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Tuesday, February 28, 2017

Lawyers, Guns, and Money 2

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.)

14 comments:

Stephen Barrett said...

My experience with PERS has been that the more they try to "fix" the the problems, the more they screw it up. Perhaps someday the legislators will discover that complex problems require careful consideration before they attempt another quick fix. Piecemeal solutions have unintended consequences. They are in effect playing "Whack A Mole" with PERS.

mrfearless47 said...

Unfortunately, PERS has little say in the changes. Their ask is to figure out how to implement any change approved by the Legislature. The actuary only answers questions that are asked, not those left unasked. Alas, when legislators operate under faulty assumptions, chaos s the only rsult. My words were carefully chosen at the beginning of this post. Spew, sclerotic, and turd-blossom were not quirks of my fevered imagination.

IPS said...

Great analysis and explanation, thank you!! And, I think I am starting to understand HB3013 (and PERS) better as a direct result. I still need to reread it a few more times.

Paul

capeman said...

I don't know. This bill sounds very doubtful to me. It's legality, even if they do everything you say to try to make it legal. Seems to common sense like a gross violation of "the contract." I know that different people see common sense differently. But given the 7-0 vote in the court last time out, how likely is it that this gross change in the rules of "the contract" would get approval of a majority of the judges?

And how likely to make it through the legislature in the first place, and as you say, to get the governor's signature? The sponsor is a Republican.

Seems to me it's more like Republican grandstanding, full of rage, but probably impotent. If the Democrats do try to pull anything, it will be much less drastic than this.

mrfearless47 said...

Worse bills than this have passed. Depending on the Supreme Court to keep shutting these down is a fools errand. Shut them down before they get to the law stage. Call, write, email your legislator. Don't le them pass this malicious bill.

Just st to be clear about this and all other bills. Nothing is targeting those already retired. These bills only target those who haven't yet retired.

capeman said...

I agree that it's a good idea to stop this in the legislature. I don't see this passing this biennium. But I don't see a solution to the long-term PERS problem, unless the stock market is very, very nice for a few years. I don't see the voters going for more taxes. At some point, the legislature might get desperate, even the Democrats. Look at how even the liberal newspapers are ganging up on PERS. The school boards. And at some point, the court might decide to buy some of the arguments, with whatever motivation guiding their thinking.

I'm beginning to wonder if there will be some sort of national government level attack on public pension plans. A Congressionally mandated mass bankruptcy, in effect, for all the states that are in over their heads, and those like Oregon that are getting close. With a President who is fond of declaring bankruptcy, and a Congress that is none too fond of public workers and unions?

With that, I can even barely imagine the current Tier 1 retirees getting hosed.

Here's hoping for a healthy stock market for the next few years.

mrfearless47 said...

The PERS problem is self-limiting. The changes made in 2003 were anticipated to take at least 20 years to work their way through the system. We are still 6 years away, and if you look at actuarial projections, employer rates will start to abate about then. If the employers weren't so greedy or cheap, and would actually pay what they owe, this problem would resolve itself.

JB said...

Individual bills should almost never be evaluated on their own when trying to predict the likelihood of passage. It may be true that this bill is sponsored and backed by the minority party, but there's no telling whether or not it might wind up as a quid pro quo with something the D's want and need Republican help to pass. D's have a majority, but they lack the votes they need to pass a revenue raiser. My advice is to keep a close eye on this one even if you don't think it carries the support to pass on its own.

mrfearless47 said...

JB. The primary reason it got its own blog post is to alert affected members to its potential impact. If I didn't think it had a chance, all things considered, I wouldn't waste time with it. This is a nasty bill and those potentially affected need to keep their eyes peeled for this one.

capeman said...

Re the actuarial projections, I can't agree that "employer rates will start to agree about then" is such a good description of the actual scenario in their report. The most likely scenarios show a rise of about 12% in PERS employers assessment from now to the peak in around 2023, followed by a very slow decline out to about 2035. Only then is there a significant abatement. In other words, we're talking about 20 years of sharply increased costs. If it plays out this way, public services are really going to be in for it.

The information can be found by going here: https://www.oregon.gov/pers/Pages/section/financial_reports/mercer_reports.aspx
then clicking on the link to Financial Modeling for 2016. The graphs on p. 5 or 6 tell the story.

mrfearless47 said...

Actually I used the term "abate" with precision. The rates will start to decline in 2023, but the abatement will take place slowly until most of the Tier 1s and their beneficiaries start falling off the cliff. Of course, the current actuarial projections (or the ones you cited) don't really take into account behavior changes, changes in the assumed rate, or flattening of the salary increase curve. I simply do not see how this problem can be solved chipping away at benefits. The problem isn't, in my opinion, a failure in the architecture of PERS, but a failure of employers to pay what they owed when they owed it. The beast is growing larger because the employers have backed away, whined, and sounded pitiful whenever circumstances required rate hikes and they didn't want to pay them. Add the employer-friendly PERS Boards since 2003 that have succumbed to every employer whine for the past 14 years, and the Legislature that capitulated to every employer whine with worthless bills that end up getting thrown out in court. In the meantime Ballot Measure 5 continues to play out in all its ugliness nearly 30 years later by making the business tax among the lowest in the country, while the personal income tax is among the highest in the country. The only solution to this problem in the long term is for businesses to pay higher axes. PERS is only fixable at the margins, and those margins are punitive, and won't save a lot of money.

treehugger1 said...

I could this bill being passed as a negotiating point between parties. The rate adopted for benefit payment computation is the current rate on effective date of retirement, daye first payment is due to death beneficiary, or recalculation due to error.

This bill could create a real conundrum given it recalculates the benefit to the survivor upon death.


My PERS retirement date is April 1, 2017 and I am glad I have 60 days to make any survivorship changes.

Maybe Jackson Browne was correct when he wrote, "In the end there is one dance we'll do alone."

mrfearless47 said...

In the past, survivors didn't have the benefit recalculated. It will be interesting if this bill doesn't change the interest rate for you because you were retired before the bill could take effect but somehow tries to apply the changes if you predecease your beneficiary. I think the benefit is set at YOUR retirement and does not change because of rule changes after you retire - even for your beneficiary. Obviously, under the new scenario, it could affect both members and beneficiaries when retirement is after the effective date iif this bill were to pass.

Since this bill gores just about every OX, I suspect the Ds would be more likely to compromise on one of the more restrictive bills.

JB said...

Marc, I should have been more clear that I was referring to Capeman's statement that he didn't see this bill passing this biennium.