| Fixing PERS |
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HB 2003 - The PERS Reform and Stabilization Act of 2003
Introduction
HB 2003 is intended to reform the PERS system for the future and correct errors of the past in a defensible and responsible way that generates significant savings, protects employee´s accrued benefits and provides a fair and adequate pension to our workforce. The problems of the pension system are not the fault of dedicated public employees, but the system is in financial crisis and is structurally unsound.
To put the system back on firm financial ground and to correct past errors, HB 2003 takes three main actions:
1. Shifts the 6% member contribution from the PERS account to a separate defined contribution account, like a 401k account.
2. Alters the mechanism for crediting interest to member accounts that essentially suspends the guarantee during periods of low investments returns, and institutes a "pay as you go" earnings policy. The guarantee of the "assumed rate" of earnings is understood to be over the course of one´s career.
3. Temporarily suspends future cost-of-living adjustments for retirees who benefited from excess interest credited to their accounts in 1999.
In combination with the new mortality tables, these reforms reduce the unfunded liability and employer contribution rates by approximately one-half of their projected levels.
Framework for the Reforms
HB 2003 rests on these three fundamental events. First, the Marion County Court highlighted significant errors and problems with the PERS system. The problems have existed for some time and are exacerbated by economic events. In particular, the court found the Board failed to adequately fund its reserves and credited too much to individual member´s accounts. This money compounded and expanded the system´s liability because of the "money match" provision.
Second, the State is in a period of financial exigency, and this alone requires action to correct the destabilizing features of PERS. This is not an ordinary time, and we need to protect the critical services of the state, municipalities and schools by arresting the escalating costs of PERS.
Third, the system as it currently operates delivers benefits beyond those envisioned by the Legislature. Decades of changes and enhancements created a series of unintended consequences resulting in pensions higher than envisioned by policy makers. In particular, the interaction of the guaranteed interest crediting and the money match calculation of the retirement benefit have created unsustainable costs.
Principles and Reforms
The reforms are designed according to several principles.
First, they protect accrued benefits. They do not reduce member´s accounts or pensions. All changes are in the future.
Second, the reforms focus on the financial health of the system to ensure that employees will have a stable pension. The reforms target design flaws in the structure.
Third, the reforms ask those who benefited from the past policies to contribute to the solution.
Fourth, the system should continue to provide an adequate pension. The core benefits of PERS will remain the formula approach that protects, with social security, employee´s standard of living in retirement.
HB 2003 is thus designed to correct past errors and reform the fundamental mechanism of the system to create a fair and sustainable public pension system.
Three Reforms
1. 6% Member Contribution
HB 2003 prohibits members from adding to their accounts in the future with the 6% contribution. Instead, this money would be shifted to a separate, companion defined contribution account, like an IRRA or a 401(k) account. Removing it from the regular PERS accounts halts the compounding of these contributions which must then be matched. However, this 6% is the members´ money and it should remain a part of their ultimate pension.
2. Reform the Mechanism for Crediting Interest to Tier 1 Member Accounts
This proposal addresses the unsustainable and escalating costs of the current system that credits each Tier 1 regular account with the assumed interest rate or more each year. The assumed rate is set by the actuary to reflect the long-term, thirty-year rate of return on invested assets, yet this long-term rate of return has been credited to accounts each and every year. Accounts rise each year irrespective of actual investment returns.
HB 2003 restructures the guarantee. PERS would not credit the assumed 8% rate each and every year, but rather would ensure the guarantee is met over the course of the employee´s career.
Currently, PERS Tier 1 members (those hired prior to 1996) are credited each year with the current assumed rate of 8%. When earnings are greater than 8%, the Board is supposed to place funds in a "gain-loss" reserve to offset years with lower returns. When there is no money in the gain-loss reserve and market returns are below 8%, the assumed rate is still credited to member accounts and the amount of the difference is posted as a deficit in the reserve.
