McClaughry: Retirement fund blues

By John McClaughry

Not the least of the fiscal problems facing the 2021 governor and legislature is the perilous condition of the two state retirement funds, for state employees (VSERS) and public school teachers and staff (VSTRS). Both of these funds are “defined benefit” funds: the state government has the obligation to pay enough into the funds each year, along with contributions from current employees, to make sure there will be enough there to pay current and future retirees the promised pension checks for the next 30 years.

That annual state payment is the actuarially determined Annual Required Contribution (ARC). The actuaries, looking years into the future, have to make assumptions about numbers of current and future retirees and crucially, the expected returns on the invested funds (now just over $4 billion).

If the actuaries calculate that there won’t be enough in the funds to make the required payments, the shortfall is the Unfunded Actuarially Accrued Liability. Ideally, this should be close to zero.

John McClaughry

John McClaughry is vice president of the Ethan Allen Institute.

The Treasurer’s Office recently made public the actuaries’ report of the condition of the two pension funds as of the beginning of fiscal year 2021, now half over. The accompanying Other Post Employment Benefit funds (OPEBs, mostly health care) are pay-as-you-go, requiring an appropriation each year to cover the expected retiree expenditures.

Here is the latest evaluation of the fiscal health of the two funds. (There’s a third fund for municipal employees that the state manages, but state taxpayers are not on the hook for its performance.)

The unfunded liability for state employee pensions is $1.040 billion. For teachers, it’s $1.933 billion. Total: $2.973 billion. These two liabilities have increased by $604 million in just one year.

The state employee pension plan is 66.4% funded; the teacher plan, 51.3%.

For OPEB (unfunded), the projected expenditures for state employees are $1.425 billion; for teachers, $1.259 billion. Total: $2.684 billion. The projected OPEB costs have increased by $416 million in just one year.

The total of the two pension funds and expected OPEB obligations went from $4.637 billion a year ago to the present $5.657 Billion. That’s an increase in required expenditures of over a billion dollars in a single year.

How did we get to this dismal situation? For one thing, for decades the legislature often voted less than the Annual Required Contributions, and that ran up the unfunded liabilities. Why? Because the ARCs are very large numbers in the annual appropriations bill, and reducing them produces no immediate calamities and frees up money for which other interests are clamoring.
For another, administrations played games with the crucial expected yield on the invested assets in the two pension funds. Until recently it was claimed to be an utterly unrealistic 8.25%, at a time when bond yields (around half of the funds) were around 2%. The projected yield has now been allowed to slide down to 7.0%, which accounts for much of the sharp increase in unfunded liabilities. A more realistic number would be at or even below 6%.

Further, the two unions who guard their retirees’ pensions and health benefits are firmly opposed to increasing worker contributions to their respective pension funds, or retiree contributions to their OPEB health benefits. Not surprisingly, the union negotiators want somebody else — taxpayers — to pay lots more to reduce the liabilities. Woe unto the governor or treasurer who stubbornly insists on increased worker payments, because both unions (VSEA and VT-NEA) are well organized to inflict retribution at the polls.

If this problem keeps on festering, at some point taxpayers will simply not allow legislators to short other programs to make huge bailout payments to support unionized retirees who are pocketing far more than a large fraction of the (non-unionized) taxpayers.

The bond rating agencies, taking note of its growing unfunded liabilities, will start downgrading the state’s overall credit. (Moody’s already has, from AAA down a notch to Aa1 two years ago). That means higher interest payments on state debt. It would be costly — and disgraceful — for Vermont to become the Illinois of New England.

With tough gubernatorial leadership, some other states — Michigan and Rhode Island among them — have reshaped their retirement plans. The most important change would be to convert both pension funds into defined contribution plans, commonplace in the private sector. The unions could still lobby for higher contributions, but there would be no more actuarial underfunding. The taxpayers would still be saddled with the responsibility of paying off the legacy underfunding year after year.

Treasurer Pierce is currently engaged in closed door reform negotiations with the two unions. The governor needs to back her up. So should the legislators, who have dismissed reform proposals from Treasurers Douglas and Spaulding in years past.

John McClaughry is vice president of the Ethan Allen Institute.

Images courtesy of Flickr/401kcalculator.org and John McClaughry
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6 thoughts on “McClaughry: Retirement fund blues

  1. John,

    Thank you for this update on this depressing situation. While a beneficiary of the state employees pension fund, where as Facilities Manager for our Town’s school for 33 years my pension comes from, I have long advocated for a reduction both a reduction in current benefits for those like myself and an increase in contributions from those now working. The alternative to prudent action now is the need for more drastic action in the future.

    At some point an article on what is included and how pensions both for teachers and state employees are calculated would be helpful to show the public what exactly they are contributing too.

  2. John:
    We arrived where we are because of incompetence, mismanagement, lack of oversight by the Legislature, and the compounding effect of just letting it be for years and years. It is that simple. Put another way, it is the old “Howard Dean” trick: a pot of money laying by itself, without a critical need/earmark at that point in time, or just plain waiting for the day it will be needed can’t happen. The spend and tax mindset always kicks in, so we use the money for something else and it will take care of itself. Remember the Transportation Fund? We are still playing “Catch Up”, bigtime because of all the money siphoned from the T fund; yes the money may have been returned, but the work in the meantime was delayed…. just drive a few Vermont roads and it will quickly come back to remind the traveler where we went wrong. Sickening as this concept is, it is still playing out; only with different players and a different stage set. And we allowed it to happen, is the bottom line. Long past time for that Housecleaning, that is still very much in need of happening.

    • It will be a long time before returns are equal to what they have been these last 3 or 4 years. If we could not make it then, well, you catch the drift here.
      God help us in our time of need, top to bottom.

  3. The future yield expectation should probably be no higher than 5%, which would probably bring the unfunded liabilities to increase by another billion dollars.

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