Warren Zevon always had an excellent ear for music, irony, and social commentary. Zevon’s observation fits perfectly with today’s referral of House Bill 3013 to the House Business and Labor Committee, which motivates this post. Much of the content has already been included in emails to the bill's chief sponsor, Rep Gene Whisnant, one of a trio of ALEC-supported, Bend area legislators responsible for the spew of anti-PERS member legislation sclerosing the Legislative pipeline this year. HB 3013 is a deceptively simple bill that effectively decouples the interest rate used for valuing the fund, setting earnings on investments for Tier 1 members and Employers, from the annuity rate used in actuarial tables to compute benefits for retiring members. In short, the annuity rate would be approximately halved relative to the assumed rate, which would have the effect of severely reducing money match benefits, and all beneficiary forms of Full Formula and Formula plus Annuity. There is but one exception to this bill left unstated, and it is to that exception that the rest of this post is devoted.
My major worry over previous suggestions to decouple the assumed rate from the pension earnings rate was that it would target only Money Match members. I knew that this method would violate contract provisions, state statutes, Oregon Administrative rules, and very possibly the Internal Revenue Service's basis for qualifying the plan. Because PERS gives Tier 1 and Tier 2 members the "best of" comparison in determining their method of retirement (Money Match, Full Formula, and Formula + Annuity for the small number of members still eligible), those benefit comparisons must be based on "Actuarial Equivalency". To change the annuity earnings rate only for Money Match would destroy the basis of actuarial equivalency, which would violate the contract, state statutes, and IRC code. It appears that HB 3013 attempts to evade this problem by changing the annuity earnings rate for ALL forms of retirement methods (Money Match, Full Formula, Formula Plus Annuity). That MAY take care of the statutory, contractual and IRC problems, but reveals a fatal flaw in the bill that would be exposed if the Actuaries were ASKED to consider employer savings for any range of scenarios instead of using only past behavior of PERS retirees. Let me explain below.
Taking the bill's assumptions, its effects would be to virtually eliminate the Money Match comparison for all but a few PERS retirees (mostly the long inactive). In effect, this bill would push the vast majority of future Tier 1 and Tier 2 retirees to the Full Formula. This won't be by choice, of course; it is a natural consequence of devaluing the Money Match benefit compared to Full Formula. And this is where the complication emerges. The calculation of Full Formula depends on only 2 variables and 1 constant: Final Average Salary (however it is computed), years of service, and a multiplier depending on class of service (General Service 1.67% per year; Police, Fire, and Legislature and Judges - 2.0% per year service). What this calculation yields is the Option 1 benefit (no survivor option). This is the highest Full Formula benefit any member can receive; any optional benefit forms all derive from this base benefit. Notice that no mortality figures into this calculation, no interest rate, no assumed rate, no annuity formula. Thus, nothing external to this Formula can change this, except for changes to the calculation of FAS and possibly the multiplier, but those can only be prospective while the previous rates are locked in statute. For anyone retiring in the next year or so, the changes to the multiplier and computation of FAS will have minimal effect.
So what you might say. Weigh that against the stark reality that there are more than 70,000 active and inactive members currently eligible to retire. What this proposal does not anticipate, and the actuaries probably haven't seriously considered is that human behavior can play a considerable role in tilting the odds against some or most of the possible savings of this bill. Recall the Option 1 benefit (no survivor option). The reasons most people don't choose this option are twofold: 1) they don't want their spouse to lose access to their benefit should they die; 2) keeping the annuity rate the same as the assumed rate provides reasonably priced "insurance" for the surviving spouse. Decouple the two rates, reducing the annuity rate relative to the assumed rate, will increase the cost of the "insurance" for adding the beneficiary. This can already be seen as an effect of lowering the assumed rate twice in the past four years, with another reduction probable for January 1, 2018. So, what are current retirees doing? I'm encountering more and more retirees choosing the Option 1 benefit and purchasing a relatively inexpensive term insurance policy on themselves to cover themselves against early death so the spouse is taken care of through an insurance or annuity program that is cheaper to finance than taking out the "insurance" on an Option 2, 2a, 3, 3a, 4 settlement. Here's the rub. If you decouple the annuity rate from the assumed rate, I anticipate that more and more people will consider taking Option 1 instead of the actuarially-affected and tested versions of Option 2, 2a, 3, 3a, 4. Thus, instead of saving employers money, every employee who selects a Full Formula Option 1 benefit is unaffected by changes in the annuity rate or the mortality tables. But, to the employers, this is the most costly option for an employee to take because PERS will require the employer to deposit cash to cover the cost of making up that employee's Option 1 benefit but using a lower earnings rate on which to base the contribution. Thus, instead of saving employers' money, this will cost them even more, as if no disconnection occurred at all. If large numbers of members start taking this Option, it will show up quickly in PERS' experience data, and downstream, employer rates will start to rise in direct proportion to the degree of disconnect between the actuarial rate and the assumed rate. This is, of course, the exact opposite of what this bill hopes to achieve. I expect that any savings this bill might create will be ephemeral, and be totally negated by employees discovering the potential value of the Option 1 benefit.
A corollary problem exists with the Lump Sum Settlement. Again, a Full Formula lump sum consists of employee contributions to Tier 1 or Tier 2 accounts plus a an amount required to generate the present value of the monthly benefit taken over the expected life of the member. But the low earnings rates that gets factored into the employee lump sum means that the expected contribution from the employer has to be considered to be what it would take to generate the monthly Option 1 benefit, but under decreased earnings assumptions. Thus, the cost to employers for Full Formula Lump Sum settlements will be higher under the reduced annuity rate than they would if the annuity rate and the assumed interest remained coupled. The logic here is exactly the same as why a lowering in the assumed interest rate requires employers to contribute more to the system.
I welcome your thoughts on this matter. I think you will find that if you ask PERS or ask its actuary to consider a scenario where increasing numbers of members choose the Option 1 Full Formula benefit, or the Total Lump Sum Settlement under Full Formula, that they will concede my points. Obviously, these scenarios would not follow the current pattern of PERS retirees, but we are no longer living in obvious times. When stressed, humans have an extraordinary capacity to adapt, and one significant adaptation would be to choose a different payout method for receiving their PERS benefit.
There are certainly some flaws in my argument. The most obvious one is that some members will not be able to get affordable term insurance to offset the beneficiary concern. Second, a no-beneficiary option requires spousal consent, which may be uncomfortable for some. Nevertheless, I think this bill will expose some real flaws in the logic and estimates behind the bill's formulation.
Bottom line though is this is a very BAD bill that could be far more harmful to far more people than anything otherwise proposed so far. To quote the full context of the late Warren Zevon's borrowed title: "...send lawyers, guns, and money, the shit has hit the fan." Indeed! (Oh yes, one more turd-blossom in this offensive piece of legislation. It would take effect on passage, so anyone not yet retired on the date this bill were to be passed, assuming the Governor would sign it - a slim likelihood, would be trapped by it. This bill has a long way to go, but if you were thinking about retiring, my advice would be sooner rather than later with this bill now in the pipeline.)