Budget & Tax

State pensions lose ground after unfunded mandate

November 10, 2020

Ray Carter

Legislators’ decision to pass an unfunded cost-of-living adjustment (COLA) that boosted payments to retired state government workers, combined with lawmakers simultaneously redirecting millions from retirement systems, has left state pension systems paying out money faster than it comes in, reducing the systems’ financial stability.

As a result, all major state pensions have greater unfunded liability today than they did a year ago, officials told members of the House Banking, Financial Services and Pensions Committee during a legislative study held Monday.

“We would suggest that, to the extent that you’re going to be introducing COLA legislation in the future, we have to come up with a way to pay for it,” said Tom Spencer, executive director of the Teachers’ Retirement System of Oklahoma. “It’s just that simple in our view. You can’t continue to grant unfunded COLAs without increasing the revenue coming into the pension plans, based on where we are today. You’re going to see a slippage of the funded ratio if that happens in the future.”

House Bill 3350, passed by lawmakers this year, provided a 4 percent COLA to most retired state government workers, but included no additional funding to cover the additional cost. As a result, state pension systems have been forced to drain cash from each system’s corpus to pay for the added benefit.

When the unfunded COLA passed in the Senate, supporters claimed it would increase the state’s unfunded liability by only $185 million, a figure disputed by the Legislature’s own prior fiscal analysis.

During the legislative study, pension officials confirmed that the $185 million figure dramatically understated the COLA’s real impact. The COLA increased unfunded liabilities by $183 million at the Oklahoma Public Employees Retirement System alone. At the Teachers’ Retirement System of Oklahoma, it added another $425 million to that system’s unfunded liability.

HB 3350 self-exempted this year’s COLA from past reform laws that required the Legislature to cover the cost of benefit increases. The bill redefined this year’s COLA as “nonfiscal retirement bill” that “does not affect the cost or funding factors of a retirement system.”

In addition to imposing an unfunded COLA on state pension systems, lawmakers also voted to redirect $73 million from those systems. That money was previously earmarked for pensions to ease the financial stresses created by prior unfunded COLAs.

Lawmakers said the redirection will end after two years, but much of the money redirected from state pensions was deposited instead into school funding. This year’s school budget included roughly $550 million in funding that lawmakers described as temporary. Those funds will have to be replaced within two years, including the pension funds, to avoid a shortfall in school appropriations.

Officials with several pension systems said the state’s prior commitment to increasing retirement benefits only when funding is provided dramatically improved the funded status of Oklahoma’s state pension systems and warned against passing more unfunded COLAs.

“If you remember back, only 10 years ago, OPERS was only 66 percent funded,” said Joe Fox, executive director of the Oklahoma Public Employees Retirement System. “We were able to have gotten above 90 percent through consistent contributions and favorable markets. And, of course, not paying a COLA for about 12 years also helped in getting that funding ratio above 90 percent.”

“We were going down until 2011 when the Legislature took out the automatic COLAs, which we got to take out of our actuaries,” said Ginger Sigler, executive director of the Oklahoma Police Pension and Retirement System. “And then, of course, that increased all of our actuarily funded ratios. I think ours went from 86 percent to 93 in 2011.”

While the Oklahoma Police Pension and Retirement System’s funded status did decline this year due in part to the unfunded COLA, the system is still more than 100 percent funded. But Sigler warned that will not last if unfunded COLAs become routine as they were prior to 2010.

“We also would like to maintain our 100-percent funded levels,” Sigler said. “With the way things are right now—the loss of the funding, paying for the COLAs—that’s going to be a hard road.”

“You’re either on a path to become fully funded and fully fund your benefits, or you’re on a path to not, and you’re on a path to run out of money,” said Chase Rankin, executive director of the Oklahoma Firefighters Pension and Retirement System.

He said the Oklahoma Firefighters Pension and Retirement System’s funded status declined from 71.5 precent funded to just 70.4 percent as of July 1, 2020, and the system has $1.2 billion in unfunded liability. Rankin said it will take 24 years for the system to reach fully funded status, assuming it realizes projected investment returns and does not face unexpected new costs like this year’s COLA.

“As you talk about COLAs in the future, I think it’s important to look at 2010 and what happened to the pension systems when the COLA assumption was taken out,” Rankin said. “And there was a dramatic increase in the pension systems because there was no longer a COLA assumption that it was going to happen every year. So if you get into too big of a pattern of granting COLAs or put in some kind of automatic increases, expect to see a significant decline in the pension systems.”

Duane Michael, executive director of the Oklahoma Law Enforcement Retirement System, told lawmakers that system’s funded status declined from 89.6 percent funded to 88.3 percent from 2019 to 2020.

Spencer said the funded status of the Teachers’ Retirement System of Oklahoma fell from 72.4 percent funded in 2019 to 67.3 percent funded as of July 1, 2020. The system now has $8.6 billion in unfunded liability.

In 2019, the Teachers’ Retirement System of Oklahoma was expected to be fully funded within 14 years. Now the system is not expected to reach fully funded status for 21 years.

The unfunded COLA and loss of dedicated revenue also coincided with some systems lowering their official anticipated returns on investment, which also contributed to increased liability.

Some sources have suggested an 80-percent funded ratio signifies a pension plan is “actuarially” sound. However, the American Academy of Actuaries has called that a “mythic standard.” In an issue brief, the academy declared, “Pension plans should have a strategy in place to attain or maintain a funded status of 100% or greater over a reasonable period of time.”

Lawmakers were told other states, such as New Jersey, have laws that prohibit passage of unfunded COLAs if a retirement system’s funded status is less than 80 percent.

During the legislative study, lawmakers also heard from a national pension expert who outlined three best practices for funding COLAs. Oklahoma lawmakers violated most of those recommendations this year.

Hank Kim, executive director of the National Conference on Public Employee Retirement Systems, said COLAs should not be passed as a fixed-rate increase, but instead linked to consumer inflation or the payment boost will be “out of sync with the actual inflation.”

The COLA passed by Oklahoma lawmakers was a flat-rate increase, based on years or retirement.

Kim also said the leaders of pension plans should be involved in COLA decisions. While Oklahoma lawmakers publicly obtained the opinions of pension directions about an unfunded COLA in November 2019, they ignored warnings from both Fox and Spencer, who said unfunded COLAs risk a system’s long-term stability.

Kim also stressed that paying for benefits is crucial to maintaining state pension stability.

“If you’re going to provide COLA, we believe the best practice is to also set up funding for it, that if you provide COLA without the funding mechanism, it leads to bad results, among which are increased unfunded status for the plan,” Kim said. “When you promise an increase, the best practice is to put (it in) the budget and fund for that increase.”