Drowning in Benefits Costs: New Jersey Case Study

Transcription

1 Drowning in Benefits Costs: New Jersey Case Study Thomas J. Healey George H. Kendall Kenneth J. Wilbur March 26,

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3 The New Jersey Public Employee Benefits Funding Mess $83 billion in unfunded pension liabilities under new GASB standards Largest pension fund depleted by 2027 $3.6 billion annual pension funding gap under State statutory formula $53 billion in unfunded retiree health benefits obligations Lawsuits! Lawsuits! Lawsuits! How did things get so bad? How can they be fixed? 3

4 Expensive Benefits Health 3 rd most expensive public employee health benefits in nation Average employee actuarial values: NJ public sector 96%+; National public sector 92%; National private sector 83% Plan Percentage of Enrollees Direct 15/HMO 95% 96.4% % 94.6% % 93.9% ACA Platinum Level 90% % 86.2% HD % 83.5% ACA Gold Level 80% ACA Silver Level 70% HD % 65.9% ACA Bronze Level 60% Actuarial Value 98.5% of State Employees Receive Platinum-Plus Level Health Benefits. No premium incentive to choose lowercost options. 4

5 Projected Increase in State Health Benefits Costs Without Reform $8, $7, $6, $5, $4, $3, $2, $1, Retired Active Ratio of employees, who contribute to health benefits premiums, to retirees, who do not, is decreasing. High number of early retirees. Family coverage costs $16,000 annually for an employee but $26,000 for an early retiree. $

6 Expensive Benefits - Retirees Terms Under Which Most Existing Pension Benefits Were Earned Provision Pre-2007 Normal Retirement Age Age 55 Early Retirement Early Retirement Reduction Cost of Living Adjustment Employee Contributions Vesting Period Period for Average Salary Formula Multiplier (Pension= Multiplier x years of service x final average salary) 25 years 1%/ yr. Yes 5%/ yr. 10 years Highest 3 years 1.818% (1/55) (in billions) Viewed individually, on most factors determining pensions, New Jersey was generous but not extravagant. Combined, and applied to relatively high NJ salaries, result in a heavy pension burden. Combined with underfunding, the result has been disaster. 6

7 Structural Factors Affecting Reform Strong Governor with line-item veto. State s budget is his budget But Must Balance Budget With Very Limited Flexibility Income Taxes Very High 7 th highest in nation per capita 5 th highest top rate (8.97%) 2 nd most progressive (CA) Last two Governors to raise them Florio and Corzine Not Re-Elected Property Taxes Stratospherically High $26 billion Primary local government funding source Average property tax bill in NJ ($8,161) is well within top 0.2% nationally Third Rail of NJ Politics 7

8 State Income Tax Can Only Be Used for Property Tax Relief State Budget Appropriations Over time, as another form of property tax relief, $4.7 billion in annual retirement benefits expenses for teachers have migrated from local governments to become a State expense. State has a $3.6 billion annual pension funding gap. 8

9 How to Balance a Budget While Increasing Employee Benefits and Reducing Taxes Pension Holidays: Use projected investment returns to self-fund public employee pensions. Then use intended pension funding for other purposes Teachers retiree health benefits paid out of projected investment surplus from teachers pension fund Pension Revaluation Act Increase assumed rate of return from 7% to 8.75% to increase projected investment surplus Pension Reform Act Further changes in actuarial assumptions intended to increase projected investment surplus Pension Security Plan State issues bonds rather than use existing revenues to pay off pension unfunded liabilities Revaluation of assets to create surplus for election year 9% pension increase State bond documents failed to disclose asset values had already decreased since 1999 date used to report values. 9

10 $ Millions Outcome: Sustained Bipartisan Contribution to $83 Billion State Pension Funding Deficit Actual Pension Contributions Relative to Statutory Annual Required Contributions (in Millions) $4,500 Actual Contributions Statutory Annual Required Contributions $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $ Billions $ * Actual ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3.1) (2.9) (2.6) (3.0) (3.3) Whitman - R McGreevey - D Co rzine - D Chris tie - R * P ro jected DiFrances co - R Co dey - D 10

11 $ Millions $ Millions The Lost Opportunity Fiscal Year Actuarial Value of Assets Actuarial Accrued Liability Unfunded Accrued Actuarial Liability GASB R $ Billions $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 Actual Contributions Statutory Annual Required Contributions FY ,078 36,752 3, $4,500 FY ,023 39,534 4, Actual Contributions Statutory Annual Required Contribut $4,000 FY ,732 46,552 4, FY ,531 50, $3,500 FY ,674 53,914 (4,241) * Actual ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3.1) (2.9) (2.6) (3.0) (3.3) Whitman - R McGreevey - D Co rzine - D Chris tie - R $3,000 ro jected DiFrancesco - R Codey - D * P $2, Recession $2,000 Exposed Danger No Action Taken $1,500 $1,000 The State granted benefits that it could afford only $500 under optimistic assumptions. When reality fell short of $0 FY ,050 81,330 (37,279) those $ assumptions Billions the State for years Actual at a time failed to fund the resulting liabilities or effectively reform the programs creating them. FY ,948 30,717 1, FY ,513 33,768 1, FY ,574 58,018 (8,444) 85.4 FY ,755 62,797 (13,041) 79.2 FY ,659 67,266 (16,607) 75.3 FY ,433 71,656 (19,222) 73.2 FY ,718 75,763 (23,045) 69.6 FY ,230 80,956 (30,727) 62.0 FY ,079 73,714 (25,635) 65.2 FY ,698 76,806 (30,108) 60.8 FY ,064 79,434 (34,370) 56.7 ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1 Whitman - R McGreevey - D Co * P ro jected DiFrances co - R Co dey - D 11

