Public Pension Reform: A Work In Progress

Many public pension funds need to reform their accounting and cost-sharing practices to protect taxpayers from growing liabilities. Photo: 401k 2012.

Washington has eight public pension systems for employees of state and local governments, and 15 plans within those systems. According to the latest numbers provided by the Office of the State Actuary, the state covers 86 percent of its total pension obligation, leaving an unfunded gap of $12 billion.

Although the state pension system is among the highest-ranked in the country for solvency, some experts worry that in general, current accounting practices could be downplaying public pension liabilities, and cause financial troubles in the future.

Those concerns apply to Washington.

Over $8 billion of the unfunded state public pension obligations are found in two systems closed in 1977 known as TRS 1 and PERS 1. There are still employees and retirees covered by the plans. The two funds are for K-12 teachers, and an assortment of state and local government officials, respectively. In 1989, the state legislature passed a law mandating they be fully funded by 2024. Deputy State Actuary Lisa Won told Lens the state is on a path to meet that mandate by then, provided certain assumptions are accurate.

Costly Promises Baked Into Rates Of Return

One of those assumptions is projected future growth of pension investments. The assumed rate of return for Washington public systems for the 2017-19 biennium is either 7.5 or 7.7 percent, depending on the plan. This is down from the eight percent rate used in previous years.

It is impossible for actuarial science to be completely exact. Still, Manhattan Institute Senior Fellow Steven Malanga argues that state and local governments are way too optimistic in their accounting. The private sector is required to adopt a “risk-free” rate of return that matches U.S. Treasury bond yields, currently at historic lows of less than 3.0 percent. State government is assuming more than twice the rate of return compared the private sector.

There is a big promise baked into the commonly far higher public sector fund rate. Said Andrew Biggs, a researcher at the American Enterprise Institute, if the economy in the long run is not as healthy as expected, “the future taxpayer has to make up the difference.”

State Treasurer candidate and financial professional Michael Waite, a Republican, told Lens that if the private sector relied on the same rates as the state, “the markets would absolutely crush you. You’ve got make sure you’re casting a very close eye to the assumptions and ensure the rates of return are reasonable,” he said.

Rate of return helps to determine pension debt obligation by the state. Even if Washington had 90 percent of the money needed to meet its pension fund obligations (rather than the current 86 percent), that would still be too low, says Leonard Gilroy. He is Director of Government Reform at the Reason Foundation. The ideal spot is just below or above 100 percent to balance out good and bad financial years, he added.

Lower Interest Rates, Riskier Investments

Both Biggs and Gilroy say it is not just the stipulated return on investment that should be cause for concern. Low interest rates have also pushed states to make more volatile investments, yet the greater financial dangers are not reflected in their projections.

In the past “you could hit an eight percent rate of return by investing purely in bonds,” Gilroy said. “Today, public pension funds shifted their portfolios quite significantly to take on a lot more risk to get these gains.”

Because of this, there is a “significant amount of risk sitting out there for taxpayers” that the actual unfunded liabilities are much greater than assumed, he added.

Harder Now To Cook The Books

Small variations in accounting practices can also result in vastly larger or smaller assumed liabilities.

Last year, the U.S. required states including Washington to more fully project pension debt obligations by factoring in benefits due a government worker over a “level, lifetime basis” of his or her career. This is in contrast to the practice of making long-term calculations based more on benefits due to workers in early years of work. The change doubled unfunded public pension liability for Washington from $5 billion to $10 billion. As a result, the proportion of state pension debt obligations funded dropped from 93 percent to 87 percent.

Key Role Of Lawmakers

The Office of the State Actuary’s vision of a fully funded pension system within the next decade or so also hinges on the state making the necessary contributions in the interim. That is something that has not always happened in the past.

“Nobody (in the state actuary’s office) can control what contributions the legislature will make,” Won said. “That’s an unknown.”

State Rep. Bruce Chandler (R-15) says he is confident the legislature will deliver. The ranking minority member in the House Appropriations Committee, he is also a member of the Pension Funding Council.

“I think we don’t know what the future of the economy is, but I believe we’re well positioned for facing a future that is uncertain,” he said. “I think we’ve been prudent, and adjust things so the plans remain solvent.”

During the 2016 legislative session, the Senate attempted to merge two public pension plans as a way to cut state spending, but the idea was dropped before the final supplemental budget was approved. However, Chandler said the proposal will likely resurface in 2017.

Greater Cost-Sharing Eyed

Jason Mercier of the Washington Policy Center (WPC) says another change the state could make to improve the pension system is to enroll more new employees in new defined-contribution plans, such as a 401k, where both the employee and employer put money into the pension. Mercier is the director of the Center for Government Reform at WPC.

Washington was the first state to offer hybrid plans, and the results so far look promising. According to a 2015 report by the Center for Education Data and Research at the University of Washington-Bothell, conventional wisdom holds that such a shift “will necessarily result in great employee turnover.” Yet the report found the outcome so far in Washington is just the opposite, with turnover “significantly lower” among workers who shifted more of their retirement savings toward defined-contribution plans. 

 

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