February 25, 2015

Major change in pension funding proposed, eliminating extra payments

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Lawyers mall in snow

By Len Lazarick


The legislature’s staff is recommending that lawmakers make another major change in pension funding, eliminating extra payments into Maryland’s underfunded pension system and returning to full actuarial funding.

The proposal would save $70 million in next year’s budget and $2 billion over the next 10 years. But it would ultimately cost taxpayers $2.5 billion more than current plans for pension contributions in the following 13 years, and further delay full funding for promised pension benefits in the following decades.

The move is an apparent attempt to come up with substantial savings in the state budget in the next few years to make up for cuts and slower growth in spending proposed by Gov. Larry Hogan. Democratic leaders are searching for ways to restore school aid and pay raises for state workers.

The Hogan administration and the State Retirement Agency only learned of the proposal on Monday, and took no official position on it after it was presented to the Senate Budget & Taxation Committee Tuesday.

Concern about bond ratings

But Budget Secretary David Brinkley pointed out that underfunding in the state’s $45 billion pension fund “was the one element that was considered a weak link in our [bond] ratings. We recognize this is a vulnerability.”

Brinkley was reinforcing comments made by Republican Sen. Andrew Serafini, a financial advisor who is one of the General Assembly’s pension hawks. Serafini quoted the reports issued just last week by the three bond rating agencies.

They continued to give Maryland government their best triple-A ratings while also expressing concern that the state has $19 billion in unfunded pension liabilities.

Michael Rubenstein, the pension expert in the Department of Legislative Services, presented the proposal as a positive move that should please the rating agencies. They have repeatedly criticized Maryland’s failure to fully pay its actuarially required contributions.

The legislature passed major changes to state and teacher pensions in 2011. Public school teachers and state employees now pay 7% of their salaries toward pensions, and will get lower benefits.

The legislature voted in 2013 to phase out the “corridor” method of pension funding that had reduced payments over the previous decades.

Among the many assumptions that go into formulating how much the state needs to contribute toward pensions is how long employees will live and collect pensions, and what kind of returns the state gets on the stocks, bonds and other assets the pension fund owns.

The State Retirement and Pension System Board has set an annual rate of return at 7.55% over the long haul. Serafini and some market analysts believe stocks and bonds will achieve returns a half point to two points lower than that.

Fitch Ratings figures that state’s future pension liabilities based on a 7% return on investment.

Rubenstein said high investment returns in the last two years –10.5% and 14.3%–, the 2011 pension reforms and the 2013 change in the corridor method make it possible to fully repeal the extra payments the state promised to make when it made teachers and employees pay more into the system.

“There’s no reason for the supplemental funding,” Rubenstein said.

Serafini asked, “Wouldn’t it be more prudent taking a more conservative approach?”

  • MD observer

    I’m skeptical these democrats are sincere about any durable fixes to pension underfunding. They see the big bucks associated with pensions and simply want to change the timing around. Not as bad as check kiting, but close.

  • mdtruth

    I think that if the legislature passes this, it would virtually cement the need to restructure pensions and scale back future benefits, again, as they are doing in other states. Repealing the extra pension payments because we have had a few good years is the equivalent of betting that red will continue to come up on the wheel. One bad year (recession) where the market tanks 20% can wipe out 3 good years. $1 we contribute now is $1.25 we do not have to put in 3 years from now. And, Maryland state revenues also tank with the economy and the stock market, so we have to put more in at exactly the time the budget is tight and pension funding looks bad.

    I strongly doubt the rating agencies will care how we bring the pensions up to fully funded status – whether it’s through contributions or higher taxes, outsize market appreciation, or ratcheting back benefits/liabilities. Credit is Character, Capital and Capacity. We have the capacity to pay, and have the capacity to restructure the obligations if needed (I do not think we are constitutionally limited like Illinois or Michigan). They are not looking at the “how,” it will boil down to whether the legislature has the political will do to whatever needs to be done (character) at the time it needs to be done.

    Anyway, if the agencies have repeatedly criticized Maryland for not making the actuarially required payments, how is ratcheting back payments expected to please them?

    If the pension asset return going forward really is a more realistic 5.5%, and the voters really are tired of more taxes, and we ratchet back contributions, then we are well past the point of no return isofar as pension restructuring.

    The good news, if there is any, is that we are still probably a few years away from the inevitable. We can roll the dice, ride the market a bit, and see what kind of pension reform deals they get in other states. We can see how the litigation plays out. Maryland can even survive a downgrade or three.