Opinion: State must address pensions

On July 10, 2019 Fitch, a major credit agency, reduced Vermont’s bond rating. This was expected, after Moody’s, another large credit agency reduced Vermont’s bond rating in October 2018. Both rating agencies have the same concerns about Vermont and it’s economy.  As a result, future state and municipal borrowings costs will increase.

Why is this happening?  Because Vermont faces daunting “economic and demographic headwinds.” We have heard these concerns for years. Vermont’s population and its workforce is flat or declining, our economic growth is slow and our citizens are old.  And our state’s unfunded pension and health care liability for current and future teacher and state employee retirees is large and growing.

Fitch notes that Vermont has a “small and modestly growing economy” and that “Vermont’s population is older than most states and growth has been relatively limited.” They state that Vermont’s population has been basically flat since the turn of the century and has been in a slight decline since 2012. Fitch is concerned that the “state’s labor force has been flat to declining over the past decade, in contrast to slow growth at the national level.” 

Fitch is also worried that Vermont’s debt and net pension liabilities was 11.9 percent of Vermont’s 2017 personal income compared to a national median of 6 percent. That is nearly double the burden of the median state in the nation. These percentages exclude the additional $2.3 billion in unfunded state employee and teachers retirement health care benefits liability.

Added to this list of bad news was The Pew Charitable Trust reportissued in June 2019. This annual report measures each states’ pension fund performance. The data in the report is as of 2017 and allows us to see how Vermont is doing compared to other states.

So how does Vermont look in this report regarding its Teachers and State Employees’ pension plans? Consistent with the concerns raised by Fitch, not very good.  

Vermont's assumed annual rate of plan return for its pension fund investments was 7.5% versus a weighted average of all states plans of 7.08%. When Vermont’s pension plans do not achieve this assumed rate of return, the difference must be made up by the taxpayers and reduces the tax dollars available for other state funded priorities. 

The report notes that this "trend toward lower investment assumptions is consistent with observations by experts, who forecast lower-than-historical returns of 6.5 percent due to expectations of lower economic growth and persistent low interest rates." In fact, Bloombergreported in June 2019 that the Chief Investment Officer of Calpers (the largest pension fund in the country) told its board that “For the next ten years, our expected returns are 6.1% not 7%.”

Only 13 other states had assumed rates of return equal to or greater than Vermont's 7.5% assumption. That means that 72% of states, or nearly three quarters of states (36 states), have assumed rates of return that are more conservative, realistic and reasonable than Vermont's.

Vermont's funded ratio (the percent of plan assets relative to the plan’s current accrued liability) was 64.3% below the total for all state pension funds of a 69.1% funded ratio. In fact, Vermont had the 17th worst funded ratio of all states, meaning that nearly two-thirds of states (66%) had higher pension funded ratios than Vermont. Vermont is basically in the bottom third of the country with its funded ratio—and this is bad news for plan members, plan retirees and taxpayers.

Nearly half (46%) of all states (23 states) have funded ratios in excess of 75% including two of our neighbors Maine (81.9% funded ratio; 6.88% assumed rate of return) and New York (94.5% funded ratio; 7% assumed rate of return).  

Pew notes that states that have strongly funded pension plans have realistic assumed rates of investment return and often have "policies to automatically lower benefits or increase contributions in response to market downturns."  

So how can we fix our pension plans? Pew identifies the policy levers available to our state legislature, Governor and Treasurer. To improve our situation, Vermont, must make some changes to its pension policies. These may include "strengthening funding policies, adopting more conservative assumptions, increasing employee contributions, changing the benefit design for new hires, reducing benefits for current employees and retirees, strengthening governance and improving transparency."

We know what we have to do to fix our pension plans. Our problems are not unique, many other states have already faced and addressed these issues. It requires our state policymakers and unions to courageously work together to compromise and to modify our pension policies to protect current plan members, existing retirees and Vermont taxpayers. 

We need to do this before it is too late—before the next recession and/or bear market.  Time is running out. We are currently in the midst of the longest bull market in history—that milestone was achieved in August 2018. The current bull market is also the second largest in terms of overall stock market gains. We are also in the midst of the longest economic expansion in US history, a record reached this month. Winter is coming and Vermont needs to be prepared.

John Pelletier is Director of the Center for Financial Literacy at Champlain College.

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