Passing The Buck: Maryland’s Unfunded Liabilities For State And Local Retirees

SUMMARY
Maryland’s state and local pension and retirement benefits plans are in for some hard times ahead. Facing budget shortfalls, governments are underfunding their retirement plans, while at the same time expanding the benefit promises to public employees. This unsustainable financing places both taxpayers and public employees at risk.

Today, the Maryland State Retirement and Pension System suffers from an unfunded deficit of over $11 billion. The State’s unfunded liabilities for non-pension retirement benefits (such as retirees’ health care) are estimated to range anywhere from $8 billion to $15 billion. Many county and local government entities face similarly severe deficits. Those liabilities will constrain state and local budgets in the decades ahead.

To make matters worse, with the implementation of the Governmental Accounting Standards Board Statement 45, state and local governments will be required for the first time to calculate and make public their retirement benefit liabilities. Those liabilities will reduce the governments’ creditworthiness and increase their borrowing costs.

This joint study by the Maryland Public Policy Institute and the Calvert Institute evaluates Maryland’s unfunded retirement liabilities for its public employees. The first report, by George Liebmann, specifically examines pension liabilities, while the second report, by Gabriel Michael, examines liabilities for other retirement benefits.

MARYLAND’S STATE AND LOCAL PENSION LIABILITIES
George W. Liebmann
MARYLAND STATE FUND

The State of Maryland and its subdivisions face equally large hidden contingent liabilities in their defined benefit pension plans.

The response of both the Robert Ehrlich and Martin O’Malley administrations to this impending crisis has been defined by the principle, “When you’re in a hole, dig deeper.” The Ehrlich administration, under pressure from Democrats in the 2006 election year, signed into law a major expansion of the state’s defined benefit pension program for teachers. Even the outgoing president of the Maryland State Teachers’ Association, Patricia Foerster, noted how remarkable this lobbying achievement was, in that Maryland was actually expanding its defined benefit program while other states were converting to sounder, defined contribution systems. Furthermore, the expansion was enacted on the premise that it was needed to bring Maryland teacher compensation in line with compensation elsewhere, a proposition promptly deflated in a careful study by the Abell Foundation and the Maryland Public Policy Institute: Is It Time To Rethink Teacher Pensions in Maryland? (2006).1 Moreover, in a feat of misplaced egalitarianism, the increases made available to teachers were also made available to state employees generally.

The result is recorded in purposefully obscure notations in “The Ninety-Day Report” issued by the Department of Legislative Services after the 2008 General Assembly. The report notes that the state’s structural deficit or annual recurring shortfall was recently increased because of “an actuarial error in retirement contributions which adds nearly $70 million per year in additional spending for teachers’ retirement costs.”2

Projecting increases for fiscal 2009, the report notes: “Teachers’ retirement, which is paid by the state on behalf of local school systems, will grow from $566.4 million to $621.8 million, an increase of $55.4 million or 9.8 percent…The increase of nearly ten percent in the teachers’ retirement program is mostly due to an 8.8 percent increase in the salary bases for local boards of education.” These include seniority increments, with the increase far exceeding the rate of inflation.3 Similarly, state retirement contributions for local employees, chiefly those in community colleges and libraries, increased from $36 million to $39.3 million.4

1. Available at http://www.abell.org/publications/detail.asp?ID=123.

2. “The Ninety-Day Report,” Department of Legislative Services, p. A-17.

3. Ibid., A-24 and A-85.

4

Notwithstanding the melancholy experience with affirmative action for investment firms, notably those of Nathan Chapman and Alan Bond,5 the 2008 legislature passed and the governor signed S.B. 606, mandating affirmative action for such firms.6 In addition, urged on by some neoconservative organizations in Washington, D.C., the General Assembly required divestiture from companies doing business with Iran and Sudan, thus reducing yields and enlarging administrative costs.7 Although the Chapman firm allegedly did not actually lose money during a five-year period when peer pension funds were enjoying 5.13 percent average annual yields, another affirmative action manager, Progressive, lost more than half the funds confided to its care.

The dimensions of the actuarial deficit of the Maryland State Retirement and Pension System are disclosed in its report for the year ending June 30, 2007.8 As of that date, the actuarial liabilities of the fund were $49.3 billion, an increase of $6 billion in one year, while actuarial assets were $37.9 billion, an increase of $2.1 billion. The actuarial deficit was thus $11.4 billion, and the funding ratio was 76.8 percent. The origins of much of this deficit are found in the years 2000 to 2005, when the five-year rate of return for the State Retirement System was an annual 3.21 percent as against 5.13 percent for peer funds,9 translating into a shortfall in investment earnings of $2.5 billion over that five-year period. The calculation of actuarial value assumes (with some qualifications) a constant investment return of 7.75 percent. Many authorities regard this sort of projected return over time as over-optimistic, though the projected return was far exceeded in
2006-2007.

“While anything is possible, does anyone really believe this is the most likely outcome?” Warren Buffett wrote in the most recent annual report of his firm, Berkshire Hathaway. A growing number of leading investors are warning that the return rates used by state and local governments are unreasonably optimistic. Buffett, for one, has pointed out that over the twentieth century, when the Dow Jones Industrial Average soared from 60 points to 13,000, the stock market produced a 5.3 percent annual return for investors. Over the next century, the Dow would have to explode to 2.4 million to produce a similar rate of return.10

4. Ibid., A-81.

5. See Calvert Institute, The Baltimore City Retirement Systems: Heading for Trouble,

March 2006, 25, n. 3.

6. Chapter 601 of the Acts of 2008, enacting Sec. 21-116(D)(1) of the State

Personnel and Pensions article.

7. Chapter 342 of the Acts of 2008, enacting Sec. 21-123.1 of the State Personnel

and Pensions article.

8. P. 66.

9. 2002-2003 Maryland State Budget, vol. I, 582.

10. David Cho, “Growing Deficits Threaten Pensions: Accounting Tactics Conceal a

Crisis for Public Workers,” The Washington Post, May 11, 2008, A-1.

Maryland’s State and Local Pension Liabilities

5

The state actuarial deficit was 115 percent of covered payroll as of June 30, 2007. The fund had an actuarial surplus as recently as 2000.11 One of the three causes of the sharp increase in the actuarial deficit is “the benefit enhancements recognized in 2006.”12 In 2007, the system shifted from “the aggregate entry age normal cost method to the individual entry age normal cost method.” Absent this change, the funding ratio as of June 30, 2007, would have been 84.6 percent, rather than the 76.8 percent reported. As at June 30, 2007, the funding deficit was equal to 115 percent of payroll. The funding ratio as of June 30, 2006, was 82.78 percent as against 88.21 percent as of June 30, 2005. Between June 30, 2005, and June 30, 2006, actuarial liabilities increased by $4.1 billion and the actuarial deficit by $3.8 billion. This sizable one-year change, unlike the one that followed, appears to have been due to the benefit improvements secured at the behest of the teachers’ unions.

In the 2006

Posted in: Publications