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Retirement program debate getting old for governments

Posted: Sunday, November 28, 2004

Talk about budgets with state and municipal officials these days and high on their lists of fiscal headaches are public employee retirement programs.

The fact that retirees are living longer coupled with the skyrocketing cost of healthcare insurance has cities and borough governments screaming for help.

The Alaska Municipal League has urged the state to "take full responsibility" for mandated increases to the Public Employee Retirement System (PERS) and the Teacher Retirement System (TRS) faced by municipalities, school districts and the University of Alaska.

The Kenai Peninsula Borough government is no exception, facing as it does the prospect of annual mandatory increases to employee retirement programs for years to come.

About $10 million of the roughly $13 million general government portion of the borough's general fund covers the cost of personnel, a cost sector that includes their retirement benefits, according to Finance Director Scott Holt.

"You're looking at the huge majority of the (general government budget) that is labor related," he said. "That is also true for the service areas' budgets."

According to borough figures, in the current fiscal year 2005, some $1.7 million goes to fund PERS for borough and service area employees. In 2006, the borough's PERS obligations will require an additional $680,000 atop the current $1.7 million, and it is likely to continue rising at a rate of at least 5 percent per year for at least the next few years, Holt said.

Meanwhile, the current Kenai Peninsula Borough School District budget pays about $7 million into PERS and TRS.

According to Melody Douglas, chief financial officer for the school district, an additional $2.6 million will be needed just to cover that obligation in fiscal year 2006.

Riding the rocket of a booming dot com stock market in the late 1990s, both programs looked flush flush enough that the rate at which the state and municipalities were required to contribute to PERS was halved. The TRS rate was not altered, however.

Then three things happened: The stock market tanked, healthcare costs began rising at double-digit annual rates, and the assumptions used to justify the contribution rate decrease were shown to be inaccurate.

Both the PERS and TRS programs have fallen behind since then seriously behind. Holt blamed the actuaries for underestimating the amount of money necessary to cover retirement costs. He wasn't alone.

Around 1998, Mercer Human Resource Consulting provided new actuarial figures to the state, in response, some observers have suggested, to political pressure from a Legislature looking for funds. The result: Lawmakers cut the PERS contribution rate from 11.5 percent to 6.5 percent. The savings were spent on other government operational costs at the state and local levels.

About two years ago, Mercer reevaluated their assumptions, Holt said. Suddenly, the rosy scenario offered in the late 1990s was looking like skunkweed.

"After reviewing life ex-pectancy and other factors, it was determined that the (PERS) program was underfunded," Holt said. "And the cost of healthcare expanded so rapidly, their assumptions were too short."

Mercer Human Resource Consulting declined to comment for this story, but Melanie Millhorn, director of the state Division of Retirement and Benefits, said the results of a recent independent audit of Mercer's analytical processes and assumptions, while producing recommendations for some procedural changes, were not a condemnation of Mercer's work nor an argument for ending their employ as the state's actuarial firm, a relationship that has lasted nearly two decades.

The facts are, however, that PERS and TRS are underfunded at the borough and state level. According to Millhorn, the latest actuarial valuation report dated in March put the unfunded liability for PERS at $2.9 billion and for TRS at $2.1 billion. That is, the two systems are $5 billion behind. At the current payoff rate, the state wouldn't catch up until 2029, Millhorn said.

Repairing the shortfall isn't a simple matter of immediately raising the employer contribution rates to where they should be.

First of all, state law fixes the amount public employees themselves must contribute to their retirement program, and those rates won't change for today's employees.

Contributions from government employers, on the other hand, tend to float. The PERS and TRS boards, panels operating under the auspices of the Alaska Department of Revenue, set their rates annually.

But regulations cap how high those boards can raise rates each year to 5 percent of total payroll. According to figures provided by Millhorn, the ideal rate government employers should be paying into PERS in fiscal year 2006 would be 25.63 percent and 38.85 percent to TRS.

If the board raises rates as expected, however, they'll only be contributing at 16.77 percent and 21 percent, respectively. Thus it will be at least several years before the contribution rates rise sufficiently to start matching the obligations.

Statewide, a 5 percent per-year increase will cost municipalities alone some $20 million more each year. That doesn't take into account the increases faced by school districts, the University of Alaska and the state itself, said Kevin Ritchie, executive director of AML.

