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Part four: The PERA puzzle
Widening pension fund gap may require taxpayer bailout
Plan needs extended market surge or extra $400 million a year
Published August 17, 2005 at midnight
Leah Schultz's mother is an educator, but it was her father who urged her to become a teacher.
"He said, 'We're retiring on your mother's pension," said Schultz, an English teacher at Douglas County High School.
Both Schultz, 28, and her mother are members of the Colorado Public Employees' Retirement Association. Her parents' retirement is assured. Hers is not.
PERA, which replaces Social Security for its more than 365,000 members, owes $43.6 billion in benefits - and has $30.8 billion in assets. That funding level is 70 percent, down from 100-plus percent just four years ago.
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Audio Meredith Williams, executive director of the Colorado Public Employees' Retirement Association, explains his findings on executive pay and perks policies at the November meeting of the pension fund's board.
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The gap is growing every year, and PERA's estimates show that while the plan can pay benefits for the next 30 years, it ultimately will run out of money unless state taxpayers bail it out or the markets have another extraordinary, long-lasting surge.
PERA Executive Director Meredith Williams told legislators in July, "The sky is not falling." PERA's board, fresh off a small package of changes it advocated in 2004, prefers to wait and monitor the plan's funding level. If investment returns do not exceed PERA's estimates, "more contributions will be needed (from taxpayers)," Williams said.
Taxpayers added $563 million to PERA's pension and health care funds last year through employer contributions made by state and local governments and schools. Employees put in $457 million - 8 percent of their salaries.
PERA's actuaries told the fund in June that to get PERA back into sound funding status, employer contributions needed to nearly double. That, according to a Rocky Mountain News analysis, would require an extra $400 million a year, starting now.
PERA's board does not think it can make any negative change to benefits for any active member without getting sued.
While the board waits, however, others may take the reins in proposing changes to the pension fund. The Treasurer's Commission to Strengthen and Secure PERA, founded by former state Treasurer Mike Coffman and chaired by former Gov. Dick Lamm, is preparing a report based on five hearings it has held since March.
Lamm, in an interview with the News, called PERA "a land mine buried in Colorado's future."
"The state of Colorado has a moral, if not legal, obligation to bail this thing out, and this problem is not going to fix itself," Lamm said. "(PERA) is absolutely in denial over the future burden they're building in for future taxpayers."
Changes in the works
Dave Slishinsky, an actuary from Buck Consultants, told the PERA board in June what needs to happen. Robert Scott, PERA's executive director from 1984 to 2000, said the same thing in a recent interview.
"Contribution rates have to go up, benefits have to be cut, or investment returns have to get better," Scott said.
PERA, with the legislature's cooperation, has made progress in all three areas.
• A 2004 law includes a gradual increase in the employer contribution rate for the state and school division, by far PERA's largest employee group, to 13.15 percent of employees' salaries by 2012.
• As of July 1, new hires in PERA have slightly fewer benefits. For example, they will not be able to retire with full benefits at age 50 with 30 years of service, as current members can. They will have to wait until age 55.
• PERA's portfolio, buoyed by the stock market, returned 24.1 percent in 2003 and 14.1 percent in 2004.
But long-term projections still look dim.
If PERA's portfolio returns an average of 8.5 percent per year - its assumed rate of return - the funding level dips to 40 percent in 2034. If it returns 7 percent, the funding ratio dips below 20 percent in 30 years. That means PERA would have only one-fifth of the funds it would need to pay retirees all their benefits from that point on.
A 10 percent annual return - in line with PERA's historic bull-market results - could fix the problem, making PERA 100 percent funded in 2034.
"If you plug that into the equation, happy days are here again," Williams told legislators in July.
Whether the stock market can perform at that extended bull-market rate is unknown. The market's growth from 1974 to 2000 - the Dow rose to 11,750 from below 600 - was one of the longest up markets in history.
A shift in strategy
Even if stocks do surge over a long period, PERA's portfolio no longer is structured to ride the market as it once did.
In November 2002, PERA's board changed its "asset allocation model" to shift money away from stocks and into bonds. The move made PERA's portfolio less risky.
At the time, stock prices had taken a huge hit, and, with interest rates low, bond prices were at historic highs. PERA sold low and bought high in making the move.
