The Big Debt

A five-point guide for understanding — and possibly solving — Louisiana’s biggest pension problem: Unfunded Accrued Liability.

By JEREMY ALFORD

Many lawmakers scratch and claw and scramble to get re-elected. They know power begets power and they know incumbency is further fuel. But they obviously don’t know that one term is sometimes enough to leave a lasting legacy.

Just consider that this new term in state government will likely witness Louisiana’s total unfunded accrued liability surpass the $20 billion mark. Depending how lawmakers and the administration react, that figure may mushroom into their collective legacy.

A lot can happen in one term. Just ask Lether Frazar. Or don’t — he died roughly 52 years ago. He’s one of those political characters from Louisiana’s past with connections to cataclysmic events, but very little modern name recognition. An incidental character.

Nonetheless, Frazar had a claim to fame. It was serving as lieutenant governor under Earl K. Long. Most notably, Frazar helped Uncle Earl bust out of a mental facility in Mandeville, where his family had him committed like a sock-wearing rooster. That is, Frazar cosigned Long’s order to fire the hospital superintendent.

But that was several years after Frazar served a single term in the Louisiana Legislature. From 1936 to 1940, he carried the policy torch in the state House for Beauregard Parish. He also carried political water for Louisiana’s teachers, as evidenced by his very first year in the Lower Chamber.

That was when Frazar became the godfather of the teachers’ retirement system as we know it today. He championed the original law, ushered it through the Capitol and lobbied for gubernatorial approval.

Despite his role in what is certainly one of the state’s craziest political tales, it is Frazar’s milestone contribution to Louisiana’s pension system that has relevance in 2012.

The newly-seated Legislature will kick off its first year with a watershed education reform agenda. While aggressive plans to address the state’s unfunded accrued liability, or UAL, have yet to be floated, this would be an opportune time, even though the UAL’s tentacles touch and infect much more than education.

That’s why THE PELICAN INSTITUTE is offering up this five-point guide to understanding the UAL, from how it originated and what kind of impact it’s having to national trends and possible solutions.

To see historical membership data for the teachers’ system, click HERE. 

1.) WHAT IS THE UAL?

It’s best to start with the basics. The state runs four separate retirement systems: the Louisiana School Employees’ Retirement System, Louisiana State Employees’ Retirement System, Louisiana State Police Retirement System and Teachers’ Retirement System of Louisiana.

These systems function as you might expect. Members are offered defined benefit plans that pay out specific retirement benefits based on a number of factors, primarily salary and years of employment.

When you hear someone refer to unfunded accrued liability in terms of these retirement systems, or read an article by a journalist about the UAL, they’re referring to the gap between what the systems have on hand to pay future benefits versus what they’ve promised. To put it another way, just consider the UAL as the difference between what the systems have available to them and the amount that would be needed if everyone retired at one time.

When the Louisiana Legislative Auditor’s Office investigated the UAL last spring, the total price tag weighed in at $18.2 billion. By the time the current fiscal year commenced in early June, another $300 million was added to the tally, making for a UAL that’s actually closer to $18.5 billion.

To put that figure into perspective, every man, woman and child in Louisiana would need to pony up somewhere in the neighborhood of $4,090 to retire the state’s entire pension-related UAL.

The Teachers’ Retirement System of Louisiana leads the way, accounting for $10.8 billion of the UAL. The Louisiana State Employees’ Retirement System is on the hook for $6.4 billion. Meanwhile, the School Employees’ Retirement System is responsible for $905 million and the State Police Retirement System $339 million.

State Rep. Kevin Pearson, R-Slidell, the chairman of the House Retirement Committee, likens the UAL challenge to the proverbial elephant in the room. In this case, ignoring it means putting Louisiana’s future in jeopardy.

“Paying down the UAL to prevent collapse of public retirement systems will keep us and future generations from having to bail out the systems,” Pearson said.  “While we’ve made some headway there’s much more to do.”

So exactly how serious is this whole thing? According to a recent Northwestern University study, Louisiana — if it basically does nothing — will see its pension programs completely run out of money by 2017. Under such a scenario, the state would either have to come up with money, which equates to pulling dollars out of the general fund, or default.

But not everyone buys the dire predictions. Cindy Rougeou, executive director of the Louisiana State Employees’ Retirement System, called the study “misleading” and questioned its value, arguing all the while that steps are being taken to head off the unthinkable.

