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Pension tensions 

The sweet retirement deal public employees enjoy just may spoil a few things for the rest of us

Glenn Gustafson, the chief financial officer for Colorado Springs School District 11, won't talk over the phone about employee pension funding. Instead, he'll invite you to his office, where he'll greet you with a sigh and several spreadsheets, charts and graphs.

Gustafson wants desperately to impress upon you — in black and white, and the red, blue and green of his visual aids — why the Public Employees' Retirement Association is eating the district alive. Since 2006, what the district is mandated to put into PERA has increased by half, and more hikes are on the way.

"It's not because we're growing or getting pay raises," Gustafson says. "It's not because we're growing in enrollment."

Instead, it's because PERA is kind of a mess.

The 80-year-old state pension fund covers 412 government agencies, and 470,000 employees and retirees. In 2009, by its own estimate, it faced a projected 30-year deficit of $23.4 billion — three times the size of Colorado's annual budget.

With this in mind, legislators in 2010 passed Senate Bill 1, which reduced employees' annual cost-of-living raises, and jacked up what employers have to contribute. Problem solved, according to the association.

Now, put aside for a moment that (1) some experts say PERA actually still faces insolvency, and (2) Senate Bill 1 is currently the target of a class-action lawsuit. Instead, just consider that because of last year's bill, agency administrators like Gustafson insist that the new burden on employers, already hefty, is now borderline unmanageable.

What does this mean for you? Well, in coming years, either you'll probably have to pony up more money in taxes, or you'll watch funding drained from classrooms, road and bridge repairs, prisons, social services and just about every other service provided by state and local government agencies.

School District 11 paid $21 million to PERA, above and beyond its salary payments, in 2010. The city of Colorado Springs saw its PERA bill hit $9.3 million, while Colorado Springs Utilities' tab reached $17.9 million. And Memorial Health System's climbed by 63 percent in the last four years, to $27.5 million, despite its payroll declining by nearly 300 workers during that time. (El Paso County government has its own pension fund, which is in better shape.)

Nobody knows how much utility or health care rates have increased due specifically to PERA's demands, or when an entity will become so strapped because of them that it will ask locals for a tax increase. But that time may not be far away. Consider Falcon School District 49's plan to eliminate free bus service in 2011, which caused such huge waves last week. When asked by the Indy about it last Friday, Falcon spokeswoman Stephanie Meredith said pressure to fund PERA is "part of the equation."

Changes to the plan can require a vote of PERA members — and, naturally, few are likely to cut their own benefits. So experts say the solution almost has to be legislative: perhaps a vote to replace the costly program with a defined contribution plan, like a 401(k). Those plans don't run up unfunded liabilities, because they don't promise a certain benefit; rather, their value fluctuates depending on the market or tool in which they're invested.

State legislators have authority over PERA, as long as the changes don't violate guarantees assured by the state Constitution. They have authority to abolish the program for future employees, although they probably couldn't pull the rug out from under members who have paid into the system for years. They also could increase the amount employees pay into the program, a move Colorado Springs Mayor Lionel Rivera is lobbying for.

So while Democrats say PERA won't be a big issue this legislative session, Republicans say it should be.

"It's a huge unfunded liability," says Sen. Keith King, R-Colorado Springs, who supports an overhaul. "I see it as a major dilemma facing Colorado for a number of years."

House of cards

During the last several years, Barry Poulson, an economics professor at the University of Colorado at Boulder, has teamed with University of Kansas economics professor Arthur Hall to study the condition of public pension funds nationwide. Their report, titled "State Pension Funds Fall Off a Cliff," says the volatile stock market, combined with overly optimistic assumptions for investment returns, have put many pension funds on a path to insolvency.

Colorado's, Poulson says today, is among the shakiest in the nation.

"I think 20 state pension funds will run out of money in the next decade, and that certainly includes Colorado," Poulson says. "We're one of the worst. We're accumulating unfunded liabilities faster than almost every other state."

PERA was established in 1931, when a pension was the biggest drawing card for government workers whose low pay was a given. From the '70s until the middle of the last decade, its parameters changed frequently to the benefit of the employee, with a lower retirement age and benefit computations based on an employee's highest three years of salary instead of five.

How bad has it gotten? PERA, with assets of $32.9 billion as of Dec. 31, 2009, was only 58.4 percent funded based on market value of assets, the most reliable measure, according to Poulson. That means for every dollar it owed current and future retirees, it had 58 cents in hand to pay.