HB 2003 makes the first priority of the system to eliminate any deficit in the reserve account. When there is a deficit, no interest would be credited to member accounts. When assets begin to recover, member accounts would earn market rates up to 8%. When there is a positive balance in the gain-loss reserve, these funds can be used to bring the interest credit up to the 8% assumed rate. Thus members will share in the economic recovery as well as the downturn.
There is now a deficit of $1.95 billion resulting from crediting Tier I accounts the assumed rate during years of investment losses. This deficit will increase if PERS continues to credit accounts at 8% when the fund is losing money.
HB 2003 suspends crediting the assumed rate when there are insufficient finds to do so. It is a "pay as you go" scheme in which there must be reserves or sufficient earnings to credit the full assumed rate. Years of over-crediting sometimes might be followed by years when the assumed rate cannot be credited. However, the bill specifies that in no case would the member´s account at retirement be less than it would have been if the assumed rate had been credited each and every year.
The following diagram illustrates the mechanism.
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When there is a deficit, no interest in credited
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Market rates are credited between 0 and 8%
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The gain-loss reserve can be used to bring up the interest credited to 8%
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HB 2001 limits crediting to 8% until the reserve is filled for several years. HB 2003 is thus a "bookend" to HB 2001.
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Over the career the member will earn at least the long-term assumed rate.
Two aspects of this new mechanisms are worthy of special mention. First, PERS would no longer add to liability during down markets. It makes no sense to credit a long-term rate during short-term downturns and thereby add to future liabilities.
Second, it has been mentioned many times that the main cause of unfunded liability is the loss in asset values. This proposal protects the assets by keeping all earnings after a downturn and eliminating any deficits. Thus it simultaneously reduces future liability and adds to the asset base, thereby generating savings. During recovery, member accounts will again earn interest.
This reform reduces the 2001 unfunded liability by $4.9 billion and 03-05 employer rates by 4.3%.
3. Recovering 1999 Excess Interest Crediting
One finding in the Eugene v. PERS case was that the PERS Board abused its discretion by crediting more than double the guaranteed rate to Tier 1 regular accounts in 1999. The Board followed aggressive crediting strategies during the boom markets of the mid-1990s, driving up Tier 1 regular accounts without sufficient reserves in the Gain-Loss and Contingency Reserves, in violation of the Board´s stated goals. PERS estimates that the reserve would have been sufficient to meet Board policy had the Board credited 11.33% to member accounts in 1999, and placed the balance of investment earnings placed in reserve accounts. Instead, the Board credited 20% to member accounts. These large account balances subsequently compound and interact with the Money Match feature in a way that destabilizes the system.
HB 2003 seeks to recapture the amount of the error in over-crediting regular accounts in 1999. For active members, this is accomplished by altering the crediting formula as described above so that member accounts will receive zero interest credits when a deficit exists. The current deficits exist in part as a result of the 1999 crediting decisions. Placing a priority on eliminating deficits with future zero interest credits seeks partial redress for this over-crediting for current active and inactive member accounts.
In the interest of equity and symmetry, HB 2003 temporarily suspends future Cost of Living Adjustments to members who retired under the Money Match method who also benefited from the 1999 interest credits. Thus, the proposal is to calculate the amount of over-crediting (the difference between 20% and 11.33%) for members who retired between February 1, 2000 (the time the excess interest was credited) and February 1, 2004 (or the day when zero percent interest is credited to accounts according to the reformed credit and reserving policy.) The logic is that these retired members participated in the boom years of the 1990s and should contribute at least in part to the solution to the system´s financial crisis.
These changes are prospective and will not reduce the monthly annuity of any retiree. The impact is that the monthly pension will not increase annually until the over-crediting is ´paid back´.
Recapturing the excess crediting would reduce the 2001 unfunded actuarial liability by $413.7 million and reduce 03-05 employer rates by 0.39%.
