by David Coates, Managing Partner, KPMG (Retired)
As promised in my previous commentary here, I will present in this article some possible solutions to the state’s pension and retiree health care benefits crisis……and, yes, it is a crisis!
Just to recap, as of June 30, 2016 the state and taxpayers are on the hook for $3.6 billion of unfunded liabilities for these benefit plans for around 32,000 state workers and teachers. By comparison the state and taxpayers are also on the hook for about $650 million of bonds issued for basically infrastructure improvements that benefit our entire population of around 625,000.
The unfunded benefits have been increasing nearly every year despite paying over $200 million annually from the state’s general fund. Further these unfunded benefits are likely substantially larger as the assumptions used by the state to compute rate of return and discount rate are questionable according to most external or industry experts. I understand the Treasurer has requested that the discount rate be reviewed by another Actuary.
Before recommending any solutions, let me make it perfectly clear that none of these suggestions would impact the current benefits that former state workers and teachers are receiving. ”Promises made are promises kept” is the mantra I have espoused since 2008, when I began reporting on this subject. However, after many years of no meaningful changes, that promise is under serious question.
The fairest and simplest way to stop this liability is to not allow new state workers and teachers to participate in the defined benefit plan. Instead, set up a defined contribution plan for new state workers and teachers that is similar to a 401 (K) plan; the very same type of plan most Vermonters have for their retirement needs. If this had been done in 2010, over 500 state workers would now be on the DC plan or around 7% of the pension participants. Clearly, it would have placed Vermont on a more sustainable path than where we now find ourselves. This one change will not solve our overall problem, but it isolates the problem, thereby giving the state an opportunity to find solutions. This is an incremental step we must take, otherwise the liability will continue to escalate the size of the problem and make any subsequent solution practically impossible.
A defined contribution plan may cost a little more in the short term, but the long term benefits would be extraordinarily beneficial to our state and taxpayers.
Another possibility would be to require state workers and teachers to contribute more to these lifetime benefits. Most of the plan participants currently pay between 5-6% of their annual pay. They receive a pension of around 50-60% (retirees also get social security benefits) based on their last few years average pay for their lifetime. Most reasonable people would agree that these are generous benefits not afforded most Vermonters.
Most of the pensions pay a cost of living adjustment (COLA) that ranges between 1-3%. A suggestion would be to freeze these benefits until the plans are 80% funded, similar to the funding level generally required of the private sector plans. The combined plans are currently at 68%…. a low level of funding and likely going lower.
The current plans could always be frozen and then place all covered participants in a defined contribution plan as recommended for new participants above. The private sector has done this. If this recommendation was pursued, then it would need further study.
Vermonters must realize that any of the above possibilities would still leave the state at risk for the ongoing defined benefit plans (frozen or otherwise). However, the risk would be substantially less than the path we are on now.
RETIREE HEALTH BENEFITS
This benefit is a non-starter as we are underfunding it by $50 million a year. In other words, we simply can’t afford it and, if you can’t afford something, then you must eliminate it instead of putting it on a credit card that you are unable to pay. This generous benefit is another one that the vast majority of Vermonters do not receive. Most retirees pay a co-pay of 20% of the premium. The plan is considered a Cadillac Plan (costly generous benefits) under the Affordable Care Act and would be subject to a special tax under the existing law if these plans aren’t changed. This could cost the state several million a year.
At a minimum, it must be stopped for new state workers and teachers. In addition, for those currently receiving this benefit, co-pays should be increased to a level that will make this a sustainable or pass-through benefit.
The complete elimination, or at least the restructuring, of this benefit as mentioned, above would allow for more modest changes in the pension plans I noted earlier.
As is obvious, there is no secret sauce or silver bullet to this crisis. However, these suggestions would put these unfunded liabilities on a glide path that would be fair and affordable to the state and taxpayers.
What are we waiting for? We are waiting for the majority party in the Legislature to decide whether they represent all of their constituents or the union leaders. The majority party controls the Legislature and, as a result, owns this $3.6 billion unfunded liability. In the interest of full disclosure……I am a member of this majority party.
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