A PERA spokeswoman denied an interview but provided a prepared statement by director Meredith Williams, who said last year's Senate Bill 1, which cuts annual cost-of-living increases from 3.5 to 2 percent, has put PERA on a path to solvency. That's why his board supported the measure, which Williams says will help bring the association to full funding in 30 years.

But according to Poulson and Hall, Senate Bill 1 doesn't touch the root of the problem: The fund's viability is based on an 8 percent annual return on investment, which is an in-your-dreams expectation. Hall says when pension funds don't achieve their targeted return, "That's when these unfunded liabilities go through the roof."

In 2008 alone, PERA saw the value of its investments sink by 26 percent, due largely to the plunging stock market. It averaged just 3.3 percent a year over the past decade.

"Even if they earned the 8 percent return," Poulson says, "many of these pension funds are in such bad shape, they will not be able to meet their obligations, and a number of them will run out of money in the next decade or so. Colorado would be in that category."

Also, between 2005 and 2009, the number of workers paying into the system declined compared to those who are retired and collecting benefits. PERA paid $2.8 billion in benefits in 2009, 40 percent more than the $1.7 billion it took in from employee and employer contributions, according to its 2009 annual report, the most recent available.

With all this, Poulson and Hall say lawmakers should be wringing their hands. "The day of reckoning will come when you have to come up with cash to keep people in the system solvent," Hall says, "because it's viewed by the courts as a contractual obligation. That's what makes it such a sticky situation."

We are not alone

When Prichard, Ala., a town of 27,000, ran out of money in 2009, it simply stopped making pension payments to its retirees, according to a story last month in the New York Times. After payments stopped, a 66-year-old retired firefighter went back to work as a mall security guard so he wouldn't lose his house; a retired fire marshal apparently lived without electricity or running water before dying in his home.

The town tried filing for bankruptcy, but the judge tossed it out. An appeal is pending.

That type of scenario is apt to play out more and more, considering one study found a $1 trillion shortfall between the amount owed to retired public employees and the amount available to pay them.

The Pew Center on the States, a division of the Pew Charitable Trusts, issued a report in February 2010 saying the $1 trillion gap was probably understated, because the study used data through June 2008 — before pension funds were devastated by the stock market's tumble that autumn.

The study found that only 10 states were funded at levels above 91.5 percent. Twenty fell below the 69 percent funding level, including Colorado, which was labeled as having "serious concerns," the lowest ranking, and being a "laggard" in funding its plan.

The report blasts Colorado for its sharp drop from 105 percent funding in 2000, and blames three factors:

• Increased benefits, including automatic cost-of-living raises and a drop in retirement age. (In recent years, some changes have finally decreased benefits, among them a switch from "the rule of 80" to "the rule of 85," in which years of service and age are added up to determine retirement eligibility.)

• Missed contributions. The state paid only 50 percent to 70 percent of what was required to keep the fund solvent during the last decade.

• And investment losses.

Among states lauded by the Pew study was Iowa, which has imposed caps on benefits and made employee benefits adjustable. Its constitution doesn't guarantee benefits, like Colorado's does.

Like Poulson and Hall, the Pew study questions the 8 percent investment return, the most common for all public pension funds analyzed. It also calls for upping the amount of money taken out of employees' paychecks; currently, they contribute 8 percent, except for troopers, who contribute 10 percent. With the exception of a temporary 2.5 percent increase for state and judicial workers in the fiscal year ending June 30, 2011, employees face no increases.

Meanwhile, Senate Bill 1 requires some employers to pay nearly three times the employee contribution by 2018. PERA splits its members into four divisions — local government, schools, state and judicial — and each division must be financially sound on its own. That means contribution rates are different for each division, and they'll rise by different amounts in coming years.

The local government and judicial divisions will actually remain flat, at 13.70 percent and 17.36 percent of employees' salaries, respectively. But the state and schools divisions will see rates go up from 13.85 percent as of this month to 20.15 percent in January 2018. And the state trooper subdivision (part of the state division) will increase from 16.55 percent today to 22.85 percent in January 2017.

A case study

So by 2018, District 11 will pay an amount equal to 20.15 percent of employees' salaries, or $8 million a year more than it's paying now. This, even after a four-year span, between 2006 and 2010, when its payments went from $13.7 million to $21 million — even though the number of district employees remained virtually unchanged.

Money for PERA's growing demands has to come from somewhere, and because the district spends 85 percent of its general fund budget on compensation — as opposed to, say, the 56 percent the city spends — cuts basically have to come in salaries and jobs.

