Public Pensions Join the "What To Do With All This Money" Debate

Is it possible to have a bill containing multiple billions of dollars of near and long-term financial implications for the state pass a government finance committee without a fiscal note, financial analysis, or for that matter any questions from committee members about what the actual impact would be?  The answer we now know is "yes."   On Thursday HF 4306, a bill proposing major changes to state public pension finance, passed on an 8-5 vote out of House State Government Finance and Elections and now heads to Ways and Means -- without any understanding on what the implications for pension plan health and funding obligations would be in the aftermath.

The bill proposes several major changes

• A permanent compounding increase in the annual cost of living adjustment (COLA) to 2.5% for most plans effective 2023
   
• A 1 percentage point reduction for three years in the employee contribution rates for statewide pension plans
   
• A reduction in the actuarial assumed investment rate of return from 7.5% to 7%.
   
• A 50% increase in amount of state aid to three plans (PERA Police and Fire, St. Paul Teachers, and MSRS Judges)
   
• A one-time $1 billion appropriation for pension support to be divided among the 8 statewide pension plans based on the share of market value among all plans.

The lack of information and discussion indicates this is an initial volley or placeholder for future negotiations on what to do, if anything, about pension finance this session.   The Senate has been silent on this so far on the topic while the Governor has proposed a modest $73 million one-time, non-compounding bump in plan cost of living adjustments. Current indications are some type of finance-related bill will be added to the Legislative Commission on Pension and Retirement agenda before the session is over (a separate omnibus pension policy bill has already been adopted.) But it’s worth contemplating for a moment the impact of this bill on plan health.

The combination of a permanent and compounding COLA increase of 2.5% combined with a 3-year reduction in employee contributions would have a profoundly negative impact on plan health.  (The justification for reducing active contributions while at the same increasing retiree COLAs is to protect active employees from the some of the cost of the COLA increase).  The reduction in the investment return assumption, which improperly serves as the discount rate, is a positive step toward responsible pension finance, but will also increase the plans’ reported unfunded obligations and therefore indicate higher contributions are required at the same time they are being reduced.   A $1 billion one-time appropriation could be argued as a smart use of one-time money to improve the plans' health  if not for the fact its beneficial impact is likely more than undone by the other provisions.   Understanding the fiscal implications of all this is the playground of actuaries, but we have heard back of the envelope estimates of a $8 billion impact on statewide plans.

The motivation behind this bill is to have governments put more money into state pension plans to ensure their long term viability.  Advocates for the bill argued that Minnesota has long pursued its public pension policy “on the cheap.”   This assessment is absolutely correct.  What's never said is that both government and employee advocacy groups (with a huge assist from the actuarial profession) have long been fully complicit in this underfunding by using improper discounting practices which makes pension obligations look far cheaper than they really are and resisting changes to evaluate liabilities responsibly.  Keeping discount rates high helped keep employee and government contributions lower than what they should have been to support the economic promises being made.  This practice also goes a long way in explaining the discrepancy advocates frequently like to point out between what Minnesota spends to support its pension obligations versus what other states do.  Minnesota public pensions have been a multi-decade state experiment in having your cake and eating it too.

In appreciation for the bill author’s commitment to adequate funding, one testifier invoked the Old Testament prophet Elijah as a voice in the wilderness calling for justice.   State pension policy reminds us of Elijah as well -- specifically the story in which a widow during a famine was able to feed the prophet with her last little bit of flour and oil but miraculously the flour and oil was never used up.   Unfortunately, tax dollars don’t work that way and difficult choices will have to be made.