After several years spent patching up the state’s ailing public pensions, lawmakers will have another pension fund bailout to weigh in 2013.
This time, a main focus will be on the pension plan for roughly 9,400 retired police officers and firefighters or their survivors. The police and fire fund, which is part of the state Public Employees Retirement Association (PERA), had a $1.6 billion unfunded liability as of July 1. The plan is projecting that it will have 78.3 percent of the funds it needs to pay benefits to retirees through 2038. Mary Most Vanek, PERA’s executive director, said the deteriorating condition of the fund has been exacerbated by factors from stock market hiccups to longer life expectancies.
“We knew last year that we had a contribution shortage,” Vanek said. “It was driven by market losses in previous years and mortality assumption updates.… We’re seeing that more and more people are retiring early, and currently we don’t reduce that benefit by very much. In other words, the plan is subsidizing those early retirements.”
An assortment of interested parties is forwarding a slate of possible police and fire fund remedies for state lawmakers to consider. The proposals, which were unanimously approved by PERA’s board of trustees, include contribution rate increases from both employees and their public employers.
Brian Rice, a lobbyist who represents the Police Officers Federation of Minneapolis, said his members are willing to increase their contributions for the sake of the financial health of their pension.
“I think the members are pretty supportive. They understand it’s a good benefit and they want to keep it and make sure it’s affordable,” Rice said.
The police and fire pension plan is but one of the plans overseen by PERA. PERA is one of the three big statewide pension plans, along with the Teachers Retirement Association (TRA) and the Minnesota State Retirement System (MSRS).
Market downturn destabilized funds
The pension plans went from being fully funded during the bull markets of the late 1990s to sprouting large unfunded liabilities last decade during the dot-com bust and Wall Street meltdown. Lawmakers have since passed significant pieces of legislation to shore up the plans. Most notably, in 2010 lawmakers increased employee and state contributions. That year’s legislation also took the unprecedented step of reducing the annual increases in retiree benefits. The legislation chipped away at $6 billion in liabilities for the state’s big three plans, $3.4 billion of which belonged to PERA.
But pension problems have persisted for state legislators. One significant issue, which lawmakers addressed in the 2012 regular legislative session, was the projected annual rate of return on pension investments. Many lawmakers on the Legislative Commission on Pensions and Retirement believed that the existing 8.5 percent return projection was too optimistic, a point of view that reflected the recent history of stock market losses and predictions regarding future rates of growth in the U.S. economy.
But the proposals to reduce the rate of return proved controversial, since reductions would have the effect of increasing the projected losses for the pension plans. TRA, in particular, objected to lowering the rate to 8 percent. The compromise ultimately reached in the 2012 omnibus pension bill lowered the rate to 8 percent for five years before returning it to 8.5 percent in 2017. The discussion about the rate of return will likely continue, as will the issue of whether the State Board of Investment should pursue relatively risky investments with the goal of increasing returns. Legislators are also likely to continue exploring alternatives to the current defined benefit system, in which the state assumes the risk for providing pension payments at stipulated levels.
Contribution increases won’t be enough
But for now, the police and fire fund appears to be the big issue.
If lawmakers were to simply increase employee and employer contributions to fix the funding deficiency, the hike would add 8 percent on top of the current contribution levels. In a December statement announcing that the PERA Board of Trustees had unanimously endorsed the legislative proposals from the working group, the pension board said an increase of 8 percent on top of the current contributions isn’t an option.
“Nearly all agree [that] increasing contributions alone to address the problem is financially impossible,” according to PERA.
Under the PERA recommendations, however, employees would kick in some of the cost of the package by increasing their contributions by 1.2 percent of their salaries, to be phased in over two years. The current rate of 9.6 percent would be raised to 10.2 percent in 2014 and 10.8 percent 2015.
The public employer would increase its contribution rate by 1.8 percent over the same two-year period, resulting in a 16.2 percent contribution level.
New employees hired after June 30, 2014, would have their retirement levels capped at 99 percent of average salary. Another change for hires after June 2014 would be increasing vesting to 50 percent after 10 years of service and then increasing at 5 percent a year until the employee’s 20th anniversary.
One of the big issues that the recommendations highlight is the financial burden on the fund from early retirements. Lawmakers made it financially easy for police and fire fighters to retire early because of the strenuous nature of their jobs. But the relatively low penalty for retiring early is putting too much stress on the police and fire fund’s finances, Vanek said.
“These folks can retire early because of the nature of their jobs,” Vanek said. “But their life expectancies have improved, and God bless them for that. But it puts a strain on the fund if we don’t have provisions within the plan sufficiently balanced for these early retirement provisions, and that’s what we need to work on.”
Under the recommendations, early retirement would be made less financially attractive by changing the so-called early retirement reduction factor from 1.2 percent per year to 5 percent per year.
Current retirees would also help shore up the fund by limiting the annual increases in benefits to 1 percent until the plan is 90 percent funded. Retirees would also have their first increase delayed by three years, which is two years more than the delay in current law.
Kim Crockett, who analyzes Minnesota pension policy at the conservative Center for the American Experiment, welcomes the acknowledgement that the fund needs to be improved. But she would prefer the state move to a different type of pension structure that gives employees more choice and flexibility than simply making fixes to the status quo.
“All they are going to be doing is tweaking the existing defined benefit system that they have,” Crockett said. “That might work out really well for people who don’t mind putting more in. And everybody should, because the reason we have such a big unfunded liability is that the state and the employees aren’t putting enough in to cover what they are taking out, given what you make in the market on it. They ought to be putting more [contributions] in. But it also ties the hands of people who don’t want to be 30, 35-year employees. They might want to do something else. “
The Legislative Commission on Pensions and Retirement will be the starting point for the 2013 omnibus pension bill. The commission is a joint House and Senate panel, and this year the Senate will have the gavel. Sen. Sandy Pappas, DFL-St. Paul, has the most seniority on the commission among the Senate members. Current commission member Rep. Phyllis Kahn, DFL-Minneapolis, wants to return to the commission in 2013 and thinks the police and fire changes can pass. She said, however, that she wants less significance placed on projecting the financial status of the funds decades into the future.
“I think we get a little too panicky about when they have to be fully funded by,” she said. “It’s not like a private company that’s going to go out of business. What you want to look at very closely is that the slope of benefits is not going up faster than the slope of money that you’re putting into it. If they start diverging, then you need to fix it.”