By Ted Sickinger | The Oregonian/OregonLive
The legislative session has reached its second half, and as usual, the topic of spiraling public pension costs is looming over the budget and tax policy discussions that will dominate the remainder.
Suddenly, it seems, everyone has a plan to reduce costs in the Public Employees Retirement System. The governor wants to protect schools by diverting state revenues, tax rebates and employee contributions to pay for increased pension costs. The business community has filed ballot measures looking to limit any new pension debt, establish a 401(k) program for new employees, and institute new employee contributions to the pension plan.
Now comes House Speaker Tina Kotek and Senate President Peter Courtney. The two haven’t publicly unveiled a plan yet, and Courtney flatly refuses to discuss any of it
Kotek, however, is a member of the Ways and Means subcommittee holding hearings on PERS financing this session, and she offered her thoughts on PERS at two recent press conferences. She discussed what she liked in the governor’s plan, including tapping a portion of the $2 billion surplus at SAIF Corp: “Absolutely. I think it’s a very legitimate discussion.”
She said what she didn’t like: the business community’s proposals, for the most part, as well as the governor’s laser focus on protecting schools, while leaving other public employers to fend for themselves with the same problem.
“My purpose is to affect the whole system,” she said. “Those impacts are affecting local government and our ability to provide public safety, not just schools.”
Kotek didn’t rule out new employee contributions to the pension fund: “I want to make sure what we propose is balanced and fair, and that could, at some point, maybe, involve employee contributions, but only if it’s fair and balanced with other things.”
Finally, she described the back and forth she’s had with Courtney and the committee chairs as a “technical discussion about system financing.” She didn’t specifically endorse the proposal, but most of her remarks focused on one option: extending the period over which PERS plans to repay its $27 billion funding deficit.
Lengthening the amortization period for the unfunded liability, in pension speak, is not a new idea. It receives airtime virtually every session, and was among recommendations the Legislative Fiscal Office shared with lawmakers earlier this session.
Many pension experts are skeptical of this kick-the-can strategy, as it shifts risks and costs into the future. It would also involve lawmakers with little expertise dictating financial terms to the independent board members who are regularly briefed on the issue and statutorily charged with safeguarding the funded status of the system.
Here’s what Kotek said about the proposal, and some context for the discussion.
Kotek: “We have one of the shortest amortization periods in the country…We’re at 15 years.”
Neither of these statements is technically correct.
Like many public pension systems, Oregon’s uses a layered amortization approach, with different repayment periods for different portions of its liability. For the Tier 1 and Tier 2 unfunded liability — the vast majority of the system’s deficit — the PERS Board sets contribution rates to repay, or return it to 100 percent funded status, over a 20-year period. The unfunded liability due Tier 3 employees, hired after August 28, 2003, is amortized over a 16-year period, but it’s not a big factor in rate setting.
Every two years, the actuary recalculates the system’s assets and liabilities and recommends adjustments over the applicable amortization period.
Oregon’s fund does not have one of the shortest amortization periods in the country. Many states’ are longer. And some, such as California PERS, have recently reduced their amortization period to 20 years to align with best practices in the industry. But there are myriad other public pension systems that have equal or shorter amortization periods than Oregon’s.
Kotek: “You will pay more costs in the end, just like when you refinance your mortgage. But if the biggest issue over the next several biennia is the rate increases, does (extending) the amortization drop (employer contributions) by a couple percentage points so we can get through this next ten years of the rate increases until the system smooths out and drops off?”
As Kotek said, lengthening the amortization period would provide some pension cost relief for employers in the short run, while increasing total costs and shifting the burden and the risk further into the future.
There is no guarantee, however, that pension costs will “smooth out or drop off.” Unlike a mortgage, the pension system’s unfunded liability is a floating obligation that changes based on the level of contributions and the system’s returns on its invested assets. If you extend the repayment period, and expected investment returns don’t pan out, the system’s deficit can increase rapidly.
In fact, some increases would take place even if investment managers do meet earnings expectations. Lengthening the amortization period, even by five years, would turn the pension deficit into a so-called “negative amortization” loan, according to PERS actuary, Milliman Inc. Public employers would effectively be paying only part of the interest and no principle on the debt, so the balance grows.
