Fouling Our Nest….Egg

As I shared in my initial blog post, “Hello World”, my first substantive introduction to the shoddy “research” done by the limited-thinkers at the Oklahoma Council of Public Affairs was taking the time to analyze their policy paper “Saving Workers’ Retirement” which provided like-minded Oklahoma legislators with their marching orders, namely first “save” the Oklahoma Public Employees Retirement System (OPERS) and then “save” the others, particularly the Oklahoma Teachers Retirement System (OTRS).  Here are direct quotes from the paper:

“Oklahoma must transition into a defined-contribution retirement plan for all new non-hazard duty government employees and teachers….Establish a defined-contribution (DC) plan, effective July 1, 2014, for all new state (OPERS-eligible) employees….Establish a defined-contribution (DC) plan, effective July 1, 2016, for all new teachers and judges.”

The OCPA’s minions got off to a good start in 2014 by passing HB 2630 which, after an unsuccessful court challenge, implemented a defined contribution plan for the vast majority of new state employees in late 2015 (See my October post “A Turkish deFright”).  Now it looks like step two is front and center for the 2017 legislative session with the filing of two bills, HB 1172 that would implement an optional defined contribution plan for new education employees and HB 1162 that would raise the retirement age for new education employees entering the existing defined benefit plan by two years, from 60 to 62 to qualify for an early retirement, otherwise from 65 to 67.  Just like the OCPA’s misnomer “Saving Workers’ Retirement”, the bills’ author Representative McDaniel (not our beloved Jeannie who was termed out) chose deceptive titles “The Retirement Freedom Act of 2017” and “The Pension Protection Act” respectively.

Where the 2014 HB 2630 used the “stick” of abruptly forbidding new state employees from participating in the existing defined benefit pension plan (which is over 93% funded so definitely not in need of “saving”), McDaniel’s bills appear designed to work in tandem as a “carrot” to lure new education employees into a cheaper and likely low-performing defined contribution plan that will not provide retirement security for Oklahoma’s future teachers and school employees.  Apparently it’s not enough to hold teacher pay flat for eight straight years, now they want to remove the one bright spot in teachers’ compensation package—a sound retirement.  In this post and a couple more I will try to explain why these bills are deceptive and not helpful to current and future school employees; bear with me while I drone on and eventually wax eloquent, I hope.

First we need a status report on OTRS.  My initial post linked to this document “Ten Facts” that summarized my thinking about Oklahoma’s public pensions at that time.  I wrote it in 2014 after OTRS had experienced some really positive financial changes, namely the elimination of assumed COLA’s for retirees (Representative McDaniel likely deserves some credit for this), increased employer contributions and superior investment performance.  The two years since, 2015 and 2016 (fiscal years ending June 30) have not been as good but the system is stable and remains on track to full funding in about 20 years.

The 2016 actuarial report specifically shows the funding period has increased from 14 to 23 years, primarily because the board has directed the actuary to assume a 7.5% return on investments, lowered from 8%, going forward.  Unfortunately, after several stellar years of investment performance, even ranking as a top performer nationally, OTRS experienced a bad year with an overall investments loss of 2.2% seemingly driven by substantial losses in its three Limited Partnership (oil and gas I think) investment funds.  A “bad” year, though, is not necessarily an indication of poor management any more than the previous “good” years indicated investment genius on the part of the board.  With defined benefit pension systems it’s always about the long run averages and OTRS remains in a healthy position if current funding streams are kept in place.

Here is a table that summarizes OTRS performance over the last ten years.

Or here for a clearer view:   OTRS 2017

Note there are two entries for 2016, the first in italics for what it would have been if the 8% assumption had been left in place and the last row for what is actually the report’s final numbers for FY 2016.  The two most important numbers to watch, in my opinion, are either AV% or MV% (two ways of determining the funding ratio with around 100% being the eventual goal) and Years, showing how many years it is likely to take the system to reach 100% funding, which should remain under 30 and trend downward.  Again, FY 2016 was not a proud result for OTRS but its fundamentals remain sound and, like OPERS, if left alone does not need “saving” though will take longer.

Now for the nitty gritty that a defined benefit retirement system’s actuarial report reveals to us.  Look again at the table and the entries at the bottom.  For this post let’s focus on 2016 and see what it tells us.  In FY 2016 about $1.020 billion was paid into OTRS by employees (the 7% required contribution), employers (like school districts) and the state (dedicated revenues from sales, income, gross production taxes and other sources).  That amount means that for every $100 of payroll, $24 is paid into OTRS which is indeed a heavy burden.  Of that $24 employees contribute a little under $7, employers a little over $10 and the state a little under $7.  Now here’s the nitty of the gritty, having all the current employees working another year (FY 2016) and earning the total payroll of $4.255 billion adds a little over $445 million to the system’s project cost or liability.  The actuarial term for that is “normal cost” and for OTRS in 2016 (and for the 2017 projection) is 10.47% of payroll.

Now go back to that $100 of payroll we analyzed above.  Again the $100 generates $24 in new revenue to the system, but the normal cost calculation tells us (rounding) that only $10.50 is needed for the additional costs/liability imposed by that new payroll.  Clearly the system needs that $10.50, but what about the other $13.50 (a little under $575 million in total)?  Isn’t that excess?  Yes and no.  It is in excess of what the current year employees’ payroll is going to cost the system, i.e. normal cost, but it is not in excess of what the system needs.  That $13.50 is necessary to pay off the past sins of our elected officials who committed to pay benefits in the future but did not provide sufficient funding to support those promised benefits.  Actuaries call that the Unfunded Actuarial Accrued Liability (UAAL) which for OTRS is a whopping $7.615 billion.  It is legally a debt of the state and, again, current projections are that if the $13.50 is kept in place it will be paid off in 23 years.

Looking again at the $10.50 normal cost, we see that education employees are contributing $7.00, so the cost to employers and the state of the current benefit structure for current employees is only $3.50 for each $100 of payroll.  For newer employees the cost is even less because I think even a limited-thinker should see that employees grandfathered in with the Rule of 80 or the old Rule of 90 are costing more than new employees coming in under the modified Rule of 90 (higher minimum retirement age).  I will come back to this in a later post but two eloquent conclusions for now:

Regardless of how the system may change for new employees going forward, the state (and its employers) is still on the hook for the $13.50 per $100 of payroll ($575 million annually) until the system is fully funded (23 years); and

Providing the current level of benefits promised to new education employees going forward under the current defined benefit system costs less than $10.50 per $100 of payroll ($445 million annually) and $7.00 ($295 million annually) of that is paid by the employees, meaning the cost to employers and the state is only $3.50 per $100 of payroll ($150 million annually).

Now that we have a basic understanding of the current OTRS defined benefit plan’s funding structure, in the next post (“What’s Up Doc?”) we’ll dissect Rep. McDaniel’s “carrot”, so stay tuned but don’t hold your breath.

As always lunch on me for the first to ID the photo location.

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