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Sunday, August 07, 2016

Set Fire To The Rain (LONG POST)

It’s that time of year again when the Oregonian and other newspapers around the state start the “hair on fire” routine about PERS.  It seems this is a biennial event occurring with remarkable regularity in even-numbered years prior to the November elections and the upcoming biennial legislative slugfest that takes place in odd numbered years.  We skated by 2014 because the Oregon Supreme Court was mulling the legality of the 2013 Legislative grab at the COLA for retirees.  As you recall, the Court ruled 8-0 (unanimously) AGAINST the Legislature and its agent PERS.  That decision didn’t get announced until the Legislature was well in session in 2015 and it was too late to really start anything and build a rally for it.

So, here we are in 2016, a major election coming on, not soon enough for me, in November.  The chicken littles of the Legislature and the various news agencies around the state are screaming that the sky is falling, and are proposing yet another set of “reforms” for PERS to be considered in the 2017 Legislative session.  I had heard rumors of two ballot initiatives that failed to get enough signatures for the November ballot; thus, all seem to be pinning hopes on the 2017 Legislature to do something, anything, to bail out the poor, impoverished public schools and local governments before they implode.  Bear in mind the following as we go through the published proposal point by point.  When the legislature passed the 2013 COLA bills, they front-loaded the savings to be gained onto the 2013-15 biennial budget of the public schools, local governments and state agencies.  At no time were they the least bit concerned that virtually all of their advisers had told them that the COLA reduction would not be likely to pass muster with the Supreme Court.  And, worse still, all the agencies that had the extra monies, built on an flimsy legal framework, gladly incorporated all this money into their budgets and promptly spent it like drunken sailors at liberty in a port city.  It did not remotely occur to any of these geniuses to perhaps escrow the money until the court had ruled.  Finally, the actions of the legislature resulted in spending approximately 10x more in anticipated savings in the first two years, than the COLA cut actually saved in real dollars in those same two years.  Thus, it comes as no surprise that PERS finds itself short about $21 billion dollars in the Unfunded Actuarial Liability (UAL).  Bear in mind that the UAL is the amount of money needed to fund every present and FUTURE beneficiary in the system for the rest of their lives.  It is, to some extent, a “paper number” based on a whole slew of assumptions that could change in a heartbeat.

Against that background, we can now consider Ted Ferrioli’s piece published in the Salem Statesman Journal about a month ago that would, in theory, wipe away about $6+ billion of that UAL by, once again, attempting to trim future benefits of current active and inactive members of PERS.  The Supreme Court pretty much ruled out any further attempts to change the terms of benefits of those members already retired.  Ferrioli proposes three broad areas for considerations, all of which he claims have a legal basis behind them.

The first of these proposals is an attempt to remediate a problem created by the 2003 Legislature (remember back that far?).  In 2003, the Legislature closed off the Tier 1 and Tier 2 member accounts to all future member contributions.  Thus, the contribution and earnings balance was frozen at 12/31/2003 levels and only earnings were added to the corpus thereafter.  At the same time, they redirected the Member contribution to a separate IAP account where contributions would grow (or decline) at market earnings and would be available to the member as mostly a lump sum at retirement.  The employer contribution continued to pay for the actual pension or annuity received in retirement, which was either Money Match or Full Formula for most members.  What the 2003 Legislature did not anticipate is that by removing the member contribution from the PERS Fund (PERF), it no longer contributed to the overall bottom line of the PERF, including the UAL.  The money was held in trust for the member, but contributed nothing towards the overall health of the fund.  So now, Ferriolli’s plan (also echoed in Tim Knopp’s screw all the actives proposal) is to somehow redirect the redirected funds into the PERF, which would have the effect of taking away all the member’s individual contributions going forward (recall that the Court won’t let them take away existing balances in the IAP) and including them in the PERF.  This is equivalent to adding another 6% to the employER contribution without any compensating benefit for the individual member.  I suspect that the rationale for this is a long-forgotten piece of HB 2003, the main PERS legislation in the 2003 Legislature) that made the 2003 changes to the PERS system explicitly non-contractual.  This overlooks another part the PERS statutes that makes the employee contribution of 6% (regardless of who pays it) mandatory for the benefit of the individual.  I can already envision both the ferocious lobbying that will take place in the legislature and the legal arguments that will materialize if this gets enacted.  I’ll let the court settle this dispute because you can rest assured that if the 2017 Legislature attempts this, it will be “Litigation ‘R Us” in the Supreme Court shortly thereafter.  I can also see some difficult contract negotiations resulting all over the state as public employees argue that this represents a 6% compensation cut, and will assert that they are due some compensatory benefit in exchange.  Supposedly, if this were to pass, it would save about $4 billion over a 20 year period.

