What’s Up Doc? or Should Teachers Eat A Carrot?

Like most kids of my generation we watched a lot of Bugs Bunny cartoons.  In those stories Bugs was definitely motivated by carrots and by Elmer Fudd’s “stick” in the form of a shotgun.  This post is about the carrot and stick approach being used by the legislature to dismantle Oklahoma’s defined benefit public pension plans.   In my last post “Fouling Our Nest….Egg” I provided information about the Oklahoma Teachers Retirement System (OTRS) taken from its most recent actuarial report which is available here https://www.ok.gov/TRS/Publications/Actuarial_Reports/index.html

Most important I showed what happens to the more than one billion dollars that flows into the system from education employees, their school districts and other employers and dedicated revenues from the state.  For every $100 in new payroll $24 is paid into the system coming, approximately, $7 from employees, $10 from their employers and $7 from the state.  In effect that $24 is actuarially allocated $10.50 to pay for the future benefits of the contributing employees (made up of the employees’ $7 and $3.50 from their employers) and the remaining $13.50 ($6.50 from employers and $7 from the state) to pay off the system’s Unfunded Actuarial Accrued Liability (UAAL) which is over $7 billion, but on track to be retired in 23 years.

Following the direction from the Oklahoma Council of Public Affairs and their ilk our legislature has been anxious to phase out the state’s defined benefit (DB) pension plans and replace them with defined contribution (DC) plans.  Here are the definitions:

      Defined Contribution Plan: A retirement plan, such as a 401(k) plan, a 403(b) plan, or a 457 plan, in which the contributions to the plan are assigned to an account for each member, and the plan’s earnings are allocated to each account, and each member’s benefits are a direct function of the account balance.

      Defined Benefit Plan: A retirement plan that is not a Defined Contribution Plan. Typically, a defined benefit plan is one in which benefits are defined by a formula applied to the member’s compensation and/or years of service.

As more fully addressed in my October post “Turkish deFright” the legislature used a “stick” (the 2014 HB 2630) to provide for the end of the OPERS DB plan for state employees by simply mandating that it would be closed to new employees who, instead, would use a DC plan for their retirement.  For political (teachers engender more sympathy than “bureaucrats”) and legal reasons, I suspect, Representative McDaniel and others are choosing to use a “carrot” approach to ending the OTRS DB plan and moving new school employees to a DC plan.  The carrot is spelled out in HB 1162 and HB 1172 he has filed for the 2017 legislature to consider.

By raising the retirement age two years for new members of the DB plan HB 1162 simply makes the existing plan less attractive.  Using the numbers from the actuarial study we see that effectively the current active and contributing members are paying $7 and their employers $3.50 for every $100 earned for the retirement benefits they will eventually receive.  But that calculation includes all active members, those under the more generous Rule of 80, the previous Rule of 90, and the tighter Rule of 90 that now applies to new employees.  I don’t know what the amounts would be but clearly the value of the employer’s contribution to a new employee under McDaniel’s plan will be well less than $3.50 that is the average of all.  However, to keep a comparison simple we’ll “stick” with $3.50.  So a new employee pays $7, the employer kicks in $3.50, and the remaining $13.50, coming from the employer and the state, goes to pay off the system’s UAAL.  Bottom line, the employee pays $7 and gets a $10.50 value.  And the state’s promise to retirees like me is kept.  Whoop De Do.

What I just said is essential to understanding the “carrot” McDaniel wants to offer new teachers and school employees.  It is an actuarial fact, fully documented and supported by the most recent OTRS actuarial report, that for every $100 of payroll generated today, under the current DB plan, $24 is paid into the system of which $10.50 goes to support the future retirement of the current employees who are contributing their 7% or $7.  The remaining $13.50 goes to pay off the systems unfunded liability for those already retired and some still working whose earlier years of service were not fully funded.  This $13.50, which is made up of the state’s $7 and the employers’ excess above the $3.50 needed to fund each year’s current promises to current teachers and school employees, will be needed regardless of how the legislature may change the plan in the future.  It could be more in which case the UAAL will be paid off sooner (just like paying more toward your mortgage); it could be less but that would lengthen the time to pay off the UAAL and could even endanger its long run solvency.  The best way to view this is that the $13.50 is “off the table” and what we have to work with is the $10.50, $7 from the teacher and $3.50 from the employer school district.    

