The Vermont Pension Crisis
In January, Vermont State Treasurer Beth Pearce issued a sobering report on the dire financial health of the pension plans for State employees and public school teachers. She indicated that the existing plans are not sustainable when considering the contributions being made, the earnings of the funds, and the benefits being paid out. The current funds are short $5.7 billion when estimating what is needed to meet the obligations to beneficiaries when they retire.
The Pension Problem, Explained.
Vermont has three “Defined Benefit” (DB) retirement systems, one each for State Employees, Public School Teachers and Municipal Employees. A DB plan, or “pension”, provides employees with steady monthly income from the time they retire for the rest of their lives. The benefits are paid from a pension fund that is built up over time from contributions by both employees and the employer and the compounded growth of the investments in the pension fund. Managing a DB plan is complex, using assumptions about investment performance, expected retirement patterns, benefit adjustments, contributions by both the employer and the employee, and the life expectancy of the plan members. If done well, DBs provide employees with financial security and peace of mind, and employers have a dedicated and loyal workforce for taking care of them.
A “Defined Contribution” (DC) retirement plan such as a 401k or SEP IRA is different in that the employer does not have the same obligation to cover the retirement benefits if the funds run out. (Gross simplification). One problem with DCs is that the vast majority of Americans can’t or won’t put money away for retirement and find themselves without adequate income in their retirement. In the “Gig economy” in which employees move frequently from one company to the next, DCs are increasingly popular.
So how did Vermont end up with a $5.7 billion unfunded liability?
1. Investment performance did not meet expectations. The actuarials assumed a high rate of return that the funds consistently failed to meet, in part because of poor investment decisions, but also because of some rosy projections. It is further compounded by the need to maintain an asset allocation in the portfolio where investments can be easily and quickly liquidated to meet benefit obligations, further depressing the possible returns.
2. From 1990-2007, the Governor and the legislature did not contribute the full amount of the annual Actuarially Determined Employer Contribution (ADEC) because of pressures to balance the annual budget. The result was $159 million less than what was recommended, missing the compounded growth the pension fund relies on to make future payouts.
3. The pension fund had a significant loss of value in the Great Recession in 2007-2008.
4. Teacher turnover and retirements as a consequence of benefit changes and workplace changes (Act 46).
5. Other Post Employment Benefits (OPEB), primarily health insurance premiums paid for qualified retirees, had been paid out of the pension instead of a separate funding source. Not only did this reduce the pension and increase that liability, the fact that OPEB is not pre-funded in any way creates a liability all its own which is part of the $5.7 billion.
6. The demographics are upside down, with many employees living in retirement longer than they worked, and soon there will be more beneficiaries than contributing employees.
What’s the plan?
The Vermont House leadership is committed to finding a solution to this problem as it gets bigger every year. The FY22 State Budget has $311 million in the employer’s contribution alone. The state put a plan in place to retire the unfunded liability in 2008 by 2038, making additional contributions to the liability every year. That catch-up deposit in FY2021 was $189 million alone. But for every step we take forward it seems like we take two back.
In March of this year the House Government Operations committee introduced a preliminary set of ideas on how to adjust benefits and contributions to pay off the liability. While it was meant to be a starting point for discussions, it was quickly clear that the stakeholders needed to be involved in the discussions if it was going to gain support in the legislature and with the Governor.
The plan right now is to focus on the governance of the pension systems – to ensure that the right assumptions are used and the right investments are made – by increasing the financial and investment expertise of the committee – currently the Vermont Pension Investment Committee. There should be legislation on that measure by the end of this legislative session in June.
The second initiative is to involve all of the stakeholders in a task force over the summer and fall to determine a path forward and make specific recommendations for the 2022 legislative session on some or all of these topics:
- Is a DB plan still the best plan for both employees and the employer?
- What is the retirement age/years of service requirement and the vesting schedule?
- How will benefits be calculated and what will be the annual cost of living adjustment (COLA)?
- What is the right contribution amount for employees, currently about 5-7%?
This is a personal issue for many. One teacher I know is close to retirement based on his age and his 30 years of service. The plan that was rolled out in March would have delayed his retirement for 12 years. There are many people in the same position. At the same time, the Employer who needs to make the annual ADEC payment (Actuarially Determined Employer Contribution) and chip away at the huge unfunded liability is the Vermont taxpayer, writ large, many of whom do not have any retirement savings.
The legislature is in the throes of a good faith effort to solve the pension crisis.I look forward to the discussions this summer and fall to craft a solution that works for all of Vermont.