May 30, 2005

Rhode Island Politics & Taxation, Part XVII: Pension Problems

The Rhode Island public sector pension system is in deep financial trouble. A new ProJo article explains the problem in greater detail:

The issue has been floating around for a while, but with mounting costs squeezing local and state budgets, government leaders are buckling down to change the retirement system for teachers and state employees.

Governor Carcieri and General Treasurer Paul J. Tavares introduced plans earlier this year that would dramatically overhaul the system.

The question now is: To what degree will lawmakers actually change the system?

The House and Senate are expected to unveil plans in the next two to three weeks.

House Speaker William J. Murphy has pledged "meaningful pension reform" but has not been willing to sit down and discuss what that actually means.

"We have a system right now that needs help," said Murphy, D-West Warwick. "We're committed to doing pension reform and something will be done this year."

Senate President Joseph A. Montalbano said that the legislature plans to implement a minimum retirement age, probably increase the number of years of service needed to retire, change the percent of salary earned for each year of service, and eliminate the automatic 3-percent cost-of-living-adjustments retirees now get each year...

Montalbano said that workers not yet vested in the state system -- those with less than 10 years of service -- are going to be affected "in a very significant way."

Rhode Island's pension system is financed through contributions from employees, contributions from employers, and the return on plan investments.

Employee contributions are fixed at 8.75 percent of pre-tax salary for state workers, and 9.5 percent for local teachers. The rest of the cost is made up by the state and the communities.

The state put $118.9 million into the pension fund this year. That figure is expected to jump to $174.3 million next year, if there are no changes to the system. Within five years, it would climb to $255 million, if there are no changes, according to the governor's office.

The state's cities and towns face a similar problem. This year, they contributed $72.3 million for teachers' pensions. Next year, without any changes, that would climb to $103.4 million, and within five years, to $149 million.

"This problem is not going away, it's going to get worse," said Carcieri, who has been pushing for pension reform since he took office in 2003.

Without change, Carcieri has warned, the state will be forced to make "dramatic tax hikes or dramatic cuts in the programs that serve our most-vulnerable citizens."...

...the Republican governor said he believes the Democrat-controlled Assembly will act now.

"My expectation is that they will do something," Carcieri said. "My fear is that they will do much less than we need to do."

Treasurer Tavares says he also fears that the Assembly will just do something "cosmetic," and that next year, the state will face the same problem...

But even if changes do come, pension costs are still expected to rise.

The plans proposed by Carcieri and Tavares both cut into next year's anticipated contributions -- but would only cut the increase roughly in half. Under Carcieri's plan, the state would still have to put $27 million more into the pension fund next year than it is putting in this year.

There are several reasons for the state's current pension problem.

The first -- and most significant, according to Tavares -- is that people are living longer. When pension systems were first designed, workers only lived a few years after reaching retirement, he said. Today, people retire and live for 20 years or more, collecting a pension during each of those years...

The second reason involves the performance of the stock market and the state's investments. The actuaries use a five-year averaging period to calculate future contributions. Because of that, the state is still hurting from the market losses of 2000, 2001 and 2002, Tavares said.

The other main contributing factor, he acknowledged is the state's failure in past years to fully finance the pension system...

The most significant of these was in the mid-1980s, when the state offered early retirement to its workers, but failed to add money to the retirement system for all the people who were suddenly collecting pensions...

The state's labor unions place the blame squarely on the state.

Robert A. Walsh Jr., executive director of the National Education Association Rhode Island, acknowledges that "there are some demographic changes," but said the problem rests primarily with the state's not fully financing the system.

Year after year, Walsh said, teachers and state workers have contributed a large portion of their salaries to the system. They have held up their end of the bargain, he said.

If there are going to be reductions in retiree benefits, Walsh condends, the employee contributions should also be reduced.

"I'm not necessarily saying we need to leave the system as is," Walsh said. However, discussions need to be held "in a balanced way," instead of the "teacher and state-employee bashing" that he contends the governor is conducting.

Under the current system, state employees can retire at any age, with no reduction in benefits, as long as they have 28 years of service. Otherwise, they can retire at age 60, with at least 10 years of service. Pension benefits are based on years of service, so those who have served less than 28 years would get a smaller pension.

Carcieri and Tavares both propose instituting a minimum retirement age. Carcieri is seeking to make the minimum age 60, with 30 years of service, or otherwise, age 65. Tavares proposes age 58, with 30 years of service, or 62, with 5 years. (Tavares is also suggesting an option where workers at age 55, and 20 years of service, can retire with reduced benefits.)

Both the governor and the treasurer propose to reduce the amount of benefits retirees would receive. State employees now stop accumulating credit toward their pension after 35 years, maxing the system out at 80 percent of their salary. Carcieri and Tavares want to lower the maximum benefit to 75 percent, after 38 years of service.

The changes would apply only to new hires to state government, or to current employees who have less than 10 years of service and are not yet vested in the system.

The two officials, however, differ on what to do with the cost-of-living adjustments that retirees get. Currently, employees start getting the 3-percent COLA on the third January after they retire.

Carcieri wants to tie COLAs to the national Consumer Price Index, a measure of inflation. Benefits would increase annually according to the CPI, or at 3 percent, whichever is lower.

Tavares wants to take the changes one step further. While Carcieri would only change the COLA for new hires and those not vested, Tavares wants to implement the same changes for everybody -- all employees and all current retirees.

