Oregon Senator Doug Whitsett District 28 11/21/12

PERS

The Public Employment Retirement System was designed to be a self-sustaining retirement program for Oregon’s public employees. The program’s actuarial liabilities were supposed to be matched by a combination of employee and employer contributions plus return on investment from the PERS Trust Fund.

That design has twice experienced woeful financial failures within a single decade. In my opinion, these failures have been primarily caused by a fundamental flaw in the assumptions made by the Board appointed to govern PERS.

The Board has assumed that annual investment returns on the PERS Trust Fund will average eight percent. This supposition has allowed them to assign more than seventy percent of the payments required to support the system to investment earnings. Their goals have been generally achieved, with two notable and disastrous exceptions.

The exceptions were the Dot-Com crash between 2000 and 2002 when the PERS Trust Fund closed with unfunded liabilities of about $18 billion. The second exception was the more recent real estate driven market crash in 2008 when the Trust Fund lost about $18 billion and closed with unfunded liabilities of more than $16 billion.

PERS was rescued from its 2002 fiscal cliff by a combination of actions. Retirement benefit reforms crafted by a Republican majority in both legislative chambers, and strongly supported by Democrat Governor Ted Kulongoski, significantly reduced PERS ongoing costs. The Legislature also convinced the people to amend the Oregon Constitution to authorize them to borrow money to pay down the PERS unfunded liabilities. They then passed HB 3659 to implement the sale of $2 billion in Pension Obligation Bonds. Other subdivisions of Oregon government sold an additional $4 billion in bonds to pay down their part of the unfunded pension liabilities.

The legislative rationale behind borrowing money to pay down the unfunded liability, at that time, may have been appropriate. However, there is simply no justification for their method of structuring the bond debt payments.

PERS was able use the proceeds of the bond sales to lock-in long term investments that paid a significantly higher rate of return than the interest cost of the bonds. This positive interest arbitrage has been successfully used for ten years to offset the cost of maintaining the State’s obligation to PERS.

On the other hand, some of the other government entities that sold Pension Obligation Bonds did not lock-in those long term investments. Many of these entities are now experiencing negative arbitrage on their bond debt. The result is the requirement to pay the full cost of PERS plus the debt service on the bonds that they sold.

Unfortunately, those who structured the debt service on the state Pension Obligation Bonds used some creative financing. They apparently made assumptions that the state workforce would grow larger with time and that public employee wages would also increase with time. The logic appears to have been that with more employees being paid more money there would be more funds available to pay the debt service on the bonds.

They structured the debt repayment to increase significantly with each succeeding two year budget cycle. For instance, the first full principle and interest payment in 2005-07 was $240 million. The payment for the current budget cycle is $304 million. The last payment in 2025-07 is scheduled to be $544 million, well more than twice the amount of the original payment.

Not only does this debt structure place the burden of payment on a future generation but it significantly increases the total debt service by prolonging the payment of interest on the principle. In fact, it will require $4.3 billion to pay back the borrowed $2 billion including principle and interest. After ten years, more than $3 billion remains to be paid.

The Oregon Supreme Court struck down several parts of the legislative reform reasoning that they violated the constitutional prohibition against altering contracts. The Court rightfully ruled that a promise made is a debt unpaid, meaning that retirement benefits cannot be reduced retroactively by one party to the contract.

The Court went on to further state that these collective bargained contracts bind the employer to the terms of the contract for the full length of employment. The employer is allowed to prospectively improve the terms of the retirement agreement in subsequent negotiations, but is not allowed to unilaterally make the terms less favorable to the employee.

This ruling appears to be in direct contradiction to the Employee Retirement Income Security Act (ERISA) that applies to private sector retirement funds. That federal law secures an employee’s vested retirement benefits up to the current date of employment. However, it does not require the employer to continue the terms of that retirement into the future. The employee is able to either accept the prospective changes in the retirement plan or move on to another employer taking their earned retirement benefits with them when they leave.

We are now facing PERS’ second woeful financial failure. Their current unfunded liability is at $16 billion including the future debt service on the Pension Obligation Bonds. Total employer contributions toward public employee retirement benefits will be equal to as much as one third of payroll for the next budget period. At best, that untenable level of contribution will continue into the foreseeable future in the absence of meaningful reform. At worst, it could spiral upward in the likely event that PERS investment earnings remain below eight percent.

Fundamental changes must be made in both faulty assumptions as well as in future retirement benefits. The alternative can only result in fewer public employees to provide critical public services to Oregonians.

Please remember, if we do not stand up for rural Oregon no one will.

Best Regards,

Doug