BY JACOB SZETO
TIGARD- In a 4-1 vote the Public Employee Retirement System (PERS) board changed how employer contribution rates will adjust for the next scheduled change in July 2011.
To fund public employee pensions, employers (schools, state agencies and local governments) are required to contribute to a trust fund that is used to pay for future and current pension obligations. Contribution levels are determined by how well funded the trust is and are a function of payroll. This is done to make sure there will be enough money to pay for benefits.
Before the rule change, if the fund is less than 100 percent funded but more than 80 percent, contribution rates increase by three percent of covered payroll. If the fund is less than 80 percent funded, rates increase by six percent of covered payroll. This method of rate increase is known as the “double rate collar.” These adjustments happen every two years, with the next adjustment scheduled for July 2011.
Mercer, PERS actuary, estimates the funded status of PERS to be 75 percent without side accounts (pension obligation bonds). The funding level is a reflection of huge losses during the financial crisis. In total, obligations exceed the money to pay for them by $14 billion.
At a 75-percent-funded level, the double collar rate of 6 percent will be in effect for the next adjustment. This is likely a sure thing. According to Mercer, “Improvement will be insufficient to avoid a ‘double rate collar’ increase for most employers.”
Under the rule changes, the existing three percent contribution increase would remain the same for a funded status below 100 percent but above 80 percent. But if the funded status were to drop below 80 percent, the rate increase wouldn’t automatically jump another three percent as it did under the old rules. Instead, it will increase linearly at 0.3 percent for every one percent under the 80 percent threshold, up to 70 percent.
For example, under the new rules and the trust funding at 75 percent, the rate would increase 4.5 percent instead of six percent, three percent for being below the 100 percent threshold, plus 0.3 percent for every percentage point under 80 percent.
The rate setting rule change is a relief to employers. A projection made by PERS estimates $273 million of what otherwise would be committed to the rate increase now can go to other spending.
Tom Grimsley, vice chairman and teacher for the Bethel School district, was the one dissenting vote. He proposed an alternative change to rate setting rules. His alternative was to reduce the double rate collar to a ceiling from six to five percent, citing that 81 percent of the Bethel School District budget already went to staffing costs and a one percent decrease in the rate would leave more available money for the children.
When asked about lowering the collar rate and creating a larger inequity, Grimsley said, “Pushing it off for two to four years, am I ok with that, what’s the alternative, the alternative is sacrificing the current generation of kids to an inadequate education…by lowering from six to five it spreads the payoff about four years.”
Several board members clarified that their fiduciary responsibility was to the pension fund and not to schools, thus negating any consideration of how employers spent their budget.
These rate increases are in addition to the current rates already being paid. Currently, average base rates are 13.4 percent. These base rates do not include the offsetting effects of side accounts or the debt service on the side accounts. Debt service is the payments that must be made to pay off the bonds that were taken out earlier in the decade.
These bonds were taken out by various employers to take advantage of the low interest rates and were invested in the market to get higher returns. The net returns between the cost of the bonds and the rate of return have been used to reduce the employer contribution rates. This strategy has mostly worked; but due to the poor performance of the economy, the reduction of the offsetting effects effectively will increase the rates.
For state agencies, this will result in a rate increase of an additional 3.1 percent. Some employers have not been so lucky, and their bonds are now under water, resulting in a negative offset. In other words, they pay more for the bonds than the interest they are earning from the bond proceeds.
The change in the rate setting rules mostly will have no effect on the future funding status of the trust. But this does not change projections that under the current assumption of eight percent returns on investments over the next decade, the funded status will essentially plateau at 80 percent, with base rates reaching 24 percent. Assuming current payroll increases of 4.8 percent a year (average of the last 15 years), over $3.5 billion a year would be going to the pension fund by 2022.
Using a more optimistic assumption of 10.5 percent returns for the next decade, funded status could reach 100 percent, with base rates peaking at 20 percent in 2014 and coming down to 14 percent by 2022. In 2022, with the same payroll increase assumption as above, taxpayers would be paying $2 billion a year to the pension fund.
But if less than optimistic assumptions are used, funded status is in dire jeopardy. At a 4.5 percent investment return for the next decade, about the same return the trust has had over the last decade, funded status is projected to decrease to approximately 60 percent, and base rates would reach 35 percent and continue to rise. That’s $5.2 billion a year of taxes going to the pension fund by 2022.
If returns dip even further to 3.5 percent, funded status will be approximately 55 percent, raising base rates to about 37 percent and costing taxpayers almost $5.6 billion.
