Pension Underfunding and the Looming Problem for Local Governments: Cost-Shifting is No Solution

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1 Pension Underfunding and the Looming Problem for Local Governments: Cost-Shifting is No Solution Prepared by Bruce Holstein, Comptroller Emeritus, United States Government Printing Office Presented by Commissioner Richard Rothschild, MBA

2 What is the problem? Teacher pensions used to be funded and managed at the county level The state of Maryland took that responsibility on teacher benefits increased the funded ratio decreased % % pdf pg % pdf pg7 Now the teacher pension fund is $11B underfunded 2

3 What is their solution? Maryland General Assembly is debating moving 50% of normal teacher pension costs to county governments to pay BUT THIS IS NOT A SOLUTION! 3

4 Why isn t this a solution? Because the amount underfunded increases each year as any of the following happens: the state continues to fund pensions less than 100% portfolio value decreases or fails to sustain a 7.75% annual return more teachers retire teacher salaries increase 4

5 Continued Inaction and the Problem for Local Governments Unsustainable growth assumptions means unsustainable cost increases for taxpayers Burden on current system employees Causes money shortages which threaten other vital public services Pension fund could run out of money Negative impact of increasing pension expenses on borrowing costs 5

6 A Little Secret The current pension shift is still insufficient to fix the system The state says they WON T transfer any of the unfunded pension liability to counties. Continued shortfalls may force the state to push more expense onto the counties. Here s why... 6

7 FY11 was a good year and the unfunded liability still increased Here is what happened last year : In 2010 the teacher pension unfunded liability $ Billion In 2011 contributions to the Pension fund were: MD State contributed + $ Billion Teachers contributed + $ Billion Fund investments made + $ 3.8 Billion Teacher Pension Fund inputs in Billion June 2011 the unfunded liability was $ Billion The unfunded liability still went UP! 7

8 What would have happened if FY11 had been a mediocre year and the portfolio remained flat? Here is what would have happened: In 2010 the teacher pension unfunded liability $ Billion In 2011 contributions to the Pension fund were: MD State contributed + $.919 Billion Teachers contributed + $.317 Billion Fund investments made + $.0 Billion Teacher Pension Fund inputs in $1.236 Billion The unfunded liability would have increased An additional $2-3 Billion This is more than $100 Million for every jurisdiction in Maryland 8

9 What does a flat investment year mean? The pension falls another $2-3 Billion behind Every family in MD incurs an additional $1500* in tax liability every year the pension portfolio remains flat, in order to avoid increases in unfunded liabilities This is more than $100 Million for every jurisdiction in Maryland *closer to $3000 for every tax paying MD family 9

10 Let s look at a simplified example showing the impact of pension liabilities on County budgets 10

11 Let s say you owe $36,000 on a debt and you pay $1,000 per month. At the end of 36 months your debt is completely paid off. $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 1 However, pension liabilities never get paid off, they continue forever... 11

12 The Problem with Pension Liabilities Pension liabilities increase everyyear more teachers retire salaries go up causing pension costs to go up So...required payments into pensions fund must increase every year Increasing liabilities means increasing annual payments- FOREVER. 12

13 Various Things Affect Pension Funds The State can shortchange the pension fund then the unfunded liability, or amount owed into the fund, goes up OR State investments can do extremely well And all contributions can be made on time BUT 13

14 Pension Fund Investments returned 20% last year...outstanding! Unfunded But not good enough to overcome the math of years of compounding deficits 14

15 The pension fund assumes a 7.75% annual return on investment This is not reasonably achievable in today s economy 15

16 Ten Year History of MD Fund Revenues 16

17 When Investment Returns Drop State and County contributions must continually increase to fully fund the pension plan and keep the unfunded liability from increasing If full contributions are not made eventually the State will not be able to pay teachers their full pensions There will simply NOT be enough money in the fund to cover what is paid out to teachers 17

18 From the 2007 State Retirement Pension CAFR Chart B Excerpt TRENDS: Cash Flows Chart B presents an emerging trend that will have investment implications. It is a trend being faced by many state-wide retirement systems, with the aging of our baby boomer generations. Payments to retirees are on the increase, while cash into the fund, from employer and employee contributions, is stable or declining. 18

19 What Counties Will Have To Do To fund adequate contributions Counties would have to seriously increase property taxes cut County budgets and services cut Education budgets, reducing money for classroom teachers and increasing class sizes for remaining teachers 19

20 Keep in mind... If the State can assign 50% of normal teacher pension costs to counties it can assign 75% or 100% to Counties! It can assign full pension costs to counties. As pension plan funding becomes more expensive the State s budget becomes more difficult. The course we are on now means that the State of Maryland will eventually be forced to take more desperate financial actions and shift more pension costs to the counties. 20

21 Possible Solutions to the Unfunded Pension Problem 1. Freeze all state salary rates of pay at their current levels until pension funds are fully funded. Employees can still be promoted to higher paying positions but the rates of pay for those positions will be frozen. 2. Provide cost of living payments to employees as bonuses not as pay increases. Allows employees to receive more money but will not increase the benefits portion of the pension payment formula. 3. Reduce benefit payments gradually over a number of years to reduce distributions from the fund. 4. Pass legislation that protects all state pensions by prohibiting the state from transferring money out of pension funds for any nonpension related expenses, similar to prohibitions in the private sector. 5. Allow employees the ability to opt-out of the traditional plan and instead receive salary increases which can be used toward a defined contribution system. 21

22 Rhode Island has recognized the potential catastrophic results if serious and immediate REAL solutions are not put into place Read their solutions at Maryland, like Rhode Island, needs to reform their pension fund asap to avoid more serious problems in the future. Shifting teacher pension costs to the Counties IS NOT solving the problem. 22