Since bonds have lower long-term rates of return than stocks, PERA was decreasing the investment return it could expect to achieve.
In June, the PERA board heard a report from its consultants at R.V. Kuhns on the ramifications of its decision. The PERA portfolio, Kuhns said, reasonably could be expected to return 7.75 percent annually - significantly below the 8.5 percent PERA uses for its projections.
Map
The retirees who are receiving benefits from Colorado PERA are spread out across the state, and 12.5 percent live outside Colorado.
Full map »
Unfunded balance growing
While PERA's assets likely will grow more slowly, its liabilities - the benefits it owes - are growing faster than ever.
PERA's assets have grown 100 percent since 1995, but its liabilities have grown 154 percent. The number has ballooned because of a series of benefit boosts enacted in the 1990s and 2000.
In 1997, the legislature passed a PERA-proposed bill that increased the annual payment for a retiree on full benefits by 15 percent. A 30-year employee making $50,000 now would get a pension of $37,500, plus cost-of-living adjustments, rather than $32,500.
The PERA board, however, relying on a legal opinion by General Counsel Greg Smith, thinks benefits cannot be cut for any active PERA member. That means not just current retirees and workers who are eligible to retire but the brand-new employee who has put less than a year of contributions into the plan.
PERA has an infinite amortization schedule, which means it's not making enough payments to reduce the fund's unfunded liabilities over time. The result is that, without intervention, the liability will grow until the plan collapses.
Coffman, who is on leave as state treasurer to serve in Iraq, said he believed that this qualifies as an "actuarial emergency," permitting PERA to reduce benefits.
Smith argued, however, that there is no precedent for declaring an actuarial emergency unless a pension fund has a serious cash liquidity problem.
Still, when considering solutions, it's possible that policymakers will see the basic PERA benefit package as one thing and the annual 3.5 percent cost-of-living adjustment as another.
State Sen. Norma Anderson, R- Lakewood, a longtime sponsor of PERA legislation, said PERA could base annual benefit increases on the Consumer Price Index rather than a fixed 3.5 percent.
"I still think (PERA) is a good program," Anderson said. "I haven't given up on it like some others have. I think we have to work to bring it back."
Looking for more cash
Absent strong investment returns or reduced benefits, the pension- plan equation turns to the final piece: contributions.
PERA's board and staff know what it would take to pay off its unfunded liability in 30 years, because its actuaries told them in June.
The actuaries at Buck Consultants said PERA needs 16.91 percent of employees' salaries from state government and school employers, starting now, to pay off the liability in 40 years.
With a payroll of about $5.3 billion in the state and school division, the higher rate translates into more than $400 million of extra taxpayer money each year. That would nearly double taxpayers' current commitment to PERA, since employers in the state and school division contributed $453 million last year. (These numbers do not include what's needed for PERA's judicial and municipal divisions, which account for about 10 percent of membership.)
PERA legislation passed in 2004 will gradually increase the employer contribution rate by 0.5 percentage points each year from 2006 to 2012. But even if PERA implemented the 2012 rate today, it still would be roughly $250 million a year short of the amount needed to stabilize the plan, according to News calculations based on PERA payroll data and the actuarial reports.
PERA's Williams has said the board would prefer more contributions sooner. In July, talking to legislators, he invoked a 1971 Fram oil filter commercial when talking about the pension plan's health: Pay a little more now . . . or pay a lot later.
But the 16.91 percent rate "is not within the realm of the possible at this time" because of squeezed state and school budgets, he said.
Colorado law says PERA is considered "actuarially sound" when the plan has a 40-year schedule to pay off its liabilities. But the law does not require the legislature to actually appropriate that money.
Other public pension funds must operate under stricter standards. Los Angeles County must adjust its contributions each year when actuaries give figures needed for a 40-year amortization, said Gregg Rademacher, assistant executive officer of the Los Angeles County Employees Retirement Association.
Besides thinking that benefits cannot be cut, PERA executives also think the employees' contribution, currently 8 percent, cannot be increased unless benefits are improved. Asking members to pay more is off the table in PERA's planning, board discussions indicated.
"I disagree totally with that," Anderson said.
If schools and government agencies must pay more, so should PERA employees, she said. "It has to be a little bit of both."
