Teachers’ pension problem festers
It’s going to take a lot of work and people coming to the table, rolling up their sleeves and trying to figure it out together, with best intentions.
— Sen. Ruth Hardy
MIDDLEBURY — While state revenues this year have been exceeding expectations, it’s not all good financial news in Montpelier. Before the end of the 2021-2022 biennium, Vermont lawmakers will need to chart a new course for a teachers’ retirement system that’s in dire financial straights.
That is due to the underperformance of investments, a shrinking population of teachers, the setting of unrealistic rates of financial return and other factors. As a result, educators are nervous about their pensions and taxpayers worried about higher costs.
“It’s going to take the state putting in more money and a restructuring of the fund, which will mean things are going to change for the retirement system for teachers,” said Sen. Ruth Hardy, D-Middlebury, who serves on the Senate Finance Committee.
“It’s going to take a lot of work and people coming to the table, rolling up their sleeves and trying to figure it out together, with best intentions,” Hardy said.
Chris Rupe, an analyst with the state Joint Fiscal Office, recently provided an overview of how the teachers’ pension fund has underperformed during the past few decades.
During a presentation earlier this year to the House Government Operations Committee, Rupe noted both the Vermont State Employees Retirement System (VSERS) and the Vermont State Teachers Retirement System (VSTRS) were “close” to fully funded 15 years ago. But by Fiscal Year 2021, the funding ratio for VSERS had dropped to 66.4% of what it needs in the future and the ratio for VSTRS stood at just 51.3%.
During that same timeframe, future pension costs grew faster than pension assets — and faster than the active payroll, Rupe noted.
“This has caused the unfunded liability — the gap between future benefit costs and assets — to grow significantly and strains budgets to make up for the shortfall,” Rupe told lawmakers. “Most of the gap grew after 2007, despite the employer fully funding ADEC (employer contribution) payments during that time.”
This means that paying down the growing unfunded liability requires higher annual employer contribution payments (paid by taxpayers), which have consumed an increasing portion of the budget, according to Rupe.
Consequently, pension payments alone now consume $199.4 million, or 10.48% of every Vermont General Fund dollar. And post-employment benefits (primarily health care) consume an additional $50 million, or 2.62% of every General Fund dollar, according to Rupe.
“During the last 5 years, pension costs to the employer have grown significantly — and at a faster rate than employee contributions,” Rupe said. “Recent changes to demographic and economic assumptions have increased the normal cost, as well. This means that the cost of each year’s pension benefits accrued by the active workforce is increasing, and also increasing the employer payment amount.”
According to Rupe, there were 10,685 educators paying into the VSTRS in 2008, with 5,555 retirees and beneficiaries receiving benefits. In 2020, there were 9,996 educators paying into the system, and 9,843 people drawing benefits.
In short: The number of VSTRS retirees grew by 77.2% between 2008 and 2020, and this demographic trend is projected to continue in future years, according to Rupe.
Contributing to the financial conundrum is that both the average and aggregate benefit payments to VSTRS members (retired teachers) have increased since 2008, and at a faster rate than contributions into the system from active members and employers, according to Rupe.
“Like many mature plans, VSTRS pays out more in benefits than it takes in from employer and member contributions each year,” Rupe said. “Pre-funded systems like VSTRS rely on investment gains from plan assets to fund most of the aggregate costs of benefit payments.”
In 2008, the VSRTRS received roughly $40.1 million and $22.1 million in employer and member contributions, respectively. The fund paid out a total of almost $84 million in benefits that year, for an average monthly benefit of $1,263.
In 2020, the VSRTRS received roughly $127 million and $40.6 million in employer and member contributions, respectively. The fund paid out a total of almost $201.3 million in benefits that year, for an average monthly benefit of $1,830.
The state’s pension systems apply an “assumed rate of return” to estimate how much of the money needed to pay for the actuarial accrued liability will come from future investment returns, according to Rupe.
“Unrealistically high assumed rates of return lead to unrealistic projections — and higher unfunded liabilities and ADEC costs later in the amortization period to make up the difference,” Rupe warned.
The state’s pension trustees set an assumed rate of return of 8.42% on pension investments in 2012, but gradually lowered it during successive years to a new low of 7% this year, according to figures supplied by Rupe. In September of 2020, managers lowered the pension funds’ assumed rate of return rom 7.5% to 7%, and the inflation assumption from 2.5% to 2.3%.
“According to data from the National Association of State Retirement Administrators, the vast majority of surveyed pension plans now adopt an assumed rate of return lower than 7.5% and a growing number of plans are adopting rates of return lower than 7%,” Rupe said. This is a trend driven by what he referred to as years of pension plans failing to achieve their assumed rates of return, lower inflation rate experience and projections, and lower expectations for investment gains in future years.
Between fiscal years 2012-15, Vermont adopted a “select-and-ultimate” assumed rate of return system, Rupe noted.
“In this system, different short-term and longer-term investment growth rates were applied,” he explained. “This system resulted in lower ADEC payments based on average annual investment assumptions exceeding 8.25% and was discontinued after four years.”
