There's more to be done on state retirement system reforms

COMMENTARY

BY DAVID COATES AND MARK CROW Just a year ago, we wrote that the recommendations by the Vermont Pension Benefits, Design and Funding Task Force to fix the retirement systems for state workers and teachers (later included in the pension reform legislation enacted in 2022) did not go far enough. A good start, but not far enough to make the systemic solutions needed for the systems' sustainability.

As we wrote, one measure to help make the systems sustainable is to conduct more frequent reviews of the systems' actuarial assumptions. The 2022 legislation, however, extended the actuarial assumptions established in 2019 to 2023. We stressed, at that time and now, that the actuarial assumptions should be reviewed at least every three years.

The actuarial assumptions (e.g., assumed rate of return on investments, inflation, medical expenses) are used to determine the amount of the systems' liabilities and the amount the state must pay each year to help fund the plans on an ongoing basis.

These assumptions can change much more frequently than every four years.

Take, for example, the recent, rapid increase in inflation or the continuing significant increases in medical expenses. If these assumptions are off, we really can't accurately assess state liabilities and annual payments.

Yet, less than a year later, we can see from the Joint Fiscal Office's The Fiscal Focus, dated December 22, 2022 (JFO Report), that the assumptions and projections are already significantly off. While the one-time contributions by the state ($266 million), an accounting adjustment for the retiree health benefits, increased contributions by participants and some limitations on cost-of-living adjustments had a significant impact, the reductions are not nearly as much as what was anticipated.

• Reduction of pension liabilities for FY 2022: Predicted in May of 2022: $293 million Actual: $144 million Difference: - $149 million

• Reduction of retiree healthcare liabilities for FY 2022: Predicted in May of 2022: $1,728 million Actual: $1,228 million Difference: - $500 million These projections are so far off largely due to unrealistic assumptions. The systems' pension plans include assumptions for: (i) investment performance of pension assets; (ii) net turnover (number of employees terminated or quit their jobs); number of retiring employees; (iii) number of deceased beneficiaries; (iv) cost of living adjustments (COLAs); and (v) annual salary increases.

For example, the assumed rate of investment return for the pension plans was 7 percent for FY 2022, but the actual rate of return was -9 percent. The actual rate used to determine COLAs increased to 7.6 percent for FY 2022 but the pension plans' assumptions were only 2.3 percent. And, due to inflation, salaries for existing employees increased by much more than plan assumptions, as well.

Increase in FY 2022 pension liabilities due to actual investment returns being lower than the assumed rate of return: $62 million.

Increase in FY 2022 pension liabilities due to other assumption rates being lower than actual rates (i.e., turnover, retirement, mortality, COLAs, salary increases, etc.): $137 million These unrealistic assumptions increased pension liabilities by $199 million, which is 99.5 percent of the extra, one-time payment of $200 million made by the state as part of the 2022 legislation.

The Vermont Pension Investment Commission is trying to make some of these assumptions more realistic.

The commission is responsible for setting the systems' actuarial assumptions for the rate of return on investments and the inflation rate. The commission spent time during the past year evaluating whether the current assumed rate of return and the assumed rate of inflation were prudent. Unfortunately, the commission ultimately decided to table the decision pending further analysis and discussion with the systems' boards - a missed opportunity to take meaningful steps to address the situation.

And there will only be more pressure on the state. The 2022 legislation requires additional contributions from the state - $22 million in FY 2024, $26 million in FY 2025 and $30 million each year thereafter, until the pensions are 90 percent funded.

Also, despite intentions to reform, this legislation created a new benefit for teachers. Once the teachers' pension funding rate reaches 80 percent, the cost-of-living benefit changes, increasing the current benefit of 50 percent of CPI to 100 percent of CPI. According to the JFO Report, the present value of that benefit is $105 million and adds another $16 million to the state's annual payments to the systems. Yet, this benefit doesn't even appear to be recognized in the unfunded liabilities as of June 30, 2022.

We must be realistic about what the actual liabilities are so that we better understand the magnitude of the problem and how critical it is that we address it now in a more sustainable fashion. The 2022 legislation helped make some headway, but there is still no clear path to making the systemic changes needed for the systems to be sustainable.

One relatively easy step towards sustainability is to make the systems' actuarial assumptions more realistic, which, hopefully, accelerates efforts to include other systemic changes to reach sustainability (e.g., alternative retirement plans for new hires and equitable risk-sharing measures to address unanticipated downturns). To do so, means we need more frequent assessments of these actuarial assumptions.

David Coates of Colchester is a retired managing partner of KPMG's Burlington office. Mark Crow of Shelburne is president of Tenth Crow Creative. The opinions expressed by columnists do not necessarily reflect the views of Vermont News & Media.