“(The study’s findings) create unwarranted alarm among the public,” Rougeou said. “This type of academic analysis is not a true reflection of public pension solvency or actuarial soundness.”

Regardless of interpretation, the study, in concert with hordes of other reports and investigations, still points to some sobering trends that can’t be ignored.

To see which state departments and agencies are shouldering the largest portion of the UAL, click HERE.

2.) HOW DID WE GET HERE?

To answer this question thoroughly, we need to divert back to our lieutenant governor of note, Lether Frazar. His original incarnation of the Teachers’ Retirement System of Louisiana 76 years ago included everything a massive pension plan might need. Everything, that is, except money.

The legislation that created the teachers’ system in 1936 was unfunded, meaning the system never really had the cash needed to support retirement payments. But who needs money? Payments were made nonetheless, creating an instant UAL.

Two years later, a state police pension was established. Ten years later, state and school employees got their own pensions, too. And, staying on theme, they were all unfunded from the get-go.

By 1987, an initial UAL of $5.8 billion was evident and breathing down state government’s throat. Lawmakers passed and voters approved a constitutional amendment forcing all of Louisiana’s pension systems to be actuarially sound. To accomplish this, a 40-year amortization schedule was put on the books the following year and is constitutionally slated to be paid off by June 30, 2029.

But even that comes with a footnote. C.B. Forgotston, who served for seven years at chief counsel of the House Appropriations Committee , said there was no amortization schedule in the constitutional amendment. “It merely required that the UAL be paid off by 2029,” Forgotston said. “If the UAL had been amortized there would be no problem.”

Today, the systems for teachers and state employees still have balances due for that initial UAL. Meanwhile, all four systems have had a hand in the new UAL that came about in the wake of the 1988 amortization schedule. Add all of this up and you’ll get to that total figure of $18.5 billion revealed earlier in this story.

By the time 2029 rolls around, Louisiana should be ready to make its final payment, between $1.3 billion and $1.9 billion, to close out the initial, pre-1988 UAL. But it won’t end there. In 2030, the new UAL will still be around and require payments of $600 million to $700 million. There’s also no end date in sight, or rather there are only rough estimates that are bound to change based on future policy decisions.

While an unfunded approach helped give birth to the initial UAL, the new UAL is a touch more complicated. Based on findings by the Louisiana Legislative Auditor’s Office, here are the reasons why the UAL continued to grow even after lawmakers thought they had a solution in the late 1980s.

— The Amortization Schedule: In 1992, the state modified the payment schedules to reduce payment amounts and to increase the debt even more. These changes modestly reduced contribution requirements through 2009, only to cause it to be significantly larger in later years.

— Political Promises: While participation provisions for state employees and teachers have not changed dramatically since 1988, benefit accrual rates were substantially increased in 1993 and 2001. These additional benefits that were essentially “promised” by lawmakers to pension members increased the overall debt of the systems.

— Prediction Errors: The Legislature and individual systems employ financial overseers and planners known as actuaries. When they craft valuations, certain demographic assumptions have to be chosen over the years to predict turnover, salaries, the number of retirees, disabilities, deaths and other factors. In theory, if the actuarial assumptions are “reasonable” over the long term, gains and losses should cancel each other out. But that hasn’t been the case. Since 1995, losses have exceeded gains and increased the UAL. Forgotston, among others, are very skeptical about this particular attribute. “There are no errors in predictions,” he said. “They are intentional misrepresentations of the return on investment.  Anybody that has a CD knows their predictions are ridiculous. It is like putting lipstick on a pig.”

— Investment Losses: In an effort to make their assets grow, Louisiana’s retirement systems invest their holdings. As such, there is a certain amount of risk. For the state employees’ and teachers’ systems, no investment gains have occurred since 2007. Only net investment losses have been recorded, which in turn adds to the overall UAL balance.

— Cost of Living Adjustments: All four state retirement systems have mechanisms that provide for COLAs. In recent years when there were investment gains, half of the gains were credited to an experience account to pay COLAs — some critics liken this account to a slush fund. As a result, the full amount of investment gains were not available to fully offset investment losses from 2001 to 2003 and from 2008 to 2011.

As for a wild card, let’s not forget all of the special retirement bills that are passed by lawmakers each session. While these policy proposals are sometimes intended to apply to only one person, they very often open up huge loopholes. For an example, check out this special report from THE PELICAN POST regarding the state’s teacher retire-rehire laws.