Now for the carrot.  HB 1172 mandates the creation of an optional DC plan within OTRS.  A new school employee has a 30 day window to decide whether to join the DC plan or not.  Those who don’t, if they are teachers, will then be in the DB plan; other school employees can opt in or out of the DB plan.  By joining the DC plan the employee is required to contribute a minimum of 4.5% of payroll, or $4.50 for every $100 of payroll.  The employer is required to “match” with 6% being $6 for every $100 of payroll.  The employer is also required to remit the difference that would have been paid to the DB plan if the employee had joined it.  That amount, on the average, is about 10%, or $10 per $100, from above (the employer percentage is generally 9.5% but is much greater for employees paid with federal grants so averages a little more than 10%).  Bottom line the employee pays $4.50 and gets a $10.50 value. 

Here then is the carrot.  If a newly employed teacher in August, 2018 asked me whether she should opt for the new DC plan or default to the legacy DB plan I would have to say to her that in each case you will have the same amount ($10.50 per $100) or percentage (10.5%) of your salary working for your retirement but it will cost you 7% to get that through the DB plan and only 4.5% through the DC plan.  That 2.5% difference, or $2.50 per $100 of payroll, stays in your pocket.  There are other pros and cons to consider (will be addressed in my next post) that might alter my recommendation if the starting math was more equal, but it’s not.  The scheme that will go into place if HB 1172 is enacted is a clear “carrot” to move all new employees into the new DC plan, certainly fulfilling the objective of McDaniel and the OCPA, but it comes at a significant cost. 

There ain’t no such thing as a free lunch even if it’s only carrots.  That 2.5% or $2.50 per $100 must come from somewhere and it does.  Note that for the existing DB plan the actuary tells us that the employer’s 10%, or $10 per $100, gets split 3.5% to the current employees and 6.5% to help pay off the UAAL.  This split changes with HB 1172; going forward 6% will be allocated to the current employees who opt in the new DC plan leaving only 4% to pay off (under the “remit the difference” requirement) the UAAL.  Assuming new employees figure this out and depending on how quickly the actuary projects this de facto “closing” of the DB system, this will certainly slow down the reduction of the system’s UAAL and may even put it on the path to insolvency.

The carrot can even get juicier.  If a new employee participant elects to put at least 7% into the DC plan then the employer “match” increases to 7%, meaning 14% is working for the new employee’s retirement contrasted with only 10.5% for the old employee in the DB plan (or $14 compared to $10.50 per $100 of payroll).  And this takes away another 1% from the employers’ pay down of the system’s UAAL, making the split 7% to the new employee and only 3% to the debt, further worsening the DB plan’s long run stability.  Yet I can see the postings on the OCPA’s blogs as their self-fulfilling prophecy plays out, saying they told us so, that the DB plans are disasters and aren’t we glad that at least new employees were “saved” by the DC plans.  We have met the enemy and it is us.

My hunch is that this blatant robbing Peter (old teachers) to pay Paul (new teachers) will not become part of the conversation about HB’s 1172 and 1162 because the math is confusing at best and can be made deceptive at worst.  Both Peter and Paul deserve better.  What would help is if the legislature would commission an actuarial study of the financial impact of this proposed legislation so that they understand the facts before taking action.  The Oklahoma Pension Actuarial Analysis Act was enacted some years ago to require both a two-year process and an actuarial analysis of proposed legislation that would have a “fiscal impact”.  Unfortunately, this law defines “fiscal impact” as only a law that would increase benefits for current or retired employees without funding the change.  It does not consider stripping away revenues that support existing benefits as having a “fiscal impact”.   Therefore, the legislature’s actuary has already certified these bills as “non-fiscal” and thus no analysis is required—just more limited thinking.

As always lunch is on me for the first to identify the photo location—hint:  it and the one before are “up the hill” from the photo on the “Short and not the Point” post. 






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