Converting the current pension plan for teachers and state employees to a defined contribution system could cost up to $15.9 billion over four decades, according to a new study.
And a replacement system likely would be more expensive for the state and school districts to operate if current levels of retiree benefits are maintained, according to the new study by the actuarial firm of Gabriel, Roeder, Smith & Co. It was presented to the Legislative Audit Committee Monday.
The 211-page report, one of three commissioned by a 2014 law, provides the first-ever detailed projections about the cost of converting the Public Employees’ Retirement Association and also gives new details about what it costs government employers to maintain current levels of retiree benefits as compared to other types of retirement plans.
The PERA system is primarily a defined-benefit plan, meaning retirees are paid monthly pensions based on years of work and an average of their three highest-salaried years. (PERA actually is called a “hybrid” plan because it also has a feature that allows people who leave the system before retirement to keep their contributions in PERA, earn interest on those and receive benefits when they do retire.)
Defined contribution plans are similar to 401(k) savings plans in that retirees receive benefits based on what they and their employers deposited into their plans, plus any investment earnings.
The PERA system’s pension obligations currently are only about 62 percent funded. The division that covers about more than 295,000 retired, active and inactive school employees is about 61 percent funded, while another division covering 30,000 Denver Public Schools members is 82 percent funded. Closing those gaps is expected to take 30 to 40 years in some cases.
That gap has sparked years of debate in the legislature, with many Republicans, worried about the unfunded liability, arguing that PERA should be converted to a defined contribution plan.
The problem is that vested PERA members and retirees have a legal right to current benefits so can’t be forced into a new system. “The state cannot eliminate the unfunded liability by moving new hires to an alternative plan, but must develop a plan to address the existing unfunded accrued liability,” the study concluded.
The Gabriel report provided the first estimates that have been made of what it would cost to switch PERA to a type of defined contribution plan. A scenario involving an accelerated pay-down of the unfunded liability from now through 2053 would cost $8.8 billion.
The study estimates it would cost $15.9 billion through 2053 if the pay-down wasn’t accelerated.
Another key aspect of the Gabriel study was a review of what it costs PERA employers to maintain the system’s current average retiree benefit, which provides an estimated 72 percent of preretirement salary for civil servants and teachers who enter the system at age 35 and work for 30 years. (PERA members are not eligible for Social Security.)
“This study found that the current PERA Hybrid Plan is more efficient and uses dollars more effectively than the other types of plans in use today,” the report concluded.
Leslie Thompson, the actuary who was the senior consultant on the project for Gabriel, told the committee, “There was no alternative plan that was as cost-effective at delivering the retirement benefit as PERA. … There is no alternative plan for which you could pay the same cost and get a higher benefit.”
Greg Smith, PERA executive director, said the Gabriel report “allows policymakers to see the efficiency of the plan we have in place. … What we learned from the report today is the most efficient way to address that is within the hybrid defined benefit plan.”
Smith said he believes the Gabriel study also demonstrates the advantages of PERA for employees such as teachers who leave the system after several years but allow their funds to remain within PERA to grow and be taken upon retirement.
“Our plan provides greater retirement security for even the short-term employee,” he said.
Some education reform groups have argued that pension systems like PERA don’t provide adequate incentives for young teachers (see story).
The PERA system was more than 100 percent funded as recently as the turn of the century, but its position has slipped because of legislative expansion of benefits and reduction of contributions early in the century. And stock markets drops in 2001 and 2008 damaged PERA’s investment portfolio.
The legislature raised employer contributions in the mid-2000s, and in 2010 lawmakers passed a comprehensive PERA overall that tightened benefits for new employees and reduced cost-of-living increases for retirees, among other changes.
Despite passage of that law, PERA has remained a popular target for Republican-sponsored bill in recent sessions, none of which have passed. The 2014 law that required the Gabriel study also commissioned a separate study of how to improve tracking of PERA’s financial health at intervals over the coming decades. (See this story for more details on the thinking behind the studies.)
And PERA is scheduled to issue a report at the end of the year on the impact of the 2010 reforms.
All of the studies will give the upcoming legislative session plenty of information to work with, although major pension charges may be unlikely, given that Democrats control the House and Republicans run the Senate and that 2016 is an election year.