For relevant blurbs from two recent news articles about the pitfalls of investment losses, click HERE.

 3.) HOW DOES THIS IMPACT ME?

This depends on who you are. But in all likelihood, there’s a sizable economic impact, and threat, especially if you’re a Louisiana taxpayer. That’s because employers are being asked with greater frequency to kick more money into retirement plans, a burden that is ultimately shouldered by taxpayers.

During the upcoming fiscal year, the employer contribution rates for the state police will be 68.1 percent. That’s an increase from 55.9 percent over the current fiscal year. Moreover, more than half of the new rate, or 41.4 percent, will be directed toward the system’s UAL. Schools will see their UAL contributions increase by an entire percentage point, while other state institutions are slated for an increase of 2.5 percentage points.

During the current fiscal year, more than $1.4 billion in taxpayer money will go toward paying down the UAL. To put this in perspective, the total state budget this fiscal year is $25 billion.

According to research conducted by Blueprint Louisiana, a good government group backed by businessmen and civic activists, the UAL is likewise affecting local school districts in a very significant way.

In 2010, a year that delivered absolutely no increases in state funding for education, Blueprint’s boosters contend that “school systems were required to spend $16 million less on classroom instruction to meet their retirement contribution obligations which now comprise one-quarter of school district spending on payroll.”

Additionally, superintendents cited layoffs and larger class sizes as examples of the immediate impact of increasing retirement costs, Blueprint found.

This theme isn’t confined to schools. The UAL is literally eating up tax dollars that could be spent elsewhere. More money for retirement can mean fewer police on the streets, for example.

Just consider the following conclusion offered up by Legislative Auditor Daryl G. Purpera: “On an annual basis for years to come, retirement costs will require a larger percentage of a shrinking state budget. Taxpayers can expect more dollars to fund the retirement of public employees, leaving less for higher education, health care and other state priorities.”

To take a gander at Blueprint’s overall agenda for pension reform, click HERE.

4.) WHAT IS BEING DONE ABOUT LOUISIANA’S UAL?

The systems for teachers and state employees have certainly received more attention in recent years. Then again, they account for the lion’s share of Louisiana’s UAL.

Last year, voters statewide approved a constitutional amendment that will eventually dedicate at least 10 percent of all non-recurring revenues during a fiscal year to the two systems in an effort to help them maintain healthier budgets.

Non-recurring revenues are basically unexpected monies that the state receives and doesn’t anticipate it will get again. Lawmakers also refer to non-recurring revenues as one-time monies or sometimes a surplus.

Mandating the use of non-recurring revenues to a certain purpose is not unprecedented, according to Barry Erwin, president of the Council for a Better Louisiana. For example, the state already uses such dollars to support the so-called “rainy day” fund and existing law already allows non-recurring revenues to be directed toward the UAL is lawmakers so wish.

“The liabilities in those systems are so huge and the increasing obligation of the state to reduce that debt is so significant that directing a minimum of 5 percent to 10 percent of non-recurring revenues to that purpose seems a reasonable and modest approach to addressing that problem,” Erwin said.

Former state Sen. Butch Gautreaux, D-Morgan City, one-time chairman of the Senate Retirement Committee and co-author of the amendment, said the money will trickle over to the systems rather slowly. Beginning July 1, 2015, 5 percent of all surpluses would be channeled into the UAL. In 2016, the threshold would be increased to 10 percent.

But it won’t be enough to make a sizable dent, compared to the overall UAL. That’s why Gautreaux, among others, believe that a strong political will, as opposed to a one-time constitutional amendment, is needed for the coming years. If lawmakers don’t start taking bolder steps, he added, the problem will only get worse.

“In my personal opinion, it’s never going to change,” Gautreaux said. “We’ll always have an unfunded accrued liability.”

Jeffrey D. Sadow, an associate professor of political science at Louisiana State University Shreveport, has come to a similar conclusion. In a recent blog post, he argued that lawmakers have already missed too many opportunities to act.

According to Sadow, state officials claimed the landmark constitutional amendment from the late 1980s that forced payoff of the UAL by 2029 meant there was no danger and that the rate of return was more than adequate to allay any concerns.

