Local Officers Network Series

Pensions:

As the economy continues to deteriorate, states and localities continue to face daunting challenges in closing budget deficits as revenues continue to fall. In the fall of 2007 the state took significant measures to raise revenues to address a structural deficit that has existed for many years and was being exacerbated by the economic cycles that were to play out (slots referendum, revenue enhancements, budget cuts). The legislature took a beating by the public for these actions but doing nothing was not an option. Since that fall, the state has endured several more rounds of budget cuts as revenue projections worsen. This year the cuts would have been draconian, affecting all major programs including education, which has fared pretty well so far.

Enter the new administration in Washington, with a laser focus on the inherited financial crisis and crash of the housing market. The new federal stimulus dollars were the difference between education facing significant funding cuts and squeaking out a modest increase. Because of the federal monies to the states, especially targeted for education, Maryland prevented rollbacks to the education funding formulas that surely would have meant numerous layoffs around the state as well as cuts in programs. Also significant, this funding also made it possible for the state to continue to fund the annual contribution to the state pension system for teachers, which this year was $760 million.

However, this also brought to light another issue that legislators were grappling with regarding teachers’ pensions. The state began to question, in formal discussions this legislative session, the feasibility of continuing to pay the whole employers cost to the retirement/pension system for teachers when they have no control over or say in the negotiated salaries, which are the primary drivers of the annual cost the state makes to the pension system on behalf of the teachers. It was remarked on multiple occasions that Maryland is one of only three states in the country to pay the entire share of the employers’ contribution to the pension system. There is a growing consensus among legislators that more parity is needed to help the state deal not only with the continuing state budget challenges, but also to get a handle on the rapidly growing annual contribution to the pension system. Because the state’s annual contribution increases precipitously during economic downturns, this relationship becomes even more onerous on the state at a time when it can least afford it.

Historically, the economic strain that the State is under is similar to the very fiscal conditions that have lead to the demise of defined benefit retirement plans in the private sector, so we need to monitor and vigorously participate in the conversation. Defined benefit plans in the public sector have come under increasing attack in recent times as a number of new accounting regulations have been promulgated that place onerous burdens on these types of retirement plans. These new regulations include now requiring public sector plans to calculate, and effectively pre-fund, the cost of providing other retirement benefits such as health care, prescription drug and dental benefits for retirees instead of the customary pay-as-you-go method that has traditionally been used. Also, there are discussions underway that would impact the way current plans value (cost out) current liabilities. The effect of this proposed change would be to make plans look far more expensive and skew the funding ratios (make plans look less funded/solvent than they actually are). All of this is being done under the guise of making traditional defined benefit pension plans more fiscally sound. Its actual effect is to scare employers away from these so called “expensive plans” to more “cost effective” 401(k)-type plans also called defined contribution plans. While these plans are less expensive for employers to administer, they also provide far less security and benefits for retirees in retirement. An example in this economic climate is the number of retirees with only 401(k)s as their primary retirement income vehicle who are now facing dire consequences as they have seen their principle (cash value of the plan) dwindle as the market plunged. These retirees now face such options as re-entering the workplace for additional income, or significantly readjusting their lifestyles to stretch their annuities. In either case, they face the very real prospect of outliving their retirement savings/annuities.

As we work with the legislature to address these challenges, we want to steer clear of anything that resembles moving to defined contribution plans. To this end, we face the very real prospect of looking at some sort of cost sharing of the annual pension contribution between the state and local jurisdictions. The current dire economic condition has changed this notion from “…if this becomes necessary…” to “…when this becomes necessary…”. As stated earlier, trying to balance a budget with declining revenues nearly made this option a reality this session. The federal stimulus monies prevented that reality from occurring this year. The problem is that this new federal money is only for two years, which means that when this money runs out the challenge remains how to pay for this growing obligation. The legislature is nearly out of options for balancing the budget and getting a better handle on all mandated spending. We remain committed to working with them on crafting a solution that does as little damage as possible to education. The problem is that there remains very few “tricks” for dealing with a problem of this magnitude – pension cost reaching $1 billion dollars annually in the near future. Having recently raised significant revenues in 2007, there is no political will at the state level to raise additional taxes, while still having a constitutional requirement to balance the budget.