Keep an eye on your pension

NEA Today, Nov 1994

Finding a cure for what ails the nation's health care system is on everyone's mind these days. But how's the health of your state's retirement system? It's a question being asked by a growing number of NEA members, as states increasingly use pension funds to balance their budgets.

These so-called "raids" of public pension plans "represent the single greatest threat to the retirement security of public employees today," said attorney and pension expert Robert Klausner at NEA's 1993 Retirement and Benefits Forum.

"Years ago, state and local governments cleverly disguised raids," he pointed out. "Today, many don't bother to disguise their actions. They simply dip their hands into the till and run out of the room with dollars falling from their pockets."

Take, for example, the widely publicized raid in Rhode Island. In 1991. the state treasurer's office withdrew nearly $21 million from Rhode Island's public pension fund to balance the state budget.

But an IRS investigation of the withdrawal revealed that it violated a law that requires pension plans to be maintained for the exclusive benefit of plan participants. The state of Rhode Island must thus repay its public pension fund $20.9 million by the end of this year.

A different kind of raid took place in California two years ago, when state lawmakers abolished the system for providing cost-of-living adjustments (COLAs) to members of CalPERS and CalSTRS, the state's two largest public employee retirement systems.

Up until then, CalPERS and CalSTRS had the best COLA programs in the country. The COLAs were funded with excess investment earnings. Together, the two retirement systems had more than $100 billion in the stock market. The earnings were excellent, and so were the COLA opportunities.

But when the state needed $12 billion to compensate for a budget shortfall, the governor and the legislature replaced the program with a guaranteed COLA at a much lower rate.

The California courts ruled that the new COLA was preferable because it provided a guaranteed benefit that wasn't dependent upon investment returns. The governor used the $4 billion in savings to solve the state's fiscal crisis.

Pension plan raids like those in Rhode Island and California have occurred in many states and localities in recent years. According to NEA Research, nine states over the past 12 months have taken actions to defer, reduce, or withhold contributions.

"Many people think of raids as taking money out of a fund and spending it on something else," says NEA Research's Pam Fielding. "But it's also a raid when the employer is supposed to make a contribution and doesn't, or reduces its obligation by changing the formula for determining the employer contribution."

In Alaska, for example, the state legislature enacted a law to cap employer contributions to the Teacher Retirement System at a maximum of 12 percent. In Connecticut, the legislature only funded 80 percent of the required contributions for the 1993-94 fiscal year.

In Maine, state lawmakers balanced the budget by reamortizing the pension system's 25-year mortgage over 35 years thus lowering the state's contributions.

The practice of raiding public pension funds has generated a great deal of concern among employee and retiree groups--so much so that Congress recently asked the General Accounting Office (GAO) to evaluate the problem.

The GAO's research revealed that 67 percent of the plans in its study--128 out of 189 plans--were underfunded. In addition, 75 of the 189 plans, or 40 percent, were undercontributed, meaning that the required contribution wasn't made.

Why do states look to their retirement systems for fiscal relief? Over the past decade, and especially during the most recent recession, many states have found themselves facing serious budget shortfalls. There's approximately $1.2 trillion in public employee retirement systems in the United States, according to NEA Research.

"Public pension funds are like the fatted calf," noted Robert Klausner. "Someone's eyeing them hungrily in difficult economic times

In addition to deferring, reducing and withholding contributions, some states have shown growing interest in moving public employees from defined benefit plans, which promise a specific benefit, to defined contribution plans, which require employers to deposit a specific amount in an employee's retirement account but guarantee no specific pension amount.

"In the eyes of the beneficiary, a defined contribution plan might look good because it's portable--you can take it with you when you change jobs," says Pam Fielding of NEA Research. "But it's really a loss of commitment on the part of the state."

Another problem is that the beneficiary can outlive the benefit provided under a defined contribution plan. A defined benefit plan always outlives the beneficiary.

In the short term, invading public pension funds may solve a state's budget problems. In the long run, however, it could reduce pension fund flexibility and even result in financial disaster.