The use of this system during the four years in question is estimated by the Vermont Business Roundtable to have increased the unfunded pension liability by a total of $137 million for VSERS and $186 million for VSTRS, according to Rupe.
PENSION CHANGE OPTIONS
Lawmakers and State Treasurer Beth Pearce this past January took some swings at a pension fund solution.
According to a report in VT Digger, an initial bill developed by the House Government Operations Committee called for, among other things:
• Preserve annual cost-of-living adjustments, but apply it only to the first $24,000 of a retiree’s benefit. There would not be a 1% minimum, but the 5% maximum would stay. Adjustments would not apply until a retiree turned 67 (or 60 for law enforcement).
• Increasing payroll deductions for all employees, as well as a new “employee risk-sharing contribution” that would kick in when the pension plan’s investment returns fall short of expectations. These “risk-sharing” contributions would be higher for employees with higher salaries.
• Increasing the retirement age, adjusting it (for most employees) to eligibility for Social Security. In most cases, a retiree’s pension benefit would be calculated using the three years at which they received their highest salary. That would change to the seven years during which they received their highest pay, reducing the average benefit.
• Doubling from the current service threshold from five to 10 years, in terms of when employees can be eligible for normal retirement benefits.
Members of the Vermont division of the National Teachers Association quickly assailed the proposal, and it became clear many legislators weren’t on board.
With encouragement from House Speaker Jill Krowinski, the Government Operations Committee killed the bill and instead passed out H.449, which proposes to change the membership and duties of the Vermont Pension Investment Commission, and instead create the Pension Benefits, Design, and Funding Task Force.
Essentially, the new bill suggests that the Investment Commission contain members with more financial expertise, and that the task force spend this off-session studying the current pension problem and recommending possible solutions for lawmakers to consider before the end of this biennium.
‘A HARD CONVERSATION’
Rep. Caleb Elder, member of the House Ways & Means Committee, is pleased with the new approach.
“There were elements with the way that (initial) plan was rolled out that I wasn’t comfortable with,” Elder said. “I’m pleased with the step (the speaker) has taken… Both the treasurer’s proposal and the first draft from Government Operations proposal, I personally don’t think they were the right starting place for a very hard conversation.”
“I completely understand why (teachers) are upset, worried and frustrated,” she said. “They feel this (pension agreement) was part of the bargain when they signed up to be a teacher. I completely get that, and I would feel the same way. I hope we can fund a solution that will keep the fund healthy for current teachers and future teachers. What that solution is, I don’t know right now, and it’s not going to be easy.”
UNDERFUNDING THE FUND
While Hardy acknowledged the state had underfunded its contributions to the VSTRS from 1991-2007, it has fully funded its payments since 2007 while chipping in more when possible to make up for the prior 16 years.
“To be fair, it hasn’t been sufficient to keep the fund healthy,” Hardy conceded.
Middlebury Union High School educator Bjarki Sears was among a group of teachers who recently demonstrated against the earlier Government Ops proposal.
He likened the current conundrum to a multi-person household where one of the roommates — in this case, the state — doesn’t pay the agreed-up amount of rent for a period of time.
“Then your landlord charges you interest on that back rent,” Sears said. “And when the time comes for that back rent to be paid, your roommate comes up to you and says, ‘What are we going to do about this rent?’
“Then the roommate is indignant and says, ‘You’re not working with me,’” Sears added.
Sears is pleased the Legislature is now suggesting a pension task force, along with more oversight over the fund.
But teachers remain wary about putting off the difficult decisions for another year.
“I would argue that by putting it off and creating a task force, they are essentially forcing teachers to give,” Sears said. “By proposing the destructive changes that they did in February/March, now smaller solutions seem more reasonable, and the point that teachers have paid every penny ever asked — and even more so — has been lost.”
Sears recalled the Legislature asked teachers to return to the pension fund bargaining table back in 2010.
“The teachers at that point made a few concessions, including changing our average contribution from around 3% of our salaries to around 5%,” Sears said. “Ten years later, they now want us to go up to 10% of our salaries — plus the risk sharing thing.
“Are we going to have to renegotiate this every decade?” he asked. “At the end of my career, am I going to be teaching until I’m 72, or 73?”
Elder is hoping for a fair solution that begins with the state “owning” the problem.
He believes the new approach shouldn’t confine itself to an “ongoing, defined benefits system, at all costs.”
And Elder said he also hopes Gov. Phil Scott will weigh in on the issue.
The Independent reached out to Scott through his spokesman, Jason Maulucci. Maulucci, in an email reply, noted the state has met its pension obligations since he took office in 2017. Scott, a Republican, is looking to the “majority party” — aka the Democrats — “to take a leadership role on pensions because that is the only way this conversation will actually get anywhere,” according to Maulucci
“Gov. Scott knows better than most what it is like to take a position that is right for all Vermonters and the state, even when it upsets a special interest voting bloc, and he appreciates Treasurer Pearce and others for recognizing the need to act, because we cannot wait,” he said.
“And again, as the governor has said, he’s ready to be at the table for a collaborative approach to solving this problem. He has made that offer to legislative leadership and unfortunately they haven’t taken him up on it yet, but we’re ready when they are.”
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