Will lawmakers go as far?

"I don't think we'll go further," Montalbano said. "I think we'll, hopefully, take some of the best parts of all of it, and come up with a plan that we hope the governor will sign on to."

The labor unions' position is not new. Here are excerpts from two August 2004 news articles referenced in this posting, which discuss the problems:

...the statewide pension problem surfaced [with this article] publicly, highlighting dire financial consequences:
State and local taxpayers should pay a whopping $121.6 million more next year toward the pensions of state employees and public school teachers…

That advice, from the state's pension-funding adviser, sent shock waves through the hearing room where top labor and government officials gathered…

In late June, the deadlocked panel voted 6-6, defeating a series of moves recommended either by Carcieri, a Republican, or state treasurer Paul Tavares, a Democrat, to rein in the escalating cost of public-employee pensions, such as the adoption of a mininum retirement age.

But yesterday's news seemed to surprise some of the union leaders who had resisted any changes in pension eligibility and benefit levels…

The warning was the result of a reexamination, by the state's actuarial advisers at Gabriel Roeder and Smith, of the assumptions that determine how much money must be set aside now to cover all the promises made to current and future retirees.

After looking back seven years, the firm concluded the state has been overestimating investment returns; underestimating the salary increases, averaging 4.5 percent annually, over the seven years that ended on June 30, 2003; and failing to account for the disproportionately large number of Rhode Island public employees who stay in their jobs long enough to qualify for pensions.

Another article reinforced the magnitude of the problem:

"We are not bleeding, we are hemorrhaging," said Daniel Beardsley, executive director of the Rhode Island League of Cities and Towns, which represents local governments in the state's 39 communities…

Local pension systems in some of the state's communities are also in trouble - especially those in Cranston and Providence, according to estimates by the Rhode Island Public Expenditure Council.

Rhode Island labor leaders have long resisted changes that would cut benefits for employees and teachers.

Then there are always recent stories in Rhode Island like this one.

Beginning on page 17, this RIPEC report provides a very valuable comparison with the public sector pension program of Massachusetts, allowing all of us to see how we have been giving away the store in Rhode Island. The comparision with our neighboring state also shows how none of the proposals on the table goes far enough in making crucial changes. And it begs the obvious question of: If Massachusetts pension benefits are good enough for the public sector unions in that state, why are similar Rhode Island unions whining so loudly and resisting change? Here are some highlights from that report:

Minimum age to receive pension benefits: RI-None; Mass-65.

Minimum years of service to receive pension benefits: RI-28 years or 10 years at age 60; Mass-10 years

Cost-of-living increase amount per year: RI-3% on total pension benefit beginning in third year; Mass-Set by legislature; most recently 3% on only first $12,000/year

Retiree contribution to healthcare insurance premiums with at least 28 years, <60 years of age: RI-10%; Mass-15%

Retiree contribution to health insurance premiums with at least 28 years, >60 years of age: RI=0%; Mass-15%

Most importantly, Massachusetts penalizes public sector employees who retire and take the pension before age 65, cutting their lifetime pension payments by 50%. The magnitude of our financial problem in Rhode Island becomes more clear when you contrast how Rhode Island immediately pays full benefits to a retiree who retires after 28 years of service, regardless of age (and which could begin as early as age 46 for employees who started immediately after high school graduation), and then increases it by 3% per year thereafter versus one of two alternatives in Massachusetts: (i) paying only 50% of the qualified pension payments if the employee takes any monies before age 65 or (ii) paying qualified pension payments only after age 65.

The broader national issue of bankrupt public sector pensions is discussed here. This posting shows how there are significant financial problems that are time bombs set to explode in the near future and which require more radical program changes - like stopping the offering of defined benefit plans and moving to defined contribution plans like 401(k)'s - not the kind of minor tweaks currently being proposed in Rhode Island. It also highlights how the misguided incentives of the public sector will make this an ongoing problem.

This EdWeek posting referenced by RI Policy Analysis highlights additional state/teacher pension problems around the country.

The effect of those misguided incentives, the effect of government intervention in the marketplace, and the additional time bomb of public sector employee health insurance costs are highlighted in this posting.

This posting continues a periodic series on Rhode Island politics and taxation, building on sixteen previous postings:
I - Guiding Principles for Sound Public Policy
II - The Outrageous Tax Burden in Rhode Island
III - 2004: The Year in Review
IV - The NEA's Disinformation Campaign
V - Governor Carcieri's State of the State Address
VI - "Citizens for Representative Government's" Deceitful Manipulation of the Constitutional Convention Vote
VII - The Extreme Tax Burden in the City of Providence
VIII - Rhode Island Gets a C+ on its Report Card
IX - How Speaker Murphy's Changing of the Rules of the House Reduces Your Freedom
X - East Greenwich Teachers' Salary and Benefits Data
XI - What Was Rep. Fox Doing in Portsmouth?
XII - Why Do RI Citizens Passively Consent to Governmental Control by Powerful Interests?
XIII - RI House Leaders Show No Respect for Rule of Law by Undermining Separations of Powers, Part I
XIV - More Bad Faith Behavior by the NEA
XV - RI House Leaders Show No Respect for Rule of Law by Undermining Separations of Powers, Part II
XVI - Tom Coyne - RI Schools: Big Bucks Have Not Brought Good Results