Falling stock prices leave PERS under-funded

By DON McINTOSH, Associate Editor

It seemed like the good times would never end. Over a period of a decade, public employees in Oregon watched their retirement fund more than double in value, from $15 billion in 1992 to $36 billion in 2002.

But a good part of that doubling in value was the result of a run-up in stock prices. Now, with the stock market falling since early 2000, so has the value of the fund. Last year it lost an estimated $2.5 billion.

The losses have added urgency to the discussion on how to cure the ails of a retirement system that all parties acknowledge is poorly structured and frustratingly complex.

Oregon's Public Employees Retirement System (PERS) is the country's 29th largest pension fund. It covers 293,000 working and retired public employees at 867 public employers - the equivalent of 8 percent of the state's population. Beneficiaries include teachers, police officers, and firefighters; union, non-union, and management employees in state and local government; legislators and judges; prison guards and child welfare workers. When these employees retire (which they may do after 30 years of service, or at age 55 if they have 20 years of service, or at age 58 regardless) they choose from several formulas for calculating their benefits: either a "defined benefits" formula that takes into account their final salary and years of service; or a "defined contribution" formula that counts contributions and associated investment earnings, doubles that amount, and divides it up into monthly installments over the participant's expected lifespan. [Both formulas also add a 2 percent annual cost of living increase.]

Complicating this arrangement, participants hired before 1996 were guaranteed that the money invested in their name would grow 8 percent annually.

To make sure the system will be able to pay the promised benefits, public employers participating in PERS make regular contributions to the fund, which are then invested.

The Oregon Investment Council, a five-member body that includes the state treasurer and the director of PERS, decides how the fund is invested. The Public Employees Retirement Board, a 12-member body that includes four public employees, determines how to distribute the investment earnings. And the Oregon Public Employees Retirement System, a state agency, administers the benefits, calculating obligations and sending out retiree checks.

When Oregon's PERS was first set up in 1946, like private pension funds of that era, its assets were invested conservatively - mostly in bonds. The idea of these investments was to preserve principal and hedge against inflation. Before 1968, the state wasn't allowed to invest in stocks at all. But in the 1970s, Oregon PERS became one of the first public funds to put money into stocks. Today, two-thirds of the fund's assets are invested in investment categories that used to be considered high-risk.

At the advice of Tacoma-based investment consultant Frank Russell Co. (Oregon's investment consultant for over 30 years), 27 percent of PERS funds are invested in bonds, 8 percent in real estate, 35 percent in publicly-traded U.S. corporate stock, 20 percent in foreign stocks, and 10 percent in "private equity," an investment category pioneered by leveraged-buyout firm Kohlberg, Kravis, & Roberts. Paradoxically, in order to maintain stock investments at a fixed percentage of the overall fund's value, the fund buys when the price is falling and sells when it's rising.

State Treasurer Randall Edwards, who sits on the Oregon Investment Council, describes the strategy as a "long-term perspective" of "aggressive" investment in the stock market. He said the strategy has delivered exceptional returns over the years. Now that it's clear the stock market has downs as well as ups, Edwards said, it's important to stick with the strategy.

Right now, of course, it has mostly downs. NASDAQ - the electronic stock exchange where most high-tech stocks are traded, has lost nearly three-fourths of its value since January 2000. The S&P 500 - a list of the largest companies' stocks - has lost nearly half its value since March 2000. And the Dow - a list of 30 indicator stocks representing companies in different sectors of the economy - has lost nearly a third of its value since March 2000. For the most part, the stock market losses suffered by PERS won't necessarily harm public employees, who are guaranteed benefits under the defined benefits formula.

But they do create a colossal "unfunded liability" that the employer, and ultimately the taxpayer, will have to make up. Currently the shortfall is estimated at $8.5 billion, representing roughly $250 million a year in increased costs for the state's public employers.

Public employee union leaders fear that this fact may fuel a renewed politicization of the issue. Public employee pensions have a history of being targeted by critics of government and opponents of unions. Attacks on PERS reached a height in 1994 when Ballot Measure 8, sponsored by Bill Sizemore, passed by 984 votes. Measure 8 required public employees to contribute 6 percent of their salary toward their pension. This would have invalidated a benefit that union workers had given up wage increases to achieve, and it was overturned by the Oregon Supreme Court as a violation of contract law.

In recent years, all sides have acknowledged that PERS has problems and will need to be reformed, said Mary Botkin, political director for the American Federation of State, County and Municipal Employees Council 75. To that end, Botkin said, a "quiet, respectful discussion" was occurring between the public employee unions and public employers.

Then, earlier this year, those discussions were eclipsed when Republican gubernatorial candidate Ron Saxton made PERS reform a campaign issue, calling for an altogether separate program for new hires and demanding that unions accept changes in PERS benefits for existing employees.

"It doesn't take long to say no," Botkin said to the latter proposal.

"Ron Saxton took a complicated 'numbers geek' problem and turned it into a bumpersticker slogan," she added. "You can't really talk about it in a measured manner if you're talking about it in a room full of cameras."

Botkin says the trouble with politicizing the issue is that legally there are no easy solutions. The courts have held that a promise is a promise - existing employees have contract rights to the pensions they were promised. And public employee unions say they intend to sue again to protect the rights of members if any attempt is made to get out of the existing obligations.

"The problems are short-term and the solutions are long-term," says Dawn Morgan, a former president of the Oregon Public Employees Union who sits on the Public Employees Retirement Board. Morgan says the pressure to do something will be almost irresistible in the next legislative session starting in January 2003.

In the interim, two committees are meeting to develop proposals: a governor-appointed task force led by Governor John Kitzhaber, and a working group appointed by the State House of Representatives and headed by State Representative Tim Knopp (R-Bend).

The PERS Board approved one solution Aug. 12: updating actuarial tables that were last set in 1978. Beginning January 2004, new tables will be used that add four years to the expected longevity of retirees. Monthly benefit payments would be reduced, since they would be spread out over a longer period. That could save public employers more than $1.5 billion. But a coalition of public employee unions plans to sue to oppose the change, arguing that it infringes on existing workers' contract rights. The case is expected to be resolved by the Oregon Supreme Court on an expedited timetable. And anxiety over the reduced payments is reportedly leading