"It is my opinion that PERA should start negotiating with employees and finding out where they are rather than just saying, 'No, we can't do it,' " Anderson said. "They need to reach out."
Bruce Mendelson, a 58-year-old retired analyst from the Department of Health, said, "If the state needs to increase the amount of money it needs to put into PERA, that's what they need to do. It's as simple as that.
"They took 8 percent out of my check for 30 years. To me, that's a contract with the state of Colorado. You serve them well, and this is what you get in return. I kept my part of the bargain, and I expect the state to keep their end of the bargain."
Schultz, the Douglas County teacher, spent 10 years in private full- and part-time jobs before beginning teaching. She views the corporate life as fulfilling short-term needs but public employment as the best deal in the long term.
"Everyone knows the best pension to have is from the government," she said. "Hearing that my entire life, I believe, perhaps naively, that it's going to be there for me."
Solving the problems
• What other underfunded pensions are trying
• ILLINOIS:
Gov. Rod Blagojevich created a pension commission to find solutions to his state's $35 billion underfunding.
Its report in February suggests eliminating a number of benefits for new hires, including increasing the minimum age to receive unreduced benefits to 65 from 60, with eight years of service. It also recommended increasing employee contribution rates and limiting employees' pay raises in their final years of service to minimize the pension payment.
The first recommendation, however, was this: "The General Assembly must not adopt any new pension benefit without a new funding source identified at the point of adoption. In addition, an explicit sunset provision must be attached to any new pension benefit."
• LOS ANGELES COUNTY:
The employer and employee contribution rates went up July 1 - by law.
Gregg Rademacher, the assistant executive officer of the Los Angeles County Employees Retirement Association, said California pension law requires counties to make the actuarially required contribution each year. This contribution, or ARC in pension lingo, is enough to make sure the plan pays off its liabilities on a set schedule - 30 years in this case.
Actuarial firm Milliman made a presentation to the pension fund's board in January, laying out a set of assumptions LACERA could adopt. Some of the choices would have saved the county money - but the board decreased its assumed investment return to 7.75 percent from 8 percent. That required that the employer's contribution rate be 15.87 percent, 1.22 percentage points higher.
Then the funds were appropriated - automatically, Rademacher said. Employee-contribution changes were negotiated by the county and employee representatives and implemented July 1.
• CITY AND COUNTY OF DENVER:
By the summer of 2004, the Denver Employees Retirement Plan had dropped to being 98 percent funded, and the pension board determined something needed to be done to prop up the funding, Executive Director Steve Hutt said.
Two changes were made: New city hires after Sept. 1, 2004, would get an annual pension benefit payment equal to 1.5 percent of salary (times years of service), rather than the 2 percent current members will receive in retirement.
"That was a big deal" for the Denver City Council, Hutt said, because "it was the first time we would have a two-tier structure" for benefits.
The second change was that the Denver pension fund said it needed contributions to increase to 11 percent of payroll, from 10 percent. "We were indifferent to where it came from - employer or employee."
So the City Council voted to split the extra 1 percent equally between the city and the employees.
PERA said it believes an increase in the employee contribution rate without new benefits would violate its pension contract with employees.
"No one raised that, either our general counsel or the city attorney. And no employee has raised it," Hutt said.
The series
• SATURDAY
Even as its pension fund declined by billions of dollars, the Colorado Public Employees' Retirement Association gave its own employees unusual perks: 52 weeks of personal leave to bank and then cash out at retirement or resignation; 12 weeks of sick leave a year for top execs; and, for some, 20 percent "longevity bonuses" every three years on top of annual bonuses.
• MONDAY
PERA board members spent $350,000 over five years to travel to luxury resorts and hotels for educational conferences filled with money managers eager to sell PERA their services.
• TUESDAY
PERA took a bath in the three-year economic downturn after investing heavily in stocks, failing to plan for the end of the bull market and selling massive amounts of credit for extra years of service so members could boost their retirement payments or retire early.
• TODAY
PERA is 70 percent funded and needs 10 percent average returns in the market or increased taxpayer contributions to fulfill its obligations to retirees in 30 years.
• ONLINE
David Milstead is finance editor of the Rocky Mountain News. He can be reached at 303-892-2648 or milstead@RockyMountainNews.com.
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