12 $ Millions $ Millions The Failed Attempt To Spend The State Out Of the Pension Hole $4,500 $4,000 Actual Contributions Statutory Annual Required Contributions $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 $ Billions $4, * Actual ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3.1) (2.9) (2.6) (3.0) (3.3) Whitman - R McGreevey - D Co rzine - D Chris tie - R $4,000 * P ro jected DiFrancesco - R Codey - D Actual Contributions Statutory Annual Required Contributions $3,500 $3,000 $2,500 New Millionaires Tax and other tax increases. $2,000 Only minor pension $1,500 reforms, primarily limited to small minority of unvested employees. $1,000 Employers permitted $500 to negotiate for employee contribution towards health benefits. $ Billions $ Great Recession hits. Asset values plummet. Unfunded liabilities skyrocket. New revenues not realized, or are needed for other priorities. Actual ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3. Whitman - R McGreevey - D Co rzine - D * P ro jected DiFrances co - R Co dey - D 12

13 $ Millions $ Millions The Immediate Crisis $4,500 $4,000 Actual Contributions Statutory Annual Required Contributions $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $4,500 $4,000 $500 Actual Contributions Statutory Annual Required Contributions $ Billions $ * $3,500 Actual ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3.1) (2.9) (2.6) (3.0) (3.3) Whitman - R McGreevey - D Co rzine - D Chris tie - R $3,000 * P ro jected DiFrancesco - R Codey - D 2010: $2,500 Legislation to fully fund pensions by Pension multipliers reduced for new employees. Minimal contributions $2,000 for health benefits premiums (1.5% of salary, $750/ yr. on $50,000) $1,500 finally required for all employees and future retirees. $1, : The Grand Bargain. Suspension of COLAs, significant $500 increase in employee pension and health benefit contributions in return $0 for contractual right to compel pension funding. $ Billions * Actual : Retirees sue over suspension of COLAs ARC Variance (0.2) (0.4) (0.2) (0.5) (0.6) (0.7) (0.7) (0.8) (1.0) (1.3) (0.8) (1.0) (2.1) (2.5) (3.1) (2.9) (2.6) (3.0) (3.3) Whitman - R McGreevey - D Co rzine - D Chris tie - R : FY 2012 and 2013 pension ramp up payments made. * P ro jected DiFrances co - R Co dey - D 2013: Due to revenue shortfalls Governor announces only normal pension costs will be paid for FY 2014 and

14 $ Millions Pension Funding Gap $3.0 Billion 2014 Pension and Health Benefit Spending by the State of New Jersey 7,000 6,000 5,000 $2,995 4,000 3,000 $6,492 2,000 $2,801 1,000 0 $696 Actual Pension Spending Actual Health Benefit Spending Unmet Pension Contribution By 2016, pension funding gap expected to exceed $3.6 billion. Minimum Requirement 14

15 Absent Reform, 23% of 2016 State Budget Would Be Consumed by Public Employee Benefits $ % Pension and PensionHealth and Benefits (in billions) $27.45 Remainder of State Budget (in billions) Projected Statutory ARC for FY 2016: billion. Projected State Health Benefits Costs for PY 2016: $3.728 billion Total: $8.054 billion. 15

16 A Hole Too Deep to Tax Our Way Out Of Potential Funding Source Action required to raise additional $3.6 billion for full funding of existing benefits through specific funding sources Income Tax Increase; 29% New Sales Tax Rate; or Additional Annual Tax per Millionaire 10% $228,062 16

17 The Commission Approach 1. Commitment to solving the entire problem, not incremental improvements. 2. Ensure solution is sustainable, fair and politically viable. Goal: provide at least privatesector level benefits while keeping State costs near $4.4 billion State was expected to spend in without increasing property taxes. 3. Facilitate acceptance by direct union negotiations. Roadmap with NJEA largest union by size of pension fund -Not an agreement, but accord on how to proceed: Freeze existing pension plans Transfer plans to employees Reform health benefits Constitutional amendment Primary negotiation with NJEA, but Commission would only consider terms that could be applied to all unions. 17

18 Freezing Existing Pensions and Replace with New Plans Freeze means no new benefits accrue under existing pension plans for current and new members. Does not affect benefits earned to date. Existing retirees not affected. Specified payment schedule gives state certainty. Cash balance plans are attractive model for new plans. Hybrid defined benefit plan. Employee guaranteed pay contributions and at least minimum rate interest over years of participation in plan. Benefits paid as a life annuity on top of benefits from frozen pension plans. Mitigates employer investment risk compared to defined benefit final average salary plan, and employee investment risk compared to 401(k). 18

