Pension Commission Hears Reports on Plan Health: The More Things Change...

The 2022 state pension plan valuation reports are out, and Commission members convened to hear from plan directors about the health status of the state’s pension funds and the legislative initiatives they plan to bring forward this year.   The Commission heard presentations covering the 3 plans administered by the Public Employees Retirement Association (PERA) serving local government employees; 4 plans under the Minnesota State Retirement System (MSRS) serving state employees; and the Teachers Retirement Association (TRA) serving licensed educators.   (The last remaining independent teacher plan, the St. Paul Teachers Retirement Fund Association, also presented)

As of July 1, 2022, collectively the state plans reported $12.2 billion of unfunded liabilities, meaning an additional $12.2 billion should have been in those plans on that date to pay for retirement benefits that have been already earned.   Individual plans differ in their reported funded status ranging from 103.2% (PERA Correctional) to 63.0% (MSRS Judges).   In dollar terms, TRA’s $6 billion of unfunded liabilities constitutes half of the total for the state plans.

These figures are all based on an assumed investment return of 7.5 % which is now the second highest in the nation.  (Only Mississippi is higher at 7.55%).  For the third consecutive year the plans’ actuary has stated the current 7.5% assumption, “deviates materially from the guidance set forth in Actuarial Standards of Practice.”   As the PERA executive director said, “in other words, it’s unreasonable.”  The actuary has recommended return assumption in the range of 5.64% - 6.84%.   In response, state pension plan boards are advocating for lowering the assumed return to 7.0% to make progress toward this objective.   Had this return been used in the 2022 valuation reports, reported state unfunded liabilities would have been totaled roughly $18.2 billion.

Plan directors noted that thanks to the plan changes enacted in 2018 and the extraordinary returns in 2021 most plans now report a “contribution sufficiency.”  That means current Minnesota employer and employee contributions are on track to pay for pension plans’ “normal cost”  -- the benefits employees will earn over the next year -- and paying off all the plans unfunded liabilities on or before the target full funding date of 2048, 25 years from now.   However, in 5 of the 8 state plans, contribution deficiencies would exist if the assumed return was lowered to 7%.

Having a target full funding -- or amortization -- date is meant to prevent intergenerational the transfer of current pension liabilities.   To accomplish this objective, the Government Finance Officers Association Standards of Best Practice states fixed pension amortization periods should “never exceed 25 years, but ideally fall in the 15-20 year range.”   Adopting GFOA best practice would likely trigger the other state funds to also report sizeable contribution deficiencies (with the possible exception of MSRS General Plan, the healthiest of the state plans). 

The sufficiency of existing contributions is also affected by many other actuarial assumptions beside the investment return.  Real world deviations from these other assumptions can also have profound impacts on fund health.  For example, the PERA executive director noted disability retirements in the Police and Fire fund are running 3 times higher than the assumed rate on which plan funding is based.   The combined impact of the reduction in the investment return assumption with an adjustment in the disability retirement rate assumption would move the PERA Police and Fire Plan from a 5.91% contribution sufficiency to a 4-5% contribution deficiency, pushing the projected full funding date beyond 2082.

While the 2023 legislative initiatives for PERA and MSRS consist of essentially no-cost administrative changes as well as the 7% assumed return change, that is not the case with TRA.  Despite having $6 billion of existing unfunded obligations for teacher benefits already earned ($8 billion under a 7% return assumption), the Teachers Retirement Association is making a major legislative push to enable current teachers to retire earlier with full pension benefits.  

Currently, teachers hired before 1989 fall under the “Rule of 90” allowing them to retire with full benefits if the sum of their age and years of service equals 90.   Those hired after 1989 face reductions in their pension benefits if they choose to retire before the age of 66.  Under the banner of equity and attracting talent, TRA is proposing to implement a modified “rule of 90” in which would allow retiring with full benefits at age 60 contingent on also having 30 years of teaching service.   In addition, TRA is seeking a one year 2.5% cost of living adjustment (COLA) for existing retirees which would become the new base benefit for COLA adjustments going forward.   All this would be accomplished with a budget pressure-reducing assist from a fresh 30-year amortization period.    The total first year cost to school districts would be $469 million with $153 million of that growing at 3% per year assuming all assumptions are realized.

We’ll have more on all this in the weeks ahead.  Despite a couple rounds of phased-in sustainability repairs over the last decade-plus and an 8.4% average annualized investment return over the last ten years (8.6% over the last twenty) which has crushed assumptions, most of Minnesota’s pension system remains in a purgatory of chronically underfunded condition.   Lawmakers clearly want to communicate to beneficiaries that the latest shared sacrifice from 2018 is working. Indeed, some improvement has been achieved.   But this progress continues to be infused with political and accounting conveniences, funding shortcuts, and faux risk management, resulting in intergenerational transfers of obligations, the need to embrace higher risk investments, and steadily growing pressure on current service delivery budgets.   In the battle between appearances and financial economics, economics always wins.