This commentary is by David Coates of Shelburne, a retired managing partner of KPMG’s Burlington office, and Mark Crow, president of Tenth Crow Creative.
Recently the Pension Benefits, Design and Funding Task Force released its final report with recommendations to fix the retirement systems for state workers and teachers.
While the recommendations are a good start, they do not include the systemic solutions needed to make the systems sustainable.
What is the deal? Basically, the state would add $200 million of one-time funding to the systems’ pensions and $67 million to prefund the systems’ retiree health care benefits. The state would also put in $30 million from fiscal year 2024 through fiscal year 2026. and then contribute $30 million annually after that. State workers’ and teachers’ contributions to the pensions would increase and there would be limitations upon cost-of-living increases.
What is the impact? All these changes are good. The systems’ unfunded liabilities would be reduced by $2 billion. Also, the retiree health care liabilities would be prefunded (amortized), something our state treasurer, Beth Pearce, has been encouraging for several years.
A closer look: After carefully analyzing the impact of the recommendations, we believe these recommendations come up short — likely far short. None of the recommendations include the structural changes needed to make the systems sustainable. Instead, they offer only temporary relief.
The $2 billion reduction in unfunded liabilities reduces the pension liabilities by only $300 million, just 10% of the current $3 billion liability (as of June 30, 2021).
The other $1.7 billion results from an accounting change. Prefunding the retiree health care benefits permits the use of a higher discount rate that then reduces the present value of the obligations to the systems. In addition to reducing liabilities, this change will bring the state’s net worth from a $300 million deficit to a positive balance.
But bear in mind, no changes would be made to alter retiree health care benefits. These extraordinary benefits, not generally found in the private sector, remain unchanged.
Looking ahead, it won’t be long before we’re in the same or worse predicament. The governor’s fiscal year 2023 budget for the systems projects costs increasing 20% by fiscal year 2026. Yet, state revenues are projected to only increase by 1% to 3% over the next several years. Clearly, the math doesn’t work.
What still needs to be done? The task force recommendations are a great first step to address our unfunded liabilities to the systems. But we must go further to make the systems sustainable.
To reach a meaningful, long-term solution, the following should be part of the plan.
1. More frequent review and adjustment of assumptions.
The current version of the bill incorporating the task force recommendations extends the existing assumptions, established in 2019, to 2023. In our opinion, actuarial assumptions should be reviewed at least every three years, if not sooner, especially when adverse economic conditions occur, such as the recent increase in inflation.
We must keep a closer watch on these assumptions to avoid or at least better manage surprises down the road.
The actuarial assumptions for the systems include using a 7% rate of return and discount rate through 2038. By comparison, the California Retirement System — CALPERS, the largest retirement system in the country — recently projected a 6.2% rate of return over the next 10 years. It’s just not realistic we will attain a 7% rate of return over that time period.
We should be realistic about what the actual liabilities are so that we better understand the magnitude of the problem and how critical it is that we address it now in a more sustainable fashion.
2. Alternative plans for new hires.
We must create different plan structures for newly hired state employees and teachers. Otherwise, the unfunded liabilities will continue growing at an unsustainable rate.
This should entail implementing some form of defined contribution plans, or at least changing the defined benefit plans for new hires, such as increasing contributions, limits/exclusion of spousal coverage, and elimination of retiree health care or excluding coverage for early retirement.
3. Risk-sharing policy.
There is no provision in the task force’s recommendations to address unanticipated, significant downturns in the economy. Yet, unfortunately, these things happen, such as our current rapid inflation rate, the 2007 Great Recession, or in response to poor investment returns or unrealistic plan-funding ratios.
The impact of these events currently falls entirely on the state (taxpayers). These unexpected costs should be equitably shared between the state and the systems. It’s only fair and the right thing to do for all Vermonters.
Final thoughts: We are grateful for the task force efforts, but more must be done to make the systems sustainable. That’s exactly what Treasurer Pearce’s 2021 recommendations for changing the systems were intended to achieve. One-time money and small plan changes won’t cut it.
Given the scale of the challenge, providing benefits structured more in line with other Vermonters does not seem unreasonable, nor does asking the state workers’ and teachers’ unions to share a more equitable portion of the burden in solving this critical issue that continues to threaten the financial well-being of our state.
