Conservatives across Oklahoma must be asking themselves how it is possible that a government controlled by Republicans can’t pass government-pension reform that is bolder than what a bunch of Democrats in Rhode Island did earlier this year.
More pointedly, why can’t Oklahoma—where labor unions are weak—pass government pension reforms similar to what Michigan—where labor unions are strong—passed way back in 1997?
The reforms in Rhode Island and Michigan significantly decreased the odds that taxpayers would get stuck with a huge government-pension bailout bill. Oklahoma’s elected officials say they want to protect taxpayers, so why aren’t they?
How Is OPERS Doing?
Because of reform legislation passed in 2011, the funded status of the Oklahoma Public Employees Retirement System pension plan (OPERS) increased from 66 percent to 80.7 percent. These figures come from the OPERS Comprehensive Annual Financial Report (CAFR) for the fiscal year ended June 30, 2011. That means that for every $1 in liabilities, OPERS possesses $0.807 in assets.
The 2011 CAFR notes that the market value of OPERS’ assets on July 1, 2011, was $6.841 billion. Though we won’t know the final figures until the 2012 CAFR is released, OPERS discloses on its website that the market value of its assets on June 30, 2012, stood at $6.805 billion. If that figure is accurate, that means OPERS lost $36 million in assets over the last year—and that is after receiving roughly $270 million in member and taxpayer contributions. This loss of -0.05 percent means that OPERS’ unfunded actuarial accrued liability increased over the last year.
With OPERS just barely above the 80 percent threshold most pension experts believe is necessary, the market-value loss likely pushed the funded status below 80 percent.
The most troubling trend for Oklahoma taxpayers is the enormous increase in funds they have to pay into OPERS to support the system, especially as compared to the number of employees in the system. The number of active employee contributors actually decreased slightly from 44,292 employees in 2002 to 40,551 employees in 2011. From 2002 to 2011, the total employee contributions increased by just 30.6 percent. At the same time, the total taxpayer contributions increased by a stunning 81.1 percent, which costs taxpayers more than a quarter of a billion dollars per year!
This large discrepancy between employee and taxpayer contributions exists because employees only have to contribute 3.5 percent of their pay to the pension plan while taxpayers have to contribute 16.5 percent of each employee’s pay to the pension plan. For private-sector Oklahomans, the average employer contribution to their 401(k) is four percent. Why are taxpayers putting in more than four times that amount into government pension plans?
OPERS Actual Liabilities Are Much Larger
Earlier this year, the Governmental Accounting Standards Board passed new rules requiring government pension plans to use more realistic investment returns when calculating unfunded liabilities. OPERS assumes a 7.5 percent investment return rate every year to arrive at the 80.7 percent unfunded actuarial accrued liabilities figure. Such an unrealistic forecast misrepresents the health of OPERS’ finances.
OPERS’ CAFR notes that in Fiscal Year 2011, it achieved a 21.2 percent rate of return. Even with that large rate of return, the annualized rate of return for OPERS over the last five years was just 5.4 percent, or 2.1 percent less per year on average than the 7.5 percent forecast. Because of the expectation of compounding the rates of return each year, this 2.1 percent reduction compounds as well, pushing OPERS further in the hole as time goes on.
The 40-year trend looks even worse without that 7.5 percent rate of return forecast. Allow me to explain.
Let us make the following assumptions:
- Active Member Salary Base Annual Increase: 2 percent (even though from 2010 to 2011 the actual increase was 1 percent)
- Member Contribution Percentage: 3.5 percent (as current law requires)
- Taxpayer Contribution Percentage: 16.5 percent (as current law requires)
- Annual Payout to Retirees Increase: 5 percent (even though from 2010 to 2011 the actual increase was 7.5 percent)
- Annual Rate of Return: 7.5 percent (as currently forecast)
If we make those assumptions—some of which are generous—then the published market value of $6.805 billion in 2012 will increase until 2046, when it then begins a steady decline.
If, however, we keep the first four assumptions above but change the rate of return to four percent, which is what private-sector pensions must use, then OPERS’ market value increases to $7.536 billion in 2022, but then drops in value each year until going into a negative balance in 2042 (i.e., in 30 years).
Bumping the rate of return to 5.5 percent only stems the bleeding by five years, as the market value goes negative in 2047.
If you believe it will be very difficult to maintain an annual rate of return of 7.5 percent, the only way to keep OPERS viable is to increase the member contribution rate and/or the taxpayer contribution rate. You also could reduce the pension payout, but that would only nibble on the margins of the problem. Without real reform, taxpayers remain at risk of having to bail out OPERS with even higher taxpayer contributions.
Real Reform Can Protect Taxpayers
At the same time Oklahoma Republicans passed modest government pension legislation in 2011, Rhode Island Democrats were bucking the labor unions and pushing through reform legislation that adopted a hybrid pension system. The hybrid system provides employees with a small defined-benefit annuity—one that won’t require a taxpayer bailout—and a defined-contribution component that provides them the portability and inheritability of a 401(k) account. The reform is estimated to save Rhode Island taxpayers roughly $3 billion.
Back in 1997, Michigan, led by Republican Governor John Engler, ended defined-benefit plans for new state workers. Today, 49 percent of Michigan state workers are in defined-contribution plans. This reform is saving Michigan taxpayers billions of dollars.
Even left-of-center voters in California are taking bolder steps than policymakers in Oklahoma. In San Diego and San Jose, voters overwhelmingly passed pension reform ballot measures. In San Diego, future government workers will be placed in a 401(k)-type defined contribution plan. In San Jose, the new plans reduce the benefits of workers and require a higher employee contribution rate.
In addition, Louisiana has moved to reduce growth in taxpayer liability by limiting taxpayer guarantees to contributions made on behalf of employees. Pending judicial approval, the Louisiana reform sets up a “cash balance” plan for all new employees.
The reality is that the private sector has moved away from pensions, making them largely a creature of government, because guaranteed large annual payouts for pensioners’ lives make predicting actual liabilities highly speculative and costly. Government workers today earn more than ever, live longer than ever, and pay very little into the system compared to the pension benefits they get.
If Oklahoma’s political class truly wants to protect taxpayers, they will reform OPERS and the other government pension plans. Bold leaders from across the political spectrum are doing it all over America.
OCPA research fellow Matt Mayer (J.D., The Ohio State University) is a former senior official at the U.S. Department of Homeland Security. Mayer also serves as a Visiting Fellow with The Heritage Foundation, where he heads the federalism project. Mayer’s newest book is Taxpayers Don’t Stand a Chance: Why Battleground Ohio Loses No Matter Who Wins (and What to Do About It).