Editor’s note: This commentary is by David Coates, a retired managing partner at KPMG — Vermont and a member of the Vermont Business Roundtable. He was a member of the 2010 state Commission on the Design and Funding of Retirement and Retiree Health Benefits Plans for State Employees and Teachers. He is on the board of directors of Green Mountain Power. He lives in Colchester.
There is both good news and bad news in the latest report from the state’s actuary. First the good news — the retiree health care benefits unfunded liability for state workers and teachers was reduced by $274 million from 2015 ($2.1 billion) to 2016 ($1.8 billion). This reduction reflects better claims experience than expected and, in fairness, many positive changes for both pensions and retiree health care benefits made by the treasurer.
Once again, the bad news is the unfunded liability for state workers and teachers pensions, which increased by $90 million from 2015 ($1.7 billion) to 2016 ($1.8 billion). In total, the combined unfunded liabilities as of June 30, 2016, is $3.6 billion, or $5,800 for every resident of Vermont. For comparison purposes, the total net tax-supported debt for the state as June 30, 2016, is $637 million or slightly over $1,000 per every Vermont resident.
In other words, these unfunded liabilities are the largest debt in our state and they have been rising despite making payments on the pensions as required by the state’s actuary. Again for comparison purposes, these unfunded liabilities were $2.7 billion in 2010 or $4,300 for every resident of Vermont.
A more detailed look at each of these unfunded liabilities can shed further light on these challenges.
As mentioned earlier, despite paying the annual required contribution, the unfunded liability continues to rise by $90 million in 2016 and $197 million in 2015. There are several reasons for this, but the primary one seems to be the assumptions used by the state.
For instance, currently the projected rate used for the earnings and discount rates is 7.95 percent down from 2014 of 8.22 percent … a good thing, but still much higher than can ever be achieved. By contrast, private sector rates for investment earnings are closer to 6-7 percent and discount rates around 4 percent. CalPers, the California Public Employees Retirement System and the largest in the country, recently reduced rates from 7.5 percent to 7 percent. If Vermont did the same, it could add close to $1 billion (including retiree health care benefits) in unfunded liabilities. This would add a significant amount to the annual required contribution, thus requiring more general fund resources putting more pressure on our limited state revenues.
As noted, annual payments to support these benefits will continue to increase even more than the actuary projects, which will continue to put pressure on the general fund and crowd out other important state programs.
For example, in 2014, the actuary projected the annual required contribution payment for pensions in 2017 would be $102 million and in 2016, projected this same payment to be $118 million. That $16 million increase exposes how little confidence our state budget committees should have in these projections because at least two critical assumptions are overstated. Remember,higher assumptions for earnings and discount rates result in a smaller liability, and lower assumptions result in a larger liability. Going forward, the assumptions must be made to reflect the real world and provide Vermonters a true sense of the actual cost of these benefits.
Retiree Health Care Benefits
Despite the reduction in these unfunded liabilities from 2015 to 2016, both the short- and long-term outlooks for the state are alarming. There is no possible way the state can correct the present course for these benefits; the annual required contribution is impossible to fund without identifying another source of annual revenue.
Annually, the state underfunds this benefit by approximately $50 million. The underfunding will continue and the liability will rise. The reduction this year was good news, but it pales in comparison to the total debt of $1.8 billion. The assumptions used to compute this liability are questionable as well. My question to the Legislature is this: Why do you provide these benefits if you can’t pay for them?
Incremental changes to date only scratch the surface. Structural change is the only solution at this point and it will take much more than the treasurer. She just can’t do it alone.
The consequences of doing nothing
As noted above, annual payments to support these benefits will continue to increase even more than the actuary projects, which will continue to put pressure on the general fund and crowd out other important state programs. If the state is unable to pay the annual required contribution, at least for the pensions, it will undoubtedly impact the state’s bond rating. And the consequences of a lower bond rating would likely be millions of additional financing costs for the state and other governmental units, including our municipalities.
The state’s financial reports will also be impacted because, as of June 30, 2018, the unfunded liability for the retiree health care benefits will be required to be recorded. The pension unfunded liability of $1.8 billion is currently included, but not the $1.8 billion liability for the retiree health care benefits. If this liability had been recorded as of June 30,2016, it would have resulted in reducing the state’s net asset position (net worth)of a positive $1.2 billion to a negative position of $600 million.
In my opinion, this would reflect poorly on the state and cause the rating agencies to take another look at our rating. Especially, if the state does not have a plan to address the situation. As I said earlier, this outlook is alarming.
In my next commentary, I will provide some context for actions that could alleviate this situation and bring some balance and fairness to our state and all Vermonters.