As many Alaskans realize, we have a budget problem. Despite four years of budget cuts – a 44 percent reduction in all – we are still spending far more than we’re earning. We consistently hear from Alaskans that they want more budget cuts.
Some of the biggest cost drivers in the state budget are hidden – that is, most Alaskans don’t see a direct or immediate benefit, but we have to pay it. One of these is annual payments to our state retirement systems. The Public Employees Retirement System and Teachers Retirement System pay out monthly benefits to state and local retirees. These payments are a constitutional obligation of the state.
Unfortunately, the retirement systems currently have unfunded liabilities totaling $6.7 billion. That means over the next 25 years, payments to retirees are expected to outpace the retirement funds’ earnings by $6.7 billion in today’s dollars.
To make up for the shortfall, the state has been paying hundreds of millions of dollars each year into the retirement systems – money that could otherwise go into road maintenance, troopers, and other public services. In the current fiscal year alone we’re paying $260 million into the retirement systems. To put it in perspective, that’s more than we’re spending on the entire Department of Public Safety.
In this time of budget shortfall, we are looking at every opportunity to reduce those annual payments. Simply paying in less may be tempting, but it would only increase the burden on future generations. Making insufficient payments in the past played a large part in creating the current mess.
The state could shift more of the burden to municipalities – many of the retirement beneficiaries were local government and school district employees – but that would only drive up local taxes, and could force some municipalities into bankruptcy.
Another option is pension obligation bonds. In 2008 the Legislature approved this tool, which allows the state to sell bonds and deposit the proceeds into the retirement funds. The bond proceeds will be invested with the retirement funds and will earn interest at the same rate.
Given current borrowing rates, the cash infusion is expected to earn almost twice the annual payment to service the bonds. Think of it this way: If you could reduce the interest on your home mortgage by up to 50 percent, would you refinance?
The interest costs on pension obligation bonds have reached historic lows in the past year, making this an optimal time for this transaction. The State of Alaska expects to pay less than 4 percent interest on the debt service for these bonds, while our retirement plans have earned an average of 7.85 percent over the last 30 years. Thus there is minimal risk that the state’s retirement investment returns will be less than the state’s costs of borrowing.
In any given year, it is possible that the pension funds will earn less than the 4 percent owed on the bonds, but since the payments are based on average return, as long as the long-term earning rate is over 4 percent, we will be better off having issued the bonds. Over the 23-year life of the bonds, the state expects to realize up to $3 billion in savings from the proposed $3.3 billion sale. If returns fall short of expectations and are closer to 7 percent, the state will still save money – about $1.8 billion.
Some have expressed concern about this process, and I want to acknowledge those concerns. No financial transaction is risk-free. That’s why we have carefully tracked the markets and studied the successes and lessons learned from pension obligation bond issuances elsewhere.
To protect the state’s treasury, we are structuring the bond offering as conservatively as possible. Specifically, the proposed pension obligation bond
— Does not include derivatives or variable-rate products;
— Provides budget stability by reducing future-year contributions;
— Does not borrow against future savings to pay current obligations;
— Does not extend the amortization period; and
— Does not reduce the statutory payment rates of employers.
The Walker-Mallott administration takes our fiduciary duty to Alaskans very seriously. After careful consideration and consultation we believe the benefits to the state of pension obligation bonds outweigh the risks. It’s critical that we reduce cost drivers wherever possible so we can continue to provide the services Alaskans value – such as protecting public safety, maintaining a safe and reliable transportation system, and educating our children.
Randy Hoffbeck is Commissioner of the Alaska Department of Revenue.