19 Transfer Pension and Retirement Plans to Unions Limiting State s role to providing funding on a set payment schedule permits plans to be transferred to employee-controlled entities who would bear risks of plans going forward, but provide employees greater collective say in plans. Because of risk, unions drive hard bargains on funding as condition of transfer. Certainty improves State credit rating and limits confrontation with unions. Entities holding plans must be structured as government plans to comply with ERISA and other regulatory requirements, but still provide employees control. Complex and novel exercise in plan design. Design needs to take into account equitable means of control over multi-union plans with significant non-union membership. 19

20 Reform Health Benefits Health benefits reform needed in its own right and as means of funding pensions. Existing health benefits would break budgets even if pensions didn t. Commission: Reset health benefits funding based on costs of benchmark plan providing private-sector level coverage. Increase average employee premium contributions and use co-pay /deductible changes to incent cost-effective behavior. Union: Adjust heath benefits through collaborative plan design process emphasizing initiatives such as patient-centered medical homes and wellness programs. Goal is not to shift costs, but reduce costs for both employers and employees. Common belief in value of approaches that yield same or better care at less cost. 20

21 The Constitutional Amendment Employees claim constitutionally-protected contractual right barring benefit changes and imposing obligation to fund existing pensions. Arguably cannot freeze pensions or implement new funding plan. State claim constitution bans State contractual obligations beyond fiscal year. Arguably cannot implement new funding plan. With this level of uncertainty, no legislative deal possible. Unions won t trust funding not constitutionally guaranteed. Need to change State Constitution to provide certainty and enable reforms. Requires 3/5 of Legislature to approve putting amendment on ballot for voter approval. Need for amendment ensures reform will have broad consensus, but dramatically raises bar for securing approval. 21

22 Result: Close Funding Gap at less than 15% of State Budget Without Raising Property Taxes. 25% 20% 15% % of Budget Actual Funding 10% % of Budget Required Funding 5% Before Reform 0% Reform Actual and Required Pension and Health Benefits Funding as Percentage of Budget: Local Expenses 2016 After Reform After Reform with Assumption of Certain Education Retirement Costs 22

23 Problems Going Forward 565 Municipalities. 590 School districts. All fearful of accepting any obligation that might increase property taxes if things change in future. No local interest in sharing local savings even if taxpayers benefit on Statewide basis. Local employees resist changes to address what they perceive as a State problem. Some unions believe their plans are bulletproof. Culture shock at private sector health benefits after years of Platinum plus with minimal contribution. Some groups opposed to compromise. Rather sue to compel funding of existing unsustainable benefits. Courts to date have been receptive to their arguments. Lurking constitutional crisis. 23

24 Implications for Other States the bigger concern is the five states [Illinois, Connecticut, Hawaii, New Jersey and Kentucky] that by our calculations would need over 30% of revenue collections to service funded and unfunded obligations. This does not appear politically viable given competing needs for state revenues to finance other expenditures. 24

25 Recent Headlines Illinois State pension payments are squeezing spending on essential state services and a 2013 law aimed at easing a $105 billion unfunded liability is being challenged in court by unions and others. Governor Rauner's policy agenda calls for "permanent pension relief" by amending the Illinois Constitution, which prohibits the impairment or diminishment of public worker retirement benefits. Note: Seven States (AK, IL, NY, AZ, HI, LA and MI) give constitutional protection to public employee pensions. California In his written opinion, U.S. Bankruptcy Court Judge Christopher M. Klein blasted CalPERS as "a bully" for weighing in on the proceeding to insist wrongly that the city had no choice but to pay workers their promised pensions. The skyrocketing bill for pensions is a problem for cities across the state. Californians now owe nearly $200 billion for pensions promised to state and local government workers, according to an analysis by Adam Tatum, research director at California Common Sense, a nonprofit think tank. Rising pension costs are eating up money needed for things such as fire trucks and street repairs, Tatum said. Kentucky Confronted with alarming shortfalls, lawmakers say they want reforms in the state's retirement plan for teachers next year before they consider borrowing any more money for pensions. The 2015 General Assembly convenes next week amid calls for billions of dollars in bonds to help the Kentucky Teachers' Retirement System grapple with its pension debt. The system faces $14 billion in unfunded liabilities and has only 54 percent of the money it needs to pay future benefits. That's on top of the $17 billion funding gap at Kentucky Retirement Systems the pension administrator for state and local government workers. 25

26 Get Your House in Order Before The Market Speaks New Jersey: Five credit downgrades in five months Date Prior Rating New Rating Standard & Poor s 4/9/2014 AA- A+ Fitch 5/1/2014 AA- A+ Moody's 5/24/2014 Aa3 A1 Fitch 9/5/2014 A+ A Standard & Poor s 9/10/2014 A+ A

27 Drowning in Benefits Costs: New Jersey Case Study 27