Combined Impacts
The PERS actuary, Mark Johnson, has estimated the system wide impacts of these three reforms along with the impacts of HB 2001 (the "cap" on the guarantee) and HB 2004, new mortality tables. The combined impact of these reforms is as follows:
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Unfunded Actuarial Liability (Billions) |
Average Employer Contribution* |
Funded Ratio |
|
current |
with reform |
current |
with reform |
current |
with reform |
| 2001 |
$9.7 |
$.6 |
16.5% |
7.9% |
78.8% |
98.3% |
| 2003 projected |
$17.3 |
$6.9 |
23.4% |
14% |
66.6% |
82.8% |
| 2005 projected |
$18.1 |
$7.5 |
26.5% |
17.1% |
69.0% |
83.1% |
| 2007 projected |
$18.4 |
$7.6 |
26.8% |
17.3% |
71.9% |
84.1% |
(*A lower cost successor system would reduce rates further)
Thus, these proposals dramatically reduce the unfunded liability of the system and therefore employer rates in the short-term and over the longer term. The approximate impact is to reduce the 2003 liability by 60 percent, from $17 billion to $7 billion. Projected employer rates for the upcoming biennium fall from 16.5% to 7.9%. Long-term employer rates fall from a projected 26.8% to 17.3% and the "funded ratio" rises from around 70% to 83% in 2006. These are illustrated in the attached graphs.
Impacts on Current PERS Members
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Tier 1 Members (those hired before 1996). The growth of member´s regular accounts would be slowed because of the shift of the 6% contribution to a separate account and the suspension of the current practice of an annual guarantee of interest earnings. However, at retirement, a member´s regular account balance would be at least what it would have been had it grown by the assumed rate (now 8%) every year. Thus, the guarantee is intended to reflect earnings over the entire period of a member´s working career. Also, the 6% companion account will accrue interest and contribute to the pension.
- Tier 2 member´s accounts do not have a guaranteed interest credit, so the change in the way the guarantee works does not affect members hired after 1995. However, these member´s accounts would also grow more slowly because of the shift of the 6% member contribution to a separate account that will not be eligible for money match. Tier 2 members will likely retire under the "full formula" calculation which is intended to replace about 50% of final salary for a career employee, plus the proceeds of the companion savings plan.
- Retirees who retired prior to February 1, 2000 should experience no impact.
- Retirees who retired between February 1, 2000 and February 1, 2004 would not receive the annual 2% cost of living adjustment until the "over-crediting" of interest in 1999 is paid back. This will be determined for each person because it depends on how much money was in the regular account and therefore received an overpayment of interest in 1999. PERS estimates that annual cost - of - living adjustments might be suspended for three to five years for an average long-service employee.
For those who are close to retirement, there should not be much difference between retiring in 2003 or waiting until 2004 or 2005. First, the new mortality tables that will take effect on July 1, 2003 are not intended to lower pensions because there is a "lookback" protection. This means that the monthly pension should not be lower than what it would have been on June 30, 2003 due to new mortality tables. That is, there is no reason to retire to "beat" the mortality tables.
Second, members retiring in 2003 and beyond will be impacted by either the COLA suspension or slower growth in their accounts. Members retiring in 2003 face suspension of cost-of-living adjustments for a few years. It is unlikely that members retiring in 2004 will earn interest on their regular accounts for 2003 and perhaps beyond. The difference between these impacts depends on how much is in the regular account.
The actuary estimates that system wide, future benefits are reduced by 20%. These reductions would be offset by the member contribution account and any future gain in the financial markets. In this way, members would share in the risks and rewards of the invested funds.
These reforms ask for a contribution from members who benefited from the interest credit decisions of the late 1990s. It is unfortunate that these sacrifices are necessary to make the PERS system actuarially sound.
Conclusion
HB 2003 has three significant features: shifting the member contribution to a separate account, severing the link between the assumed rate and annual interest credits during volatile economic times, and recapturing the excess crediting of 1999. In combination with new mortality tables and stricter policies on crediting earnings over the assumed rate, HB 2003 produces the savings needed for Oregon public institutions and puts the PERS system on a sound actuarial path while providing a secure pension to public employees.
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