D-11 already has closed schools, cut back on instructional materials, eliminated out-of-state travel and trimmed administration in response to financial woes brought on by the recession. New targets might include reducing bus service, increasing classroom size by laying off teachers, and outsourcing services such as custodial, food service, bus driving and secretarial. Gustafson says the board doesn't want to outsource jobs, but he's prepared a list for board members to consider.

"When it comes down to teachers or custodians, who are we going to pick?" Gustafson says. "PERA is going to force us down this road that's not the road we want to go down, because we don't think it's the best road for the district.

"To improve student achievement, it's more important than ever to attract qualified and talented teachers," he adds. "But we're shifting a disproportionate amount of compensation to retirement benefits and health care. We will be challenged to give any pay increases."

How can D-11 compete, he asks, when districts in Nebraska and Wyoming pay 21 percent and 11 percent more, respectively, than D-11 does? Richardson, Texas, a Dallas suburb, pays 48 percent more for teachers just starting their careers.

D-11 board member Charlie Bobbitt isn't sure how soon deep cuts will happen, but he fears whatever additional money the district gets from the state will "end up going to PERA, rather than being able to pay higher salaries so we can attract better folks."

He notes PERA actually can discourage people from teaching, if it's a second or third career, because those covered by PERA must sacrifice at least some of their benefits from Social Security that they've already earned from working other jobs.

Part of the problem, Bobbitt says, relates to PERA's structure, which encourages people to retire too soon. He points to Tom Kelly, who'll step down as Palmer High School principal this year at 58 years old, with 37 years in education.

"He's at the top of his game," Bobbitt says. "Now I have to find someone else. This is repeated with teachers and administrators and other folks. We're going to lose them because we allow them to retire so young with all this institutional knowledge."

Today, members earn 2.5 percent of their salary per year of service, meaning they've earned 25 percent after 10 years, 50 percent after 20, 75 percent after 30 and 100 percent after 40 years. Gustafson feels the benefit should be revamped so that it caps at 60 percent after 40 years of service. A member of PERA himself, Gustafson says he gets hate mail from employees for his views.

And although the D-11 board has committed to lobbying its legislative delegation for reform, Gustafson isn't hopeful. PERA is powerful politically, and even legislators themselves are vested in the plan.

"The whole system," Gustafson says, "is biased towards members."

Part of the contract

Those members can be powerful. Three days after Gov. Bill Ritter signed Senate Bill 1, a group of PERA retirees filed suit, alleging, among other things, that their cost-of-living increase is a benefit the state can't legislate away.

"The state has limited ability to rescind its contractual obligations," says Stephen Pincus, a Pittsburgh, Pa., attorney who specializes in pension law and represents the roughly 100,000 retirees in PERA. "But there is some leeway that gives the state some opportunity to amend the plan to save taxpayer money, if it's reasonable and necessary for an important public purpose. But what does that mean?

"What courts have really found is, they say it has to be some severe financial emergency, distress, on the brink of bankruptcy for the state not to honor the contract. What courts say is you have to have tried everything you can, including raise taxes, before you go back to people you have a contract with to violate that contract."

Pincus also points to a 1959 Colorado Supreme Court ruling that said changes in the plan are OK for workers who haven't yet retired or aren't eligible to retire. "But for those already out the door," Pincus says, "the deal is sealed."

Seeking to have the bill overturned, the lawsuit states a retiree receiving $33,264 a year in benefits would lose $165,000 over 20 years due to the cost-of-living reduction.

"For most retirees in Colorado, the average pension is pretty modest," Pincus says. "They took these jobs at a time when they had the opportunity to go out and, for many people, could have gotten higher salaries in the private market. They went to work for the government, because they knew they would be able to retire with a guaranteed pension. They knew this was a substitute for Social Security."

The maximum Social Security benefit provided upon retirement was $2,346 monthly ($28,152 annually) last year for someone retiring at 66. Some PERA retirees can pocket well over $100,000 a year, depending on age at retirement, years served and their last salary figure. But PERA's 2009 annual report shows the average monthly benefit is $2,885 ($34,620 annually).

Anita Smith receives roughly $40,000 in retirement pay a year, about 80 percent of her full-time pay. She worked six years at Memorial Hospital and 25 years at the city doing clerical work, before retiring last September.

"That's why I stayed with the city, because PERA was a great benefit," she says. "When you work for the government, you don't have profit-sharing or bonuses, but that is the one perk you get at the end."

