If you are like most people in Oregon, including state leaders and the policy-setting PERS Board, you find PERS’s multi-billion-dollar unfunded liability horrifying. And you may be tempted to come up with all kinds of ways to reduce it, like Governor Kate Brown did with a recent commission that recommended selling off valuable state assets to pay down the liability by a relatively paltry $5 billion.
It’s time to calm down. The fact is PERS’s unfunded liability does not matter as long as it is prevented from growing and taxpayers are willing to bear some reasonable contribution each year.
To understand this, we need a quick review of Pension Systems 101.
What does the term “unfunded liability” mean when applied to pension funds?
A pension fund has an unfunded liability when the funds set aside to pay pensions (the Oregon Public Employees Retirement Fund, or OPERF), plus its investment returns over time, are predicted to be insufficient to pay all of its pension obligations.
That’s a problem, right?
It’s a big problem if outside funds are not regularly added to the pension fund. Without outside funds, the pension fund would be depleted, leaving pensions unpaid.
How is PERS different from pensions operated by private companies?
When private pensions develop an unfunded liability, there is substantial risk to future pensions. If the company develops financial problems and cannot make regular contributions, or if the company goes out of business, the pension could go bankrupt.
Can that happen to PERS?
Not in any scenario outside of the end of the world. First, the state of Oregon is never going out of business. And second, it has the taxing authority to always make pension contributions. So PERS can go on forever with an unfunded liability as long as a level of contributions can be found that is acceptable to taxpayers.
But that’s the controversy, isn’t it? PERS is requiring higher and higher contributions from taxpayers.
That’s right. But in addition to a contribution amount that would ensure that OPERF is never depleted, PERS Board policies implement large additional contributions in an effort to completely eliminate the unfunded liability in 20 years or less.
How much are these additional contributions costing taxpayers?
An eye-popping amount. Over half of total contributions for the 2019-2021 biennium, amounting to more than $600 million, is going to eliminate the unfunded liability.
That’s the background. Now here’s what lies ahead, and what needs to be done.
This spring, the PERS Board will begin work on setting the amount that public employers must pay into PERS for the 2021-2023 biennium. The preliminary report from the board’s actuary predicts new costs that can only be described as horrific.
Recall that when the preliminary rates were announced for the 2019-2021 biennium some time ago, there was widespread shock among public employers and state leaders. At that time, the PERS board raised rates from about 14 percent of payroll to nearly 18 percent, resulting in an increase of payments into PERS of over $200 million.
The picture for 2021-2023 is much grimmer. Actuaries are now predicting the rate will likely increase to 25 percent of payroll under current policies, from 18 percent. That will require employers to find an appalling $450 million in additional tax dollars, and perhaps more, to satisfy their PERS obligations. An increase like this is utterly unacceptable. It would devastate public budgets throughout the state, hit our underfunded schools especially hard, and undoubtedly create calls for tax increases.
The rate-setting policies employed by the PERS Board need to change. I call on the PERS Board to implement a policy that calls for preventing growth of the unfunded liability while suspending the current policy of eliminating the unfunded liability in 20 years. Efforts to reduce the unfunded liability should wait until after expected benefit payments peak around 2040. At that point, with the tailwind of dropping benefit payments, the board could resume reasonable reductions in the liability if they so choose.
The PERS Board owes the citizens of Oregon a great deal. This board, by making monumentally awful decisions years ago, created the monster that PERS has become today. These decisions have divided Oregonians like no other issue, effectively creating two classes of citizen, the privileged PERS recipients, and everyone else, whose anger and frustration only grow with every new demand for tax dollars by PERS.
The time for half measures has come to an end. The board must make bold moves to tame this beast as a way to show Oregonians that they can indeed serve the interests of all citizens.
Doug, Somehow this ended up in my email feed. You’re making a variety of common mistakes in your analysis. Benefits don’t decline after 2040. The graph from Milliman you’re referencing is for existing employees only. It doesn’t count any new employees. We are already negatively amortizing the unfunded liability and a policy choice like the one you’re advocating would exacerbate the problem and put the system deeper in the hole. Don’t fool yourself. The unfunded liability does matter, and the problem is getting worse. Moreover, the systemwide 2021/23 rate increase is projected at $1.6 billion, not $450 million.
Ted, thanks for your response.
The graph I was referring to is Milliman’s Projected Benefits by Status in their December 2017 actuarial analysis, which was presented to the PERS Board in September 2018. There is another flavor of the same graph in the August 3, 2018 meeting materials, showing Projected Benefit Payments by Tier.
It’s not quite right to say it only reflects existing employees. It is projecting benefit payments for existing members, which includes retirees. I understand it does not include a projection of future new employees, but it is a good indicator that starting around 2040, the enormous pressure on the system caused by the most expensive members will begin to abate as payments to Tier 1 and Tier 2 members begin to drop sharply. That should provide some breathing room to the system. New employees coming in now of course will eventually have benefits paid to them, but not at nearly the levels of Tier 1 and Tier2 members.
You’re correct to say, that despite all of the efforts of the PERS Board to amortize the unfunded liability, they are not having much, if any success. But there is a good reason for that, and it can be corrected. As you know, a gigantic factor in calculating the unfunded liability is trying to predict future investment returns. The PERS Board has utterly failed to adopt a policy that provides a meaningful prediction of future investment returns. Their assumed rate of return, at 7.2 percent, is still way too high, but they are scared to death to lower it because it will make the unfunded liability look a lot worse.
The result of having an assumed rate of return that is chronically too high is that the Board is always be playing catch-up, so to speak, when actual returns come in lower year after year. In reality, the system is trying to reset itself to an unfunded liability that better matches reality.
I will soon be publishing a companion post to this one that might bring into clearer focus what I was getting at in my first post. In my forthcoming post, I will call on the board to, in one action, to set the assumed rate of return to the actual rate of return on OPERF investments for the most recent 10-year period that includes a full economic cycle (i.e., both rising and falling markets). That period is 2008-2017, and the actual returns were 6 percent. An action like this would shock many, because the calculated unfunded liability would increase by about $10 billion, and the funding percentage of PERS would drop into the low 60’s.
But with an action like this, suddenly the investment return part of the equation stops providing yearly shocks to the system and starts providing, at least a lot of the time, some welcome relief.
I’ll save more details for my actual post, which I’ll forward to you in a few days.
One more thing on your comments. You should check on your claim that the 2021-2023 rate increase is projected to be $1.6 billion. I believe this figure is an estimate for the entire employer contribution, not an increase over the existing contribution. Note in Milliman’s October 5, 2018 report to the board, that entire 2019-2021 contribution is $1.125 billion. If you inflate payroll by 3.5 percent per year and apply the projected 25 percent net collared rate for 2021-2023, you come up with a figure close to yours.
I really admire your reporting on the PERS issue. It’s an enormously complex and hard-to-understand issue, but you do a great job of explaining it. I might see you at a future PERS Board meeting. Cheers.
I have a correction to the above post.
Ted Sickinger is correct: the preliminary estimate for 2021-2023 employer rates is for a $1.6 billion increase over the biennium. (My error was the result of using a chart that did not include the entire payroll).
Needless to say, such an increase would be little short of catastrophic, especially coming on the heels of last biennium’s sharp increase.
I’ll have more to say on this in an upcoming post.