Editor’s note: This commentary is by Bill Huff, of Thetford, a former certified financial planner and former employee of two major airlines that went bankrupt and terminated pension plans.

Vermont pension plan participants are upset, and rightfully so. The pension plan unfunded liability has been growing for years and is now nearly $6 billion dollars, and the Actuarial Determined Expected Contribution, or ADEC, is out of control. This is the amount of money that the Legislature should commit to the pension funds each year. Just the annual increase in the contribution is nearly $100 million bringing the total expected contribution next year to $316 million.

Bill Huff

In an effort to lower the ADEC to a more reasonable figure, and attempting to reverse the unfunded liability, the Vermont House Government Ops Committee was charged with finding a solution. Dems on the committee met with party leadership behind closed doors and put together a package of reforms that clearly weigh on the backs of the teachers, state employees, judges and troopers that are covered under the plan. They are being asked to contribute more and work longer for lower pension payments. Some groups could see a 45% increase in the amount of required contributions while all will see vesting schedules double to 10 years. C.O.L.A.s in retirement, beyond a $24,000 threshold, will virtually be eliminated, although the proposal does allow for them to resume if pension funds ever reach 85% fully funded. Under ideal circumstances, estimates suggest that could happen for state employees in 12 years and 20 years for teachers.

Plan participants were made promises when they were hired. Over the years they have fervently guarded the specific elements of their retirement plan during contract negations, often at the expense of other benefits or additional pay. The Defined Benefit Plan provides two things that are of paramount importance to participants. One, pensions provide a guaranteed retirement income source, and two, there is no investment risk for participants. The amount of the pension is of course dictated by the agreed upon rules at hire. The risk of making the correct investment decisions is the responsibility of the plan sponsor, in this case the state.

The proposed changes to the state pension plan, however, make it clear that things are different here in Vermont. Poor investment performance and lower than required payments to the pension plans in past years are largely responsible for the snowballing ADEC and enormous unfunded liability. The current proposals seek to shore up the pension plans and reduce annual plan contributions by reneging on the promises made. The suggested draconian changes for participants would have a cumulative impact on ADEC of just over $80 million and perhaps reduce the unfunded liability by just over $500 million. These “savings” are coming out of the pockets of plan participants. In effect, the supposed benefits of a Defined Benefit Plan disappear. For one group, judges, the guarantee of a safe retirement income is proposed to be slashed by 40%. Clearly, participants are also being asked to make up for poor investment performance of the past to reduce the unfunded liability, but one proposed provision actually goes so far as to mandate an additional participant contribution should investment performance continue to be below targets. Participants are being forced to accept investment risk in a Defined Benefit Plan which is simply unfathomable.

I mentioned above that under the proposal, ADEC would be reduced by $80 million — yes reduced! Let that sink in for a moment. In order to shore up pension plans, the proposal would actually allow the State to contribute LESS money to the plan! How can this be? It has to do with OPEB, or “Other Post-Employment Benefits.” This is essentially a health insurance benefit for retirees. The state currently uses a “pay-go” system to pay premiums for retirees. Generally Accepted Accounting Principles allow for only a small interest rate assumption on any account balances which result in a higher actuarial estimated payment. If the state changes to a pre-fund system, accounting rules allow for a much higher “assumed interest rate,” which lowers the amount to be contributed! In essence, and over time, the proposal is to accumulate funds and turn OPEB into another pension like system since that has gone so well for the state so far.

In order to fix this for both plan participants and taxpayers, every conceivable solution should be considered, and yet Democratic Party leadership has time and again refused to discuss alternative plans. No testimony about alternatives or what might be working for other states has been allowed. Even if all of the draconian proposals are passed into law, we are still $10 million short of even meeting the increase in ADEC for next year. This is not a solution; it is a recipe for continued enormous pension problems that will lead to higher taxes for residents, and another haircut for plan participants down the road. These issues are already having an impact on retaining key employees and hiring new candidates to fill numerous statewide vacancies that already exist. Its time for something different and something bold.

I believe there is a solution that will keep the promises made to plan participants, reduce plan costs over time, and eliminate the unfunded liability we face today. Annual employer contributions would become sustainable and predictable.

First, and most importantly, implement a plan freeze. That means no more new participants into the Defined Benefit Plan. Existing participants would be allowed to continue in the existing DB Plan under current rules, no changes. The benefit paid in retirement would be everything that has been earned up until the time of the freeze. Promises made would be promises kept. Additionally, plan participants should be given the option of staying in the current DB Plan, or opting for an exchange of the present value of their estimated benefit into a new Defined Contribution Plan. New hires and participants that opted for the exchange would be enrolled into the new DC plan with a simple state match. If new hires contributed at a rate consistent with the new proposals, were able to earn as much as the state suggests is prudent now, and the state matched 4.5 percent, a participant could earn enough money to prudently pay out a lifetime income that matches the current pension plan benefits.

The second part is obviously the start of a new Defined Contribution Plan. This hybrid approach would be used until such time as the last enrolled DB plan retiree were to die, effectively ending the DB Plan. This plan will take years to complete but will treat current plan participants fairly, provide a good retirement for all, eliminate the unfunded liability over time, eliminate an enormous overhead of costs currently needed to operate the Defined Benefit Plan, and provide relief for taxpayers.

I know there is a lot of resistance to even considering a Defined Contribution Plan, however consider the benefits over the current DB Plan. Assets you contribute under the DC Plan are yours, forever. The state match would be yours to keep after whatever vesting schedule was implemented. The asset is yours, not just the benefit. You could accumulate hundreds of thousands of dollars over a typical career, even over a million, and it is yours to use at whatever rate you determine. Should assets remain after you and a spouse are deceased, that money creates an estate for heirs, not so under the current DB plan, unless a “period certain” payout is selected and then for a limited time only. Afraid you would be tempted to spend it all away shortly after retirement? Include an annuity in the new DC Plan as an investment choice. You essentially create your own personal DB plan and annuity payout after retirement with payments that can last for your lifetime and the lifetime of a beneficiary. These days, safe harbor investments are frequently an option in a DC Plan so if you don’t feel up to investing on your own, you can put it on autopilot and age-appropriate investment decisions are made for you.

Plan participants and union reps must decide if keeping the Defined Benefit plan is worth all the additional requirements about to be imposed on them. The guaranteed income is only as good as the entity making the promise. Do you think the state is keeping their promises? Do you feel the DB Plan affords retirement income without investment risk? You are being asked to pay for the fact the pension is unfunded. Whether you want to be or not, you have been subjected to investment risk. For those who disagree, my suggested plan freeze would allow you to continue, as is, until no longer a plan participant. The state wins by eliminating the unfunded liability. Taxpayers win by reducing liabilities and plan expenses, therefore taxes. Most importantly, plan participants win with a plan that can create family wealth, can grow enough to support a comfortable retirement, and eliminates another “forced haircut” in the future.