"This is not a short-term problem," Ritchie said. "It will be literally crushing to a number of municipalities as far as the property tax rates that will be needed to fund it."

It also could mean cuts to municipal programs, he added.

Legal restrictions also limit other avenues to relief. For instance, Article 12 of the Alaska Constitution requires that employee retirement systems be considered firm contracts. Accrued benefits cannot be diminished or impaired. Anyone already in the system will get the promised benefits for as long as they live after they retire.

Inundated by rising insurance and healthcare costs, among other things, municipalities are finding it increasingly costly to make good on those promises.

The costs "are locked in," said Pete Sprague, a Kenai Peninsula Borough assembly member and president of the AML. "There is no real room for negotiations on past benefits. We will have to roll with it, basically."

Several factors led to the under funding of state and municipal retirement accounts, said Larry Persily, former deputy commissioner of the Alaska Department of Revenue, not the least of which is the fact that people are simply living longer and will be around longer to draw pensions and use their healthcare insurance benefits. The annual double-digit increases in health insurance costs seen nationally from 2001 through 2003 are another major factor. (The latest data shows the rate has fallen to single-digits in 2004). The flat stock market certainly hasn't helped, Persily added. But while market ups and downs matter, lengthening life spans and rising health insurance costs will have the much greater impact on the bottom line long term, he said.

"Chart those out for 20 or 30 years and they'll just kill you," Persily said.

He also called criticisms of the move to lower contribution rates in the late 1990s "Monday morning quarterbacking."

An analysis provided by AML shows that PERS and TRS obligations in fiscal year 2007 will hit $41.5 million for the state, $39.7 million for the school districts, $22.5 million for municipalities and $8 million for the University of Alaska. And it won't stop there, climbing still further until at least 2009, when the costs are expected to level out, Ritchie predicted.

In a resolution passed at its meeting in Fairbanks earlier this month, AML members urged the state to take full fiscal responsibility for mandated PERS-TRS increases, to adopt a statutory process that ensures any future increases in retirement benefits get a full actuarial analysis, and that all impacted employers participate in the review and adoption process. They also requested that all employer categories have direct representation on the PERS-TRS boards.

High oil prices may lead the Legislature to consider some relief. But Persily warned that many lawmakers might be reluctant to cover increases to municipal PERS and TRS programs because oil prices cannot be expected to remain elevated forever. Persily predicted more money for schools and roads, but little for PERS and TRS.

"I would be surprised if the Legislature got into a large and comprehensive municipal assistance program again," he said. "They probably are not inclined to restore something they can't afford again in two years."

That public employee retirement programs were going to become problematic was known back in the late 1970s when studies suggested contribution rates of 36 percent would be needed to accumulate the money necessary to meet the level of future obligations existing then. But there was no great push to accelerate funding.

By the mid-1980s when the state was looking for ways to shave costs, it created a two-tiered system within PERS that took effect July 1, 1986. Those already hired under the existing program (labeled Tier 1) remained there, and those hired subsequently fell under new, less costly terms. In 1990, a second tier was added to TRS, taking effect July 1 of that year. A third tier was added to PERS in 1996, again as a cost-containment measure.

Though they changed benefits, the new retirement packages still were attractive programs for retirees, Persily said.

The state has been looking at possible new tiers for more than a year. On Nov. 20, the PERS-TRS boards met in Anchorage to discuss a proposed Tier 4 for PERS and new Tier 3 for TRS and heard alternative approaches from Mercer.

However, the PERS board deadlocked at 2-2 on a move to recommend one of those alternatives to the Legislature. Thus, the PERS board failed to reach a decision. The TRS board, meanwhile, voted 3-2 to take no position regarding a new tier for the teachers retirement system.

Dave Fremming, special assistant to the commissioner of the Department of Administration, said a task force began looking at a new tier in September 2003 in an effort to balance the ability of employers to recruit and keep high-quality employees with the need for an affordable contribution rate.

Whether the Legislature ultimately adopts a new tier, one thing should be left clear, he said.

"The most important thing to remember is that the benefits for current retirees and workers are constitutionally protected," he said.

Millhorn predicted the Legislature would take up the PERS-TRS issue and investigate ways to aid municipalities, school districts and the university, despite the inaction of the boards.

"I'm confident that all that work and information will be available to the Legislature and will be key in their decision-making process," she said.



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