[Note: this is a work in progress. Expect some changes over the next day or two, mostly in clarifying language and as I discover more things along the way. Legislative language is torturous to read and decipher.]
As the 2019 Oregon Legislature nears the final month of its session, the biennial hair-on-fire “PERS is going to bankrupt Oregon” faeries are out in full force. The latest attempt to rein in PERS costs has cleared the first committee hurdle. SB 1049 was voted out of Committee and sent on to the Joint Ways and Means Committee for consideration. So, what have our hucksters, tricksters, and scamps cooked up for the Oregon Supreme Court to review this time? Why it is an absolute cornucopia of “fixes” that will, in all probability, spend the next two years being picked apart by the Oregon Supreme Court. (Some of it is so impenetrable that even I don’t have the patience to try to decipher it).
SB 1049 contains a whole passel of changes. It directs proceeds of Sports Betting in the Oregon Lottery to be directed to PERS. Frankly, who cares? This isn’t a huge amount of money, and it is entirely discretionary spending on the part of Oregon citizens; therefore, if you don’t want your Lottery money going to PERS, stop betting on sports.
The second piece is to extend the amortization (payback) schedule of the UAL to 22 years, from 20 years, for the Tier 1 and Tier 2 UAL. The OPSRP UAL would remain at 16 years. This one befuddles me. I doubt it is illegal, since GAAP guidelines permit lengths as long as 40 years. Oregon’s current schedule is comparatively short. Nevertheless, the longer you amortize debt in an uncertain world, the higher the likelihood that your debt will grow rather than shrink. Unlike a fixed-rate mortgage, the UAL is amortized based on assumptions about earnings rate, which change regularly every two years. Currently, the rate is 7.2%, and that is surely to fall to below 7% beginning on January 1, 2020* (but see below). Unfortunately, when the assumed rate falls, the UAL rises because more money is expected to be covered by employer contributions than by earnings. Thus, once the new rate is determined on July 28, 2019, the actuary will revise the existing UAL to the new (2 year) rate assumption. The general direction of assumed rates across the country is down. Every time the assumed rate goes down, the UAL rises. A booming economy may help; a recession would be catastrophic. Despite all the hoopla about the booming stock market, 2018 was really kind of dreadful. The PERS fund missed its 7.2% by 5.8 points, which is why the UAL increased from $22 billion to $27 billion. If you don’t hit your target, the UAL increases. Moreover, the assumed rate is perverse. People think that lowering the assumed rate would cure all problems, but the employers don’t want that to happen; neither do members. The PERS fund is currently funded by Earnings + Contributions. A PERS benefit is constructed from Earnings + Contributions. All things being equal, if earnings are assumed to be lower, then contributions (from the employer) have to increase to make up the difference. Getting the assumed rate correct for the economy is a goal, but an imperfect one. The rate has to be decided in advance; rarely do actuaries, market analysts, investment advisers get it exactly right. A too low rate provides more room to be wrong in a positive direction; a too high rate provides more room to be very wrong in a negative direction. In this context, extending the amortization period of a variable rate UAL simply broadens the horizon over which to be wrong. The principal reason the UAL is so high is that since 1997, employers have used every dodge, every ruse, every possible accounting trick to keep their contribution rates artificially low. If you pay too little for too long, you end up being underwater, which is where the employers are today, in a situation that is mostly of their own making. So why would you want to extend the time over which they can pay too little for a debt that has been accumulating for more than 20 years. The bill says that the amortization rate will be only for 22 years one time, after which it returns to 20 years. Yep, and Bill’s your uncle. Having said that the idea is stupid, I guarantee it isn’t illegal, so the court won’t touch it, and the unions probably won’t litigate. It falls into the “I bet this is a FAIL” category.
The third piece is the first to directly affect active workers. In 2003, the Legislature ended Tier 2 (Tier 1 ended in 1995), and froze the principal balances but continued to let them grow by the assumed rate (Tier 1) and by market rates (Tier 2). For employees starting on or after 8/29/2003, the legislature created something called OPSRP (which, for simplicity here is going to be called Tier 3). For Tier 1, Tier 2, and Tier 3, the legislature directed the formation of something called the Individual Account Program (IAP for short) into which the employee contribution (the 6%, regardless of who actually paid it) would go. This money was allowed to earn market rates, but ownership of the account was treated like a 401K. Because of an inability to think outside of the box, the morons of 2003 didn’t really consider the implications of removing a 6% member contribution into a privately owned, but PERS managed, account. As of end 2018, individual IAP accounts hold almost $9 BILLION, not a penny of which contributes to the overall balance of the PERS Fund, which is currently running an approximately $25-$27 Billion Unfunded Actuarial Liability (UAL). So the geniuses of 2003 effectively punched a $9 billion hole in the PERS fund in their effort to stanch the growth of Tier 1 and Tier 2 account balances. The action accomplished one of their intended goals. By 2008, Money Match no longer was the dominant method of retirement for active members; for those inactive members, it changed nothing since no new money was going into their accounts anyway. By today, so few active members retire under Money Match that it is virtually inconsequential in the overall scheme of things. However, there are still many inactive Tier 1 and Tier 2 members whose accounts have continued to grow and for which Money Match is the obvious and only likely method of retirement (more of this below). So, recognizing that the 6% member contribution isn’t helping the fund at all, members have been accused of “having no skin in the game” (which beggars belief since the members didn’t want this in the first place back in 2003). Now, SB 1049 proposes a sort of “give at the office” scenario in which 2.5% of the 6% Tier 1 and Tier 2 member contribution is DIVERTED into an Employee Pension Stability Fund (i.e. other than to the IAP). This isn’t a voluntary contribution and its objective is to create a pseudo-employee account that grows in the same way that the IAP does, except that the member doesn’t really get a dime of the money at retirement as he or she did before. The money is in the employee’s name, but counts as part of the overall PERS Fund. (The fact that it is in the employee’s name is probably because the Legislature didn’t want to get slapped with a “wage theft” claim in the Oregon Supreme Court). The intent of this money is to contribute to the member’s likely Full Formula benefit at retirement. It is often believed that the member account balance is irrelevant to a Full Formula benefit. This is only partly true. If you add together the member’s regular account balance plus the EPSF balance, the Full Formula benefit is funded from these balances plus a contribution from the employer. To the extent that a worker continues for, say, another 10-12 years before retiring, the Employee Pension Stability Fund can knock a big chunk off the employer obligation for the Full Formula Pension. For Tier 3, which has a lower benefit structure, the Legislature only wants a tithe of 0.75% of the 6% member contribution. Again, the idea is to reduce the employer’s obligation to fund the Full Formula benefit. (Whether an involuntary redirection of money you can no longer lay your hands on constitutes “wage theft” or an involuntary “salary reduction” will ultimately rest with the unions and the courts).