Smith still rarely eats out or spends money on vacations and entertainment. She actually works part-time. But if she didn't have PERA, she'd be working full-time for another 10 to 20 years, she figures. Or, she might have just switched jobs long ago.

"Turnover at the city was always pretty low, because PERA was such a great benefit," Smith says. If PERA is dramatically altered to erode that benefit, she says, "that would make the employees rethink how long they wanted to stay with the city."

'A different era'

Smith's point might worry Colorado Springs Mayor Lionel Rivera — if he wasn't so concerned with the way PERA's been sucking money from taxpayers, utilities ratepayers, and patients at Memorial Health System.

He figures that if the city shared PERA contributions with employees equally, instead of paying 13.7 percent while employees pay 8 percent, the city and its enterprises would save more than $11 million annually — $1.8 million for the general fund, $3.75 million for Utilities and $5.7 million for Memorial.

"That's money that could go back into services," Rivera says. "You have to cut back [on services to pay for pensions] because, pensions, according to the [City] Charter, have a higher mandate to be funded than anything else. It was written back in the 1920s, and it was a different era back then."

Although Rivera's 50-50 idea means less take-home pay for workers, "when you're going to provide lifetime benefits with [cost-of-living adjustments], why shouldn't the employee share that cost?" Rivera asks. "It's better than Social Security. It's a retirement system that very few in the private sector have."

Rivera and City Council have asked state Sen. Kent Lambert, R-Colorado Springs, to propose a 50-50 bill this year to give local governments authority to alter the contribution ratio (without altering PERA's bottom line). Lambert's proposed bill, introduced last week, calls for a slightly different split, with employees paying 10.5 percent and local governments, 11.2 percent.

The mayor also has another, more controversial, idea: Allow cities the option of pulling out of PERA's defined benefit plan for employees hired after Jan. 1, 2012. Those workers would be covered by a defined contribution plan, much like 401(k)s favored by private companies.

Rivera says the city would split the contribution 50-50 with employees, with the city dividing its share between Social Security (6.2 percent) and a defined contribution plan (4.65 percent). It's not likely, he says, that the city will try for legislative approval this year, but it might next year.

Exit plan

Getting out of PERA can be nearly impossible. A local government hasn't disaffiliated since the early 1990s, says PERA spokeswoman Katie Kaufmanis.

It's no wonder why. First, two of three employees at an agency must vote to cut their own benefits. The governing body, such as City Council, also has to approve.

Next, PERA officials compute the cost associated with disaffiliation. This includes the amount necessary to fully fund the benefits of existing recipients, vested members and inactive members (those no longer working for the city but who have benefits accrued). The local government then has to pay that lump sum.

If voters approve converting Memorial Health System into a nonprofit in April, as its leaders wish, the system will no longer qualify to be part of PERA. So it'll have to make a huge payment as it exits; the only question is how huge. Memorial is waiting for an estimate from a consultant, but Rivera says it could be in the $20 million range.

While legislators have authority over PERA, most ideas for change don't mess with existing regulations, but rather focus on the fund going forward. For instance, both King and Rep. Bob Gardner, R-Colorado Springs, argue the best long-term answer would be to convert all new hires after a future date to a defined contribution plan.

King proposed that measure last year, but neither it nor a bill similar to Rivera's 50-50 idea went anywhere. The General Assembly, controlled by Democrats, instead approved Senate Bill 1. Several Democratic legislative leaders, including Senate Majority Leader John Morse of Colorado Springs, and House Minority Leader Sal Pace of Pueblo, say they believe SB 1 has put PERA on firm financial ground, at least for now.

This year, though, Republicans control the House, and some are hopeful new Democratic Gov. John Hickenlooper will bring more of a business-first mentality to the debate. In his first day in office, Hickenlooper sent just such a signal by issuing an executive order barring state agencies from imposing regulations on local governments unless those governments are consulted and the state provides funding for local compliance.

Moreover, with taxpayers clamoring for less government spending, the political environment could favor a serious look at reining in public pensions.

"Historically, the argument was that teachers and public employees are underpaid, so they deserve these generous pension benefits," Poulson says. "But that's simply not true.

"The recent data show public employees are doing better than people in the private sector, and there's a growing awareness of this: 'Why are more and more of my taxes being used to bail out these public retirement and health plans that are more generous than the private sector?'"

As Rivera sees it, the state is backed into a corner.

"It's the right thing to do," he says of reform, "because the state can't afford what we're doing now."

zubeck@csindy.com

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