“But what they didn’t admit was the payoff scenario, as legislators have punted on opportunities to sequester money in good times to reduce the UAL, has become increasingly unsustainable,” Sadow said. “In 2008, only about two-thirds of the actual required payout was coming into the system, at that time leaving a $4.4 billion gap.”

For a better understanding of the leadership structures that guide Louisiana’s pension systems, click HERE.

5.) CAN LOUISIANA LEARN ANYTHING FROM OTHER STATES?

Based on datum prepared and analyzed by the Pew Center on the States, Louisiana has the ninth worst retirement liability in the nation in terms of unfunded portions. It ranks behind Connecticut, Hawaii, West Virginia, New Jersey, Kentucky, New Hampshire and Massachusetts.

So there’s certainly room for improvement.

Josh B. McGee, Ph.D, vice president of public accountability for the Arnold Foundation, a nonprofit think-tank based in Houston, said there are solutions that have worked in other states. In part, that’s because some are realizing that “failing to address the public pension crisis promptly would be economically catastrophic, triggering bankruptcies of cities, school systems and potentially even entire state governments.”

The states’ own estimates of the unfunded liability due to their pension benefit promises grew to $1.26 trillion in fiscal year 2009, up from $1 trillion just one year earlier, McGee said. However, using standard private sector accounting rules, the shortfall estimate increases to approximately $3 trillion, a sum that represents roughly one-fifth of the United States’ gross domestic product.

“In other words, the assets that states have set aside to pay for employee retirement benefits fall short of what they owe for those benefits by approximately $3 trillion,” he added.

Here are five potential solutions for Louisiana, as drafted by the Arnold Foundation.

— Defined Contribution: In a defined contribution plan, or DC plan, the employer  promises each employee a fixed percentage of salary. These contributions are placed in an account that is managed by the employee. The employee has the flexibility to choose her investment allocation and to make individual choices about the timing and structure of her retirement. The market risk of these choices is borne solely by the employee. Michigan has had a DC in place for state employees since the 1990s, and higher education and many private sector firms have used the DC structure successfully for decades.

— Cash Balance: Cash balance plans have features that are commonly associated with both defined benefit, or DB, and DC plans. A cash balance plan is a DB plan, but unlike the traditional DB plan, benefits are defined as a lump sum or “cash balance” in an employee’s account. Under a cash balance plan, much like in a DC plan, the employer promises a fixed percentage of salary and contributes that amount to an account for the employee. However, unlike a DC plan, the employee does not manage her account. Instead, the retirement system manages the funds for the employee and promises an average investment return. When an employee reaches retirement age, the employer may offer the employee an annuity based on the size of her retirement account and/or the ability to take all or a portion of the account as a lump sum. Nebraska and many private sector firms use the cash balance structure.

— Side-by-Side Hybrid: In a side-by-side hybrid, the sponsor maintains both a DB and DC plan and allows employees to choose between the plans. When implemented correctly, the sponsor institutes strict accounting controls to keep the problems created by the DB structure in check. Utah and Florida operate DB and DC systems side-by-side, allowing employees to choose between the two structures.

— Stacked Hybrid: In a stacked hybrid system, employees are offered a small DB, meant to provide a minimum amount of retirement security, with a DC stacked on top. The federal employee retirement system and the recently adopted reforms in Rhode Island use a stacked hybrid approach.

— Cap on Employer Contributions with Explicit Cost Sharing: This approach is agnostic about the specific plan structure and seeks only to eliminate cost uncertainty and provide a political incentive to keep future cost increases controlled. A proposed ballot initiative in California takes this approach. The proposed initiative caps employer cost at a specific percentage of earnings and specifies that the cost of all benefits will be divided equally between employee and employer.

If not one of these options, then what? Because of mounting UAL-related shortfalls, McGee said states, municipalities and school districts will soon be forced to take drastic measures to pay for their pension obligations.

For those who don’t think Louisiana’s UAL is impacting them, that means they soon will.

“(Governments) will pass the burden on to the public either in the form of increased taxes or, more realistically, cuts to services that are critical to society, such as education,” he warned. “Without significant changes to the current systems, public pension payments will quickly begin to crowd out other discretionary spending.”

To learn about other possible solutions and to see the latest in UAL news, visit the State Budget Solutions Project HERE.

Jeremy Alford is a freelance journalist based in Baton Rouge. You can reach him through his Web site at www.jeremyalford.com and follow his work at www.thepoliticaldesk.com.