A second proposal is to limit the maximum pension to $100,000.  This one is a non-starter to me.  Since the pensions of Tier 1 and Tier 2 individuals are derived from the account balances of individuals, total years of service, final average salary, and, in the case of Full Formula, a multiplier of 1.67% per year of creditable service, there is nothing in the pre-2003 laws that give the Legislature license to change the maximum benefit.  The pre-2003 statutes still form the basis for Tier 1 and Tier 2 retirements, and the Legislature would be breaching the contract of those workers whose earnings on account balances, or their total service time generate more than $100,000 per year in income.  While there aren’t all that many people in the system who earn sizable 6-figure salaries - administrators of agencies, physicians at OHSU and the State Hospital, a fair number of Professors in OUS - the Legislature cannot suddenly say to them that at a certain point, there is nothing they can do to increase retirement benefits beyond $100,000 per year.  In the case of Money Match, it takes a combined employer/employee account balance of more than $1,000,000 to generate an annuity paying more than $100,000 per year.  Under current statutes, the employee is entitled to whatever the highest benefit is under the system of Tier 1 or Tier 2 rules in force.  Since these are likely to be long term employees, a change such as this would be tantamount to stealing a portion of the person’s earned benefit and redirecting it to the system.  This goes against statute as well as against the rule of fiduciaries.  Similarly, a member earning say $250,000 per year after 33 years of service would be entitled to a Tier 1, Option 1 benefit of no less than $135,000 per year under Full Formula.  There is no way you can finesse the law to say that person cannot get the benefit promised him/her at the time of hire.  No law has ever redefined the maximum benefit that can be received, and even if it were only prospective, it couldn’t apply to any Tier 1 or Tier 2 member.  Thus, the anticipated savings from this would never materialize because the court would never allow it to become law.  It might be applicable to those members who started on or after 8/29/2003 - about half the system now - since their system, OPSRP, has no contract provisions associated with it.  But, as Mr. Carlson said on the comedy “WKRP in Cincinnati”  “…I swear to god I thought turkeys could fly”. This would be good advice for the Rs in the Legislature who want to propose this “fix”.

The third proposal is the trickiest to deal with.  Ferriolli proposes to “…use a market rate for Money Match annuities, instead of the assumed rate that is currently double the market rate”.   First, consider that since the 2003 reforms went into effect, the percentage of members retiring under Money Match has been steadily decreasing from the high point of about 85% of retirees to less than 15% of retirees today.  Thus, relatively little money would be saved in either the short or long run, while the contractual elements of the current assumed rate on account balances seems pretty well established.  What Ferriolli and others are proposing is to “decouple” the annuity rate of return for Money Match retirements from the actuarially assumed rate set every two years for the fund.  The basis of the actuarially assumed interest rate is from market research done by the actuaries and the resulting rate is used to value the fund, determine the UAL, set employer contribution rates, and to establish the Actuarial Equivalency Factors for all modes of retirement.  The key words here are “actuarial equivalency”.  When PERS does its calculations for a person’s retirement benefit, it is required to award the individual the highest benefit based on the results from examining Money Match, Full Formula and, in a small number of instances, Formula + Annuity.  PERS must compare these “…on the same actuarial basis”.  It is no longer a fair comparison if PERS suddenly were to be forced to use some amorphous “market rate” (based on some unknown “market” bogey) for Money Match retirements, and the actuarially assumed interest rate (based on a totally different “market” bogey) for Full Formula retirements.  It would be shocking to discover in this world where the Money Match benefit could ever exceed a Full Formula benefit, because the comparison would be like comparing a fruit fly to a hippopotamus.  Moreover, the structure of Money Match would be corrupted in a way not permissible by current statutes.  Tier 1 member benefits receive a guaranteed rate of return on money invested.  The current rate is 7.5%, likely to go down in the not-too-distant future.  To suddenly claim that the employers get to assume earnings growth at 7.5%, members get to assume growth at 7.5%, but retirees under Money Match only get to use a considerably lesser rate of return to annuitize their account balances is absurd logic.  The assumed interest rate has been linked or coupled together for Tier 1 member balances, actuarial equivalency tables, employer contributions, and overall fund valuation since the very late 1960s.  I think the Oregon Supreme Court would have a hard time making a compelling argument that “actuarial equivalency” doesn’t really have to mean “actuarially equivalent” (based on the same set of assumptions).  The only way I can see that the Legislature’s goal could be achieved would be to lower the “actuarially assumed interest rate” to something considerably lower than it is today.  But to do that would mean that employer contributions would skyrocket, which is exactly the opposite of what anyone wants.  Employer rates move opposite to the assumed interest rate.  Higher rates mean that the fund assumes more money from earnings and less from contributions, while the lower earnings rate means more from contributions.  I’m afraid that any attempt to solve the interest rate problem would involve some messy litigation, and lots of unhappy campers, not least of whom are the loudmouth public employers.

In Ferriolli’s letter to his constituents and in his Op Ed to the Statesman Journal. he claimed these three measures would be found to be constitutional by the Oregon Supreme Court.  While I don’t doubt Mr. Ferriolli’s sincerity in his beliefs, my experience in observing the Court over the past 20 years or so has been that the Court will probably take a dim view of any of these measures, dimmer with some than with others, but, in the end, rejecting all as suitable remedies for the current ills. But, I have a recommendation for anyone proposing Legislation like this in the 2017 Legislature.  Before you set fire to the rain, put in a clause staying the implementation of any of these features until after the Court rules on their legality, and do not appropriate the funds anticipated from these measures until after you are certain that the measures will actually pass muster with the Court.  I also recommend that you listen closely to those voices yelling in your ears that these measures won’t fly with the Court.  They’ve been right too many times for you to ignore.  Don’t fall victim to the same stupidity that the 2013 Legislature fell for.  Although the good news for 2017 is that the Ds are likely to retain control of the Governor’s Office, the Senate, and the House, but that is no reason to be smug.  Both the 2003 reforms and the 2013 reforms were brought to us by D Governors and supported by D Legislative bodies.  The Rs didn’t go along in 2013 only because the COLA cuts weren’t drastic enough, so for them to claim the moral high ground over 2013’s disaster is disingenuous at best.