4.2.2021 – Understanding the Pension Problem
In recent weeks, there has been a lot of conversation about pensions, in particular for our state employees and teachers. My understanding of pensions is negligible – as a legislator it was not an option – so it is not something that is part of my own life. However, we all value the hard work of the dedicated folks who make our state run and who educate our children, so I thought it was important to try to educate myself in order to have a better understanding of the moving pieces and the problem that needs to be solved.
At the beginning of the Legislative Session, State Treasurer Beth Pearce announced that our pension systems are in trouble and significantly underfunded. There is not enough money in the funds to cover the expected expenses in coming years. That’s the reality. The question is what do we need to do to fix it?
The first thing I had to understand is how pensions work? I want to say at the outset that I have relied heavily on a Power Point presentation by Chris Rupe who is a Fiscal Analyst at our Joint Fiscal Office and Rep. John Gannon of Wilmington who is the Vice Chair of the House Government Operations Committee. My sincere thanks to both of them. My goal is to make this understandable to the average person (me) and to make clear that I, as your representative, may have to make decisions on behalf of you that will cost all of us money. This is not an “I and them” situation, we are the state and we’re all in this together.
So back to the question, how do pensions work? There are a number of different designs for pension systems, but we will focus on two – the Defined Benefit and Defined Contribution systems. In a Defined Benefit system, contributions from employers and employees go into a fund and are invested. The benefit to the employee is guaranteed and calculated based on a formula, regardless of the investment performance. This is the system that we have in Vermont.
Another system is a Defined Contribution system, in which the employer contributes into an investment account that frequently requires a match by the employee. This account is similar to a 401(k) and its success depends on how much the employee saves and how well their investments do. In this case, the risk is assumed by the employee as opposed to the Defined Benefit system where the risk is assumed by the employer if investments don’t do well.
Who manages, makes decisions about, and oversees the investments that are made? There are three pension systems that are managed by the State of Vermont. They are the Vermont State Employees’ Retirement System (VSERS), the Vermont State Teachers’ Retirement System (VSTRS), and the Vermont Municipal Employees’ Retirement System (VMERS), which are all governed by boards of trustees, each of which includes the State Treasurer. The number of people serving on the boards varies but each has a complement of governor appointees and plan member representatives elected by the unions. It should be noted that there is no requirement for pension or investment expertise to serve on a board. The board of trustees is responsible for the general administration and proper operation of the systems and the State Treasurer is responsible for the day-to-day operations and is custodian of plan assets. The Vermont Pension Investment Committee (VPIC), which has seven members including the Treasurer, is responsible for investing the assets of all three plans.
The next question I had is how did we get here? There are, apparently, several factors contributing to the problem and in naming them, I do not mean to assign blame. I also want to observe the fact that some state leaders have been critical of the proposed solutions but do not offer any suggestions themselves, which does not instill my confidence or respect for them. It is easy to point fingers, it’s much harder to solve a thorny problem. I would prefer that everyone come to the table, roll up their sleeves, and get to work solving the problem.
In some ways, this could be considered a perfect storm, but it has been brewing for a long time and here are some of the factors. Between 1991 and 2006, we underfunded the teacher’s pension program in the amount of $163,603,769, which is a small number when compared to the current unfunded liability of $1.933 billion, but had that money been invested, the fund would be in better shape today. It should be noted here that we have always fully funded the state employees’ fund, but it, too, is in trouble.
One of the reasons this has not been on my radar screen is that back in 2010 when Jeb Spaulding was Treasurer, a plan was made to fully fund the Actuarial Determined Employer Contribution (our share) and amortize the unfunded liability so that the pensions would be fully funded by 2038. We have lived up to that plan but other factors that had not been anticipated in 2010 have created challenges to that goal.
One of the problems is that retirees are living longer. That’s great for the retiree but it’s a problem for the retirement funds because that retiree is drawing from the fund longer than they were actuarially anticipated to. With both funds there are more retired people drawing on the funds then there are working people contributing to them. Salaries and Cost of Living Adjustments have been growing and the way the ultimate benefit is calculated is outpacing the fund growth. Additionally, it takes five to ten years for an employee to become vested and be able to take advantage of their pension upon retirement. If they leave before they are vested, they may withdraw what they have contributed to the fund. Employee turnover has increased so there has been a higher rate of withdrawal.
Another factor is underperforming investments. In 2009, the rates of return dropped precipitously, and the ensuing Great Recession caused the funds to underperform. In fact, in only three of the last thirteen years have we had the needed rate of return. As mentioned earlier, the Defined Benefit system places all the risk on the employer (that’s us), so the state has been on the hook for higher and higher contributions. For instance, in 2016 teachers contributed $28 million into the fund and the state contributed $84 million. In 2020, the teachers contributed $37 million, the state contributed $188 million. A similar situation exists for the state employees; in 2016 employees contributed $31 million and the state $50 million and in 2020, employees contributed $39 million and the state $115 million.
What is clear is that the pension system cannot continue in its current form. Structural changes are going to have to occur if we are going to have a system that remains solvent without breaking the bank. There is palpable concern because every year the problem gets worse and the question we must ask ourselves is how we are going to raise the revenue to cover the cost. Speaker Jill Krowinski is calling for a task force that will bring people together to make recommendations that we can consider next year. Perhaps, a first step would be to assure those serving on the pension boards have some expertise in pensions and investment.
For people who want to learn more and view Chris Rupe’s presentations, go to the www.legislature.vermont.gov, click on Joint Fiscal Office, and search for Pensions Overview Presentation. There are three parts, and all are clear and very understandable.