By Francis Charbonnier
In 2000, the Public Employees Retirement System was in great shape - excellent benefits, acceptable employer costs, assets sufficient to pay promised benefits for the next 25 years. Three years later, the benefits are better than ever, but the system has a $17 billion unfunded liability which must be paid over time by the tax-funded employers.
To appreciate this appalling disaster, consider that the total state revenue is about $5.6 billion a year. Last year PERS' deficit grew by $7 billion.
Without reform, benefits will double and employer costs will increase from 9 percent of salary five years ago, to 18.6 percent in July, to 29 percent in about six years. This would cause massive cuts in services, including schools, and layoffs of up to 20 percent of public employees. PERS is out of control and threatens to bankrupt the state.
After months of heated debate in public hearings and work sessions, the House PERS Committee sent four reform bills to legislators for approval. Gov. Kulongoski and Sen. Tony Corcoran, both with strong ties to labor unions, pushed for passage and convinced enough Democrats that the four bills were approved by strong majorities in both houses and were signed by the governor May 9. The public employee unions claim that the bills breach labor contracts and break promises. They plan to appeal to the Supreme Court as soon as possible.
Proponents say the bills are necessary to protect public agencies from lasting damage, that the bills leave employee accounts and accrued benefits intact, that future benefits will still grow but more slowly and that even 15-20 years from now, public employees will still be able to retire in their mid-50s at 60 percent of their highest salary, more if they work longer and not counting Social Security.
There are two types of retirement plans: defined benefit and defined contribution. The first guarantees a retirement benefit based on the highest salary multiplied by years of service. The cost to employers is low if the average investment return is high, but very high if the return is low.
The defined contribution plan is the opposite. It specifies the yearly contributions of the employer (and/or the employee). A high return and a long career produce very high benefits. Most employees prefer the benefit certainty of the defined benefit plan; employers prefer the cost certainty of the other.
In 1946, the pension system was created with a defined contribution plan modified by money match in which the employee contributed 6 percent of salary to a personal account; the employer contributed to a separate account the amount needed to double the employee's account at retirement.
There have been other enhancements to PERS over the years. In 1973, the stock market was bad and employees were upset. So the Legislature decided to guarantee that the earnings credited every year could not be less than an assumed rate guarantee, 5.5 percent at the time, regardless of the actual earnings or losses. In the boom years, 1980-1999, the average credited earnings were 13 percent for regular accounts and 17 percent for variable.
In 1981, the Legislature created the "full formula defined benefit plan," which allowed a career employee to retire at age 58 with a PERS benefit equal to 60 percent of his highest salary. Retiring employees calculate benefits under both the money match and full formula plans and pick the higher.
By 1995, most employees chose the money match formula and it was clear that the 8 percent guarantee would be enormously costly in bad stock market years. So legislators decided that all future employees (Tier 2) would have no guarantee. This year, 30 to 40 percent were in this plan, but more than 95 percent of the funds in employee accounts belong to Tier 1 employees, so the cost of the guarantee is only reduced by less than 5 percent.
Consider: In 2001, Tier 1 employee regular accounts lost 7 percent, but they must be credited with 8 percent. This can only be done by transferring funds from the employer accounts. Then, when the employee retires under money match, the employer must add 15 percent to his account.
It is estimated that about 25 percent of the $17 billion shortfall is due to mismanagement by the PERS board, which a judge recently charged with violating statutes, ignoring its polices. That ruling is being appealed.
The PERS reform bills:
HB2001: Caps investment earnings at 8 percent on regular accounts until deficits are erased and reserves rebuilt. Very small savings, since this would be done anyway even without the bill.
HB2005: Historically, the board has been controlled by PERS beneficiaries and dominated by public employee unions (obvious conflicts of interest). The new board has three non-PERS members, one representing public employees and one representing employers.
HB2004: Instructs PERS to adopt current mortality tables, instead of the 1978 tables, which PERS wanted to continue using for many years. The obsolete tables underestimate retiree life expectancy by four or five years, inflating benefits. A "look-back" feature protects employees from any benefit cut.
HB2003: The most important (employer and business coalition) bill which 1) protects current employee accounts and accrued benefits, 2) shifts the 6 percent employee contribution (generally picked up by employers - two-thirds of school districts but not in the McMinnville district) to a separate account outside of money match, 3) most importantly, redefines the 8 percent guarantee for Tier 1 employees to apply to their career average, not to every single year and 4) suspends the cost of living increase for employees retiring in 2000-2004 for the period necessary to repay excessive earnings credited for 1999.
It is estimated that these bills, if fully sustained by the Supreme Court, will reduce the unfunded liability at the end of 2002 to about $9 billion. Also, PERS will recalculate employer rates effective July 1, saving approximately $650 million overall for the biennium.
In conclusion, the PERS financial crisis grew to such magnitude that thorough reform was necessary. The governor and legislators understood that and passed the bills that will protect public services from severe harm and even bankruptcy. The taxpayers could not be expected to agree to large tax increases to bail out a system that provides retirement benefits that most people only dream about.
PERS cannot be restored to health without reducing liabilities, which requires breaking some promises and expectations by reducing benefits. But this was achieved without any reduction in current accounts and accrued benefits and current career employees will continue to retire under money match with excellent benefits, replacement ratios gradually decreasing from the present 100 percent to the 60 percent floor guaranteed under the full formula.
Guest writer Francis Chabonnier, 23-year McMinnville School Board member, has has been following the PERS issue closely because of its profound effect on the school district. He has testified frequently before House committees on education issues. He retired in 1994 from Hewlett-Packard as a research and development manager. He skiis, scuba dives and travels around the world, including to his native France.