There is a “safety valve” in two forms. If you want to fully fund your IAP, you have the option to contribute your own after tax dollars to the IAP to make up for the diversion. The second form is that should the fund reach a 90% funding level, PERS would stop diverting the money (until, of course, the fund dives below 90%). Basically, the diversion is a correction for the monumentally stupid IAP plan created by some of the same people who are still today bemoaning the sorry state of PERS by failing to admit their own complicity in the problem.
The fourth piece of SB 1049 probably affects a relatively small number of individuals in the larger scheme, but will make recruiting even harder at places where high salaries are required to recruit and retain high priced talent. The Legislation calls for a cap of $195,000 on salary earned on or after 1/1/2020 to be included in FAS calculations. This one continues to bewilder me for a variety of reasons. First, it is not problematic for anyone well-below the threshold of $195,000 (subject to adjustment by the same factor used in calculations of the retiree annual COLA). For people already over the threshold, it really isn’t a problem that I can see for retirements occurring before 2023. Currently FAS is calculated by taking your highest 36 month salary total and dividing by 3 to come up with FAS. Included in the salary computation is half the value of accumulated sick leave (if the employer participates), the 6% member contribution (diverted or not), and the value of unused vacation time (Tier 1 and Tier 2 only). Since your highest 36 months is likely to come in the last 10 years, you have a long look back window over which to draw 36 months, which could EXCLUDE** the period after the salary cap goes into effect. So, for members nearing retirement, the practical effects of this are small. Longer term, the picture isn’t quite as rosy. Complicating this is the fact that Tier 2 has a limit at the IRS threshold (currently $280,000) as does Tier 3 (OPSRP). Tier 1 has no such limit, as the limit wasn’t in existence at the time Tier 1 was created. So, this new rule caps the amount of salary that can be credited for FAS purposes after 1/1/2020, but doesn’t affect uncapped salaries prior. (**Do not interpret this to mean that THIS will be the way it is implemented. As I note below, the devil lies in the details or the weeds. Converting statutory language into software is a daunting task when language is ambiguous).
As they always say about legislation, the devil is in the implementation details. Questions: Does the PERS cap (not the IRS cap) prevent employees from contributing past $195,000 of earned salary? Does the employer have to continue contributing once the member has passed $195,000? What happens with any contributions between the PERS cap and the IRS cap for Tier 2 and OPSRP? To put these questions a different way, at what point does the cap come into play - at the time the salary is earned, or at the time of retirement? This distinction is critically important for those small number of members who are already earning over the PERS cap before this change is implemented. It becomes a secondary problem for Tier 2 and 3 members earning over the PERS cap but still under their IRS caps that already exist on their plans. (I have no explanation for why the Legislature decided to set the cap at $195,000. I suppose they did this to make their numbers come out right).
I suspect that the court will have a problem with the salary cap for still-working Tier 1 members. It doesn’t apply to the inactive Tier 1s. The court may be also troubled by the existence of two caps for Tier 2 and Tier 3, and how they will interact.
Collectively, these changes will reduce employer contribution rates by about 5.43%, pretty much the amount that they would go up in 2021, other things being equal.
There is an additional clinker buried deeply in the bowels of SB 1049. The PERS Board will, if SB 1049 passes, be required to report to the Legislature 30 days before they make any changes to the assumed interest rate (and, by inference, the employer contribution rate, the actuarial equivalency factors). Since the assumed interest rate is always adjusted (for the upcoming calendar year) in the summer of an odd-numbered year, this will compel PERS to make decisions about this slightly earlier than usual, and will now subject the decision to political pressures heretofore not required of an independent Board. The reason for this is painfully obvious. Go back to my third paragraph. Raising the assumed rate means lower employer contributions; lowering the assumed rate means HIGHER employer contributions. The stakeholders always had the opportunity to provide input to the process of rate setting, but the Legislature stayed out of the fray. Now, the Legislature will get a voice, and can potentially use its political will to force the PERS Board to make decisions that are not in the Fund’s best interests, thereby exacerbating the problem that SB 1049 attempts to fix.
This is just a first pass through the bigger pieces of SB 1049. The bill has other elements that I haven’t had a chance to study as well. I will follow this post with another if SB 1049 gets any further in the Legislative process.
UPDATE: Not more than 15 minutes after I posted this, the Oregon Senate suspended the rules and voted out this bill in a 16-12 vote. Three D’s voted against the bill. The bill now moves on to the House where it is likely to have few hurdles to clear. I’m happy to report that my Senator, Rob Wagner was one of the No votes. Thanks Rob.
