| October 1, 2010

The Coming Explosion of Oklahoma’s Pension Bomb

There are significant problems in Oklahoma’s two largest pension systems.

Some of the problems in the Oklahoma Teachers Retirement System (OTRS) and the Oklahoma Public Employees Retirement System (OPERS) are well known and widely reported. Others are not as apparent but have their own negative effects on the fiscal stability of our state.

Here is what State Treasurer Scott Meacham said about the pension problems: “a significant infusion of money” is needed to offset more than $12 billion in current unfunded liabilities. According to Mr. Meacham, “if this problem is left unaddressed, the systems will eventually require a cash infusion of staggering proportions to meet current payment obligations. This could result in the need for the state to raise taxes or dramatically reduce funding to vital state programs.”

Lest you are tempted to say, “It’s not my problem,” you need to consider that Attorney General Drew Edmondson opined in AG Opinion 96-20 that this debt is an absolute obligation of Oklahoma taxpayers. That means future generations of Oklahomans are on the hook for this mess if something isn’t done soon.

The retirement fund for Oklahoma’s public school teachers is one of the most underfunded plans of its type in the nation, even though it reported a 17 percent return on investments last fiscal year. The OTRS pension fund as of June 30, 2009 was carrying $9.5 billion in unfunded liabilities. During the last fiscal year its pension plan was funded to 49.8 percent—a far cry from the 80 percent that experts prefer. A recent Public Fund Survey ranked the OTRS as having the fourth-lowest funding ratio among the 126 state pension plans it reviewed.

Unbeknownst to most people, the “cash infusion” Treasurer Meacham warned about has actually already started. OTRS receives 5 percent of the state’s revenues from sales taxes, use taxes, and corporate and individual income taxes. These are collected as a “dedicated” revenue stream that goes directly to OTRS. OTRS also receives 1 percent of the cigarette taxes collected by the state and 5 percent of net lottery proceeds collected by the state. OTRS received approximately $257 million in 2009 and $267 million in 2008 from these dedicated sources.

The cost of the pension systems to taxpayers doesn’t stop there. The systems also require large employer contributions—far larger than most employer contributions in the private sector. The contribution rates for employers—which is you, the taxpayer—covered by the Education Employees Service Incentive Plan (EESIP) is now 9.50 percent.

For employees not covered by the EESIP—those in the comprehensive and regional four-year universities—the contribution rate for fiscal year 2009 was 7.55 percent through December 31, 2008 and increased to 8.05 percent on January 1, 2009. This rate increased to 8.55 percent on January 1, 2010.

While the other major state pension system, OPERS, carries only $3.1 billion in unfunded liabilities, the system has a hidden impact on annual state budgets that serves to reduce the amount of funding available for actual services. State employees contribute 3.5 percent of their salary for their retirement benefits, but the state (i.e., the taxpayer) contributed 14.5 percent of the employee’s salary to OPERS in 2009. This exorbitant employer rate resulted in over $240 million in employer contributions to the system last year, and is actually scheduled to go to 16.5 percent next fiscal year.

Since 1989 OTRS liabilities have grown by an average of 15.5 percent annually, while OPERS has experienced a 9.2 percent average annual growth of its liabilities. Compare that to the assumed rate of investment return in OTRS (8 percent) and OPERS (7.5 percent) and it becomes clear that even if the systems invest wisely that they are doomed to implode at some point in the future.

In 1989 OTRS had an unfunded liability of $2.4 billion and OPERS carried only $490 million in unfunded liabilities. However, despite two decades of predominantly exceptional market returns on the system’s investments, high employer contributions, and a growing cash infusion of your tax dollars, the systems carried $9.5 billion and $3 billion in unfunded liabilities, respectively.

Actual cash benefit payments from OTRS to current retirees have grown at a rate of 9.3 percent since 1981 and in 2009 topped $950 million. The nearby chart shows the projected growth in benefit payments based on the average rate of growth since 1991 of actual payments for both OTRS and OPERS combined.

By 2054 the state would be paying an incredible $60 billion in payments just to retirees! Obviously this is not sustainable without impacting state services.

A Way Out

How did we get into this mess? The simple answer is that the state embraces a type of retirement plan that has shown a tendency to become fiscally insolvent. Defined-benefit plans, such as the state uses in each of its systems, have flaws that are almost unavoidable. In a defined-benefit plan the employer guarantees a certain benefit payment to an employee for his or her lifetime, come hell or high water. The collapse of Bethlehem Steel, the crisis at General Motors, and dozens of other examples have spotlighted the inherent problems with defined-benefit plans.

Unfortunately, the flaws of defined-benefit plans are even more pronounced in the public sector. For years a perverse incentive existed where Oklahoma politicians could use the plan to buy votes but hide their actions from all but the most knowledgeable financial wizards. For many years the unfunded liabilities were hidden thanks to governmental accounting rules which allowed politicians to cover their tracks. Fortunately, recent rule changes enacted by the Governmental Accounting Standards Board (GASB) have required government entities to reveal these debts to the public in their annual financial statements. However, those numbers are buried in places in the financial statements that still require a sleuth to find them.

In addition, the defined-benefit plan structure favors older employees who can accumulate benefits much faster in the public systems than would be available through the more common defined-contribution plan type that private businesses favor. This tilt towards older employers creates an employee demographic whose health costs are higher. This compounding effect creates ever-increasing employee costs that serve to reduce the amount of tax dollars available to address service needs and long-term capital projects, such as roads and bridges.

The fundamental questions are: (1) Can Oklahoma legislators finally muster the courage to address the problems, and (2) can they find a way—short of bankrupting the state—to extinguish the debt while providing the promised benefits to teachers, support personnel, and government employees?

Often in government affairs it takes a crisis in order for politicians to “muster the courage” to address a difficult issue. The recession has helped to put Oklahoma in just such a situation. And if the answer to the first question is yes, I believe the answer to the second question is also yes.

Indeed, if we act now there are ways not only to eliminate the debt but also to reduce current state employment costs. OCPA has developed a plan that will:

  • Pay off the debt over time without a need for an infusion of new money;
  • Free up more than $300 million immediately for state services; and
  • Promise all current members of OTRS and OPERS their full retirement plus a guaranteed 2 percent Cost of Living Adjustment every year.

How is this possible? I’ll explain it in next month’s issue of Perspective.

Steve Anderson (MBA, University of Central Oklahoma) is an OCPA research fellow and a Certified Public Accountant with more than 20 years of experience in private practice. He spent two years as a budget analyst in the Oklahoma Office of State Finance, and was formerly a state-certified teacher with 17 teaching certifications.

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