Escalating costs of the Public Employee Retirement System are becoming a crushing burden on local governments and state agencies. The system is out of control, an intolerable burden on all Oregonians, and urgently needs reform. It will severely impact the quality of education in Oregon.

Why do we find ourselves in this situation, and what can we do to prevent future problems?

PERS was created in 1946. Initially, it was funded by equal employee and employer contributions, and money match was used to calculate benefits. Dissatisfied with investments averaging only 3 percent annual return in the 1950-1969 period, legislators in 1967 developed a new formula.

The final formula in 1981 was based on the highest salary and years of service and gave an employee retiring after 30 years a pension of 50 to 60 percent of highest salary, with an incentive to work longer and get higher benefits — 80 percent after 40 years. Everybody was pleased and money match was forgotten although, inadvertently, it remained on the books.

But in the 1980-1990 period, investment returns averaged 14.8 percent. Employee accounts skyrocketed and money match became the way to higher benefits. By now, 95 percent use it and get ever-increasing benefits at substantial cost to public employers, i.e. taxpayers.

In 2001, following multiple enhancements and irresponsible management by a PERS Board dominated by beneficiaries, most members were retiring as soon as they reached 30 years of credited service and received an average benefit equal to 105 percent of their highest salary. Future retirees will do even better.

To satisfy promises made by the PERS Board to public employees, Oregon taxpayers will receive a bill for about $8.5 billion because the 2000-2001 unfunded actuarial liabilities greatly exceed the gain/loss reserve fund.

The school districts' share is about $4 billion. This will be paid over 20 to 30 years by increasing their PERS contribution rate from about 11 percent last year to about 17 percent next year, while the employee contribution remains fixed at 6 percent. There may be more unfunded liabilities in the future, starting with this year.

The Legislature took a small step toward reform in 1995 by creating a second category of employees, called Tier 2. They are those who have been hired in 1996 or later. The main difference is that they do not have a 8 percent guarantee of growth in their accounts as do those in Tier 1. This hardly makes any difference because Tier 1 employee accounts represent about 98 percent of all funds. The only way to control PERS costs in the next few years is to make changes which affect all employees and particularly those in Tier 1.

I am very concerned because the escalating costs force schools to lay off teachers and cut programs, hence denying Oregon students a quality education.

We need reform by concerted action of the Legislature and the PERS Board, with the following objectives:

n Operate the PERS system on a sound financial basis, with reasonable and sustainable employer contribution rates.

n Ensure that a prudent, responsible and objective PERS Board, with active legislative oversight, manages the system efficiently and with strict adherence to sound actuarial principles and its fiduciary duties.

n Maintain an essential balance between providing good benefits to long-term public employees and controlling the cost of PERS to public employers (i.e. Oregon taxpayers).

Eight percent guarantee

The 2000-01 unfunded actuarial liabilities that increased the PERS shortfall by $7.6 billion were primarily the result of the PERS Board's 1974 promise that all Tier 1 employees (active, inactive or retired) would receive every year a minimum return (currently 8 percent) regardless of how low the actual return on investments may be. (25 percent in 1999, 0.6 percent in 2000 and -7.2 percent in 2001). The employers (i.e. taxpayers) must pay for this promise in the form of increased contribution rates. PERS worked well without a guarantee for 27 years.

n If the Legislature could unilaterally create a guarantee in 1974, it seems to me that it can repeal it in 2002 or 2003.

n If PERS could arbitrarily set the guarantee in 1974 at a level 60 percent above historical levels and then increase the guarantee three times to 8 percent by 1989, it certainly can reduce it in 2002 or 2003.

n If PERS chose to make the guarantee equal to the assumed earnings rate, a decision which cannot be defended logically, it can certainly decouple the two.

n During the 1980-1999 period when actual returns on regular employee accounts averaged 15 percent, the PERS Board could have — in fact, had a duty to — build the Gain/Loss Reserve Fund to a level sufficient to cover fully the 2000 and 2001 liabilities, with billions left for possible future deficits.

However, the PERS Board ignored warnings, violated its own policies and systematically underfunded the reserve fund. The consequence is the fund now shows a deficit of $2.5 billion, which must be paid by Oregon taxpayers within five years.

Public employers are legitimately obligated to pay for increased PERS costs that are the inevitable consequence of legislative commitments. But public employers should not accept responsibility for billions of dollars due to PERS Board mismanagement and should challenge the bill in court.

Money match

Let me illustrate this feature: At the end of 2000, Tier 1 employee accounts held about $16 billion. The actual investment return was a 7.17 percent loss.

To satisfy the guarantee of an 8 percent increase, employers must contribute $2.4 billion to the accounts. Then, because of money match, they must add a comparable amount in their own account, thus doubling the added cost to taxpayers to $4.8 billion for just the year 2001.

And we can expect more in 2002.

In a perfect world, both the guarantee and money match would be revoked. If this cannot be done, at least one of them should be eliminated. In any event, money match should apply just to regular accounts and then only if employees and employers have the same choice of investments.

Mortality tables

Sound actuarial principles require that the most accurate mortality tables be used in the calculation of retirement annuities, regardless of impact (positive or negative) on calculated retirement annuities. This should be done without delay, although legislators again in this special session have refused to do so.

The key point: The combination of the 8 percent guarantee for Tier 1 employees and money match has driven the shortfall from less than $1 billion to $8.5 billion in just two years. It will cause more billion-dollar increases in the future. If must be eliminated by rescinding one or the other — or, preferably, both.

Guest writer Francis Charbonnier, a longtime member of the McMinnville School Board, has been a scientist, engineer and manager at Linfield Research Institute, Field Emissions Corp. and Hewlett-Packard, and now Applied Physics Technologies. Since retiring in 1994, he has conducted research projects for LRI and spoken at various international conferences.