage people to stay on the job and contribute to the pension system longer, either of which improves the bottom line. Lawmakers need to make sure this is legally safe, and that it covers retirees who are consultants or contractors, in addition to salaried employees.
Both plans raise the 6.5 percent contribution rate for current employees, the House to 7.5 percent, the Senate to 8 percent. The Legislature has raised the rate before without legal challenge, likely because it simultaneously raised the employer contribution, and these plans do that as well, making last fall’s temporary increase from 9.5 percent to 10.6 percent permanent. I’d rather be able to keep state employees’ costs down, but the Senate’s higher rate might be the price that must be paid in order to avoid the riskier provisions in the House plan.
Likewise, I don’t like the idea of doing away with automatic cost-of-living adjustments for people who already retired with the understanding that they would receive them, but the fact is that a law that temporarily guaranteed those COLAs played a large role in driving the pension system back into the red. The House’s plan to tie increases to the performance of the investment portfolio is much more sustainable than the Senate’s plan to go back to a guaranteed increase.
What I’m not so sure about is a provision in both plans that requires both future and current employees to pay the full cost of any additional service credit they purchase toward retirement. Although that change is necessary, lawmakers need to make a compelling case that it’s safe to apply it to current employees.
Of course, if they can make that case, then they’ll have no excuse for not shutting down a much more generous program that lets former legislators purchase extra credit at the same super-subsidized rate as current legislators. In fact, I’m not convinced that they have a legitimate excuse for continuing that program anyway, since unlike any other part of the pension system, it allows people to keep growing their pensions after they retire.
The change to the legislative pension that is legally questionable is the House’s plan to stop letting legislators trade their salaries for pensions while they continue to serve. Much safer is the Senate plan to close the Legislature’s special pension system to new enrollees. It’s also a more significant reform, because it means that system will finally come to an end — once all our current legislators die off.
I’m not crazy about how we got to this point. The House and Senate panels that constructed these plans spent months discussing the problem and then presented the proposals as a fait accompli. The process was particularly troubling in the Senate, where there was literally nothing in writing until the day that both a subcommittee and the full Senate Finance Committee adopted it.
But here we are, and between them, the two plans contain a reasonable way to start digging ourselves out of the hole that the Legislature pushed us into. Both acknowledge, to varying degrees, the danger of changing the rules for current employees. And both acknowledge, for the first time, that we cannot continue to pay people not to work for longer than we pay them to work.
What we need now is for House and Senate negotiators to pick the smartest and safest provisions of each plan, and sell that package to the Legislature. What we do not need — indeed, cannot accept — is for pride of authorship or political posturing or anything else to prevent lawmakers from taking action this year to put our pension system back on solid footing.
Ms. Scoppe can be reached at email@example.com or at (803) 771-8571.
About Cindi Ross Scoppe
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