The Oregon pension system is a mess.
The Oregon Public Employee Retirement System (PERS) is currently facing a $14 billion unfunded liability, assuming the most optimistic investment return of 8% over thirty years. In July, the board overseeing PERS finally agreed to reduce the assumed return rate to 7.75% after years of sub-7% investment returns, a decision to be put up for a formal vote in September, which will drive up the unfunded liability even further. With this assumption, Oregon taxpayers will either need to spend $150 million more a year on pensions and/or make substantive reforms.
There are three primary pension programs within PERS, based on when an employee was hired. Employees hired before 1996 participate in the Tier 1 pension program. Employees hired between 1996 and August 28, 2003 participate in the Tier 2 program. Employees hired on or after August 29, 2003 participate in the Oregon Public Service Retirement Plan (OPSRP). These are defined benefit plans currently funded only by employer contributions. Each program operates with different retirement ages, pension calculation formulas, and definitions of final average salary.
Formulas generally take the form of “final average salary” (FAS) x retirement factor (1.5-2.0% depending on the plan) x years of credit service. In Oregon, what constitutes FAS for the purposes of pension calculations isn’t what common sense would lead you to believe. Tier 1 and 2 employees, in a practice colloquially known as “spiking,” soon-to-be-retirees can pile on unused vacation and sick pay and other payments to inflate the FAS, thereby increasing the pensions the retiree will receive for life. One estimate puts the cost of spiking to taxpayers at $129 million every two years.
Prior to 2004, Tier 1 and Tier 2 programs were funded through member contributions and employer contributions, which were deposited in fixed or variable accounts. The PERS sets employer contribution rates every two years; Oregon law requires that employees participating in PERS must contribute six percent of their salary to PERS. Historically, most Oregon public employees get their member contributions “picked-up” by their employer. In other words, they haven’t had to contribute anything. In 1994, Oregon voters approved Ballot Measure 8 to end the pension pickup; two years later, the Oregon Supreme Court deemed the Ballot Measure unconstitutional.
Tier 1 and Tier 2 participants had their retirement accounts in the controversial Money Match program. In the Money Match program, the employer and employee contributions were converted into an annuity invested by PERS. For Tier 1 employees, the annuity was tied to a fixed earnings rate of 8%, regardless of whether or not the returns ever came close to 8%. Tier 2 employees, in contrast, had their retirement accounts tied to actual investment returns. Employees participating in the Money Match program in the late 90s and early 2000s were able to retire with bloated pensions thanks to the booming economy of the 1990s. Between 1998 and 2003, over 15% of retirees (~3400 out of 22,138) received pensions higher than their final salaries.
In 2004, PERS created the Individual Account Program (IAP), a defined contribution component that Tier 1, Tier 2, and OPSRP employees now participate in. Tier 1 and Tier 2 employees who once paid into fixed or variable accounts now pay into the IAP. The IAP is designed to allow employees to either accept lump sums upon retirement or monthly payments. The IAP is funded entirely through six percent member contributions and investments of the fund by PERS. In reality, only 30% of public employees actually pay the 6%; taxpayers foot the bill for the other 70% of workers because public employees have consistently secured “pickup” agreements in labor negotiations. One 2013 bill that sought to end this practice, SB 754, died during the last legislative session. The “pickup” of the 6% contribution is estimated to cost taxpayers hundreds of millions of dollars a year.
The pension system has been generous: 947 retired public employees currently receive pensions in excess of $100,000, including 736 who are receiving getting paid more for being retired than they ever made on the job. There are also 3,240 retirees currently receiving between $75,000 and $100,000 a year, including over 2,000 who are also getting paid more for being retired than they ever made on the job. Just last year, another 170 employees retired with pension benefits exceeding their final salary.
In 2012, the average Oregon public sector employee retired at age 61 with a pension of $29,000. Taken together with generous COLAs, through which retirees receive annual increases to their pensions, and Social Security benefits, the average public employee in Oregon makes nearly as much retired as the median household income of Oregonians who are still plugging away at a private sector job, which, between 2007 and 2011 was $49,850.
Oregon public employees contribute far less to their pensions than public employees in Washington and Idaho. Ongoing research from Portland State University has compared the retirement benefits (pensions and Social Security) of teachers, police officers, and accountants in the three states.
Earlier this year, researchers assumed the employees made $66,000 in their final year of working, with 25-30 years of employment, for a total retirement benefit, including Social Security, of $1 million. According to these assumptions, for every $1 million Oregon public employees will receive in retirement benefits, they will have only personally contributed $160,000 of it. Since 70% of Oregon employees don’t contribute to their Oregon pension at all, the $160,000 is entirely accounted for by Social Security contributions. In contrast, public employees in Idaho and Washington receiving similar benefits would have personally contributed $370,000 to $560,000 for every $1 million in benefits. In other words, public employees in neighboring Idaho and Washington pay over two to three times as much towards their pensions as Oregon public employees do.
The rising unfunded liabilities, unsustainable benefits, and historically low employee contributions have prompted Oregon Governor Kitzhaber to push for pension reform. Chief among Governor Kitzhaber’s pension reform ideas for the 2013 legislative sessions were: 1) reduce or end the pension “pickup” of employee contributions to their pensions, and 2) reform the current cost-of-living adjustments (COLA) that increase annual pensions.
However, political pressure from the Governor's own Democratic Party made reform of pickups an impossibility. This past legislative session did see a small reform in Senate Bill 822, which adjusted the annual COLA. Prior to the law, pensioners automatically received a 2% COLA on their pension earnings. Beginning in August 2014, pensioners will receive a 2% COLA on the first $20,000 of their pension. They will receive 1.5% COLA for benefits between $20,000 and $40,000; 1% on a benefit between $40,000 and $60,000 and .25% on benefits above $60,000. For example, those making between $20,000 and $40,000 will receive a $400 COLA on the first $20,000 of their pension total and an additional 1.5% of total above $20,000. The bill is estimated to save $400 million over the next two years. However, with the expected September lowering of the 30-year 8% PERS investment return assumption, $300 million of these savings will be offset, resulting in a more modest $100 million savings to taxpayers.
Governor Kitzhaber wanted to go further and crafted an unpalatable “grand bargain” that combined pension reform and tax increases. Further reductions of the COLA were to come with a package worth $200 million in revenue. Part of this revenue would have included $55 million in taxes on alcohol and tobacco and $65 million increases in corporate taxes. Fortunately, this idea didn't get anywhere. Democrats balked at further cuts and Republicans were unwilling to accept tax increases.
Oregonians are currently awaiting an announcement from Governor John Kitzhaber about whether or not there will be a special legislative session to tackle pension reform in Oregon. Even less certain is if anyone will be proposing any good ideas. Simple common sense changes such as limiting “final average salary” to actual salaries and ending the practice of pickups could save Oregon taxpayers hundreds of millions of dollars, while giving legislators slightly more time to get serious about pension reform and eliminating the unfunded liability.