Dangerous Trends Require Action: David Coates Helps Define our Current Pension Challenge

Dangerous Trends Require Action
By David Coates, KPMG Managing Partner (retired) and
Member, Vermont Business Roundtable

Rising mandatory expenditures in the state of Vermont translates into less discretionary dollars to support important programs for needy Vermonters. Two such expenditures are retirement plans and other post-retirement benefits for state workers and teachers, whose costs are rising at unsustainable levels. It is time to begin talking about changing from the path we’re on.

There are essentially two types of pension plans….a defined contribution, similar to a 401 (K) plan, and a defined benefit plan which guarantees a certain lifetime benefit upon retirement. As of June 30th the state employees defined pension plan covered most of the state’s 8442 workers. Effective July 1st, workers contribute 5.1% of their pay, and the state is responsible for funding the balance of lifetime benefits paid to retirees. In 2008 the state paid approximately $23 million (projected at $40 million in 2015) from the general fund into the retirement fund. The state workers can retire after 30 years of service or age 62, and receive a lifetime benefit of 50%. For workers employed after June 30, 2008 the retirement age is 65 and they receive a lifetime benefit of 60%.

Although the wages for the teachers are determined locally, the state is required to pay their pension costs. As of June 30th there were 10,685 teachers in the plan. Teachers contribute 3.5% of their pay annually and the state is responsible for funding the balance of lifetime benefits. In 2008 the state paid approximately $40 million (projected at $52 million in 2015). Teachers can retire after 30 years of service or age 62 and receive a lifetime benefit of 50%.

As a result of the recent decline in the investment markets and the significant under-funding of the teachers plan, the state has unfunded pension liabilities of over $466 million as of June 30. This is roughly a three-fold increase in just five years. With obvious market declines since June, these liabilities are certain to be much higher; requiring the state to pay even more to assure the financial integrity of the plans.

The situation with other post-retirement benefits (i.e. medical insurance) is more alarming. Retired state workers pay 20% of the cost of the premiums, which covers the retiree and all dependents. Teachers pay 20% as well, but this covers only the retiree.

In 2008 Vermont paid in about $17 million for state workers, but nothing for the teachers. This left a liability, for 2008, of $29 million for state workers and $60 million for teachers. The state actuary has calculated the unfunded liability for both plans at June 30 to be $1.6 billion. This is projected to increase to over $4 billion in thirty years, if we continue to fund these plans as we have in the past.

Clearly, Vermont is currently on a path that is not financially sustainable. The private sector and most not-for-profit institutions have done away with those benefit plans because they are expensive to maintain and the liability will forever remain with the employer, in this case, the state.

So, what are the alternatives to avoid state bankruptcy? There are several: Fully fund the pension and benefits; reduce the work force; cut the benefits to more closely align with the private and not-for-profit sectors; freeze or eliminate some or all of the plans; or, require the local governments to fund the costs for teachers.

Not addressing the issues now will only require future generations of Vermonters (our children) to pay for the promises we have made but failed to fund. We need the leadership of the legislature, the administration and the unions to come together and identify a common solution to these vexing issues now. The current economic climate is precisely the motivation for changing current practice toward a more sustainable system.