With a 25-year amortization period, no progress is made in reducing the initial deficit until the tenth year, Milliman told the PERS Board at its last meeting. In a 30-year scenario, the deficit increases by almost 10 percent after the first decade, and no progress is made reducing the deficit until 18 years later.
Kotek: “We have a point-in-time problem in the next 10 to 15 years because of Tier 1 and Tier 2 and how long people are in the system. We sit down and talk about our pension system as being one of the best funded programs in the system, nationally.”
The “point-in-time problem” is a common talking point about PERS. It was an implicit part of the plan that the governor detailed for lawmakers last week. But it’s very much up for debate whether the state has a point-in-time problem or a pension deficit it will never escape.
The size of the deficit – $27 billion – is immense compared to the size of the payroll being taxed to dig out of it, hence the affordability problem. There is no silver-bullet solution, and as Kotek suggested in her press conferences, most of the plans being considered would lower employers’ contributions and create some budget breathing room, but don’t meaningfully reduce the deficit.
The bulk of Tier 1 and 2 employees may be retired in 15 years, but the pension deficit won’t disappear at that point, particularly if the state adopts a slower payment plan. The size of the deficit, and employers’ future rates, will be largely dependent on whether the system meets its assumed earnings rate on investments.
Oregon does not have “one of the best-funded” pension plans in the country. It’s true that Oregon PERS doesn’t face imminent insolvency, like a handful of state pension systems that have been badly mismanaged. But its funded status is between 70 and 80 percent, depending on whether you include employer’s side accounts with PERS. Either way, that puts Oregon in the middle of the pack nationally, according to a recent study by Wilshire Consulting on funding levels in state retirement systems.
Kotek: “When you look at the PERS board, they do all these (rate) estimates based on a 100 percent funded program. Not a single pension system in the country is 100 percent funded. So if we assume a 90 percent funding is about where we end up, what do we do in the short term to keep us there, knowing that we might not get to 100 percent?”
Not many state pension plans are fully funded, but there are a few. And while there are a few systems that are targeting funding levels below 100 percent, they tend to be those on the brink of insolvency, with little hope of getting back to fully funded.
The only real standard for healthy public pension funding, according to the American Academy of Actuaries, is that they be fully funded or have a plan to get there. Targeting 90 percent doesn’t get you there.
As it stands, Oregon’s system is in danger of falling below a funding trigger point – 70 percent without side accounts. That would force the system to increase required contributions to protect its funded status. If investment returns don’t meet the system’s 7.2 percent earnings rate assumption this year, it’s likely some employers’ rate increases will be even bigger than forecast in 2021.
Kotek: “Knowing what our goal is has been part of the discussion, because the PERS Board wants 100 percent funded, they don’t care about the rates. They’re just focused on the numbers. We as legislators have to be focused on the impact.”
Kotek implied that the PERS Board is making decisions in a vacuum based on technical considerations — without much thought to how those affect public employers.
The speaker has never attended a PERS Board meeting, but one of its guiding principles is to set rates that are stable and transparent. And when it comes to setting economic assumptions like the amortization period, which it reconsiders every two years, it does so in public meetings after getting feedback from employers, consultants and the Oregon Investment Council, which oversees the system’s investments.
The board already faces considerable pressure to avoid changes that increase employer rates, and it has accommodated those pressures in various ways. One is by limiting rate changes in any given biennium to 20 percent of the existing rate. It’s called rate collaring, and in effect, it is already allowing employers to underpay the system every biennium in order to protect their budgets from volatile pension costs. It’s not a small break, either. The PERS Board collared off about $1.6 billion in additional employer contributions in the current biennium.
Reached Thursday, Kotek said she still has a lot to learn about PERS. She said she doesn’t want to compromise the decision making or independence of the board, but that communications and reporting of its actions to lawmakers — and how they will affect budgets — is weak.
She says the PERS plan she is considering with Courtney will include one-time money from many of the same sources the governor identified, but that it would likely spread that money around the state rather than focusing solely on schools. Freezing all rate increases, as the governor’s plan attempts to do for schools, is probably not a realistic goal, Kotek said.
She added that there are tradeoffs involved in measures like extending the amortization period for the unfunded liability, and that state statute allows the repayments period to be as long as 40 years.
“We still need to make decisions that will help us mitigate these rate increases,” she said. “Our goal is to have a light touch if we do anything here. I don’t want every actuary on earth coming after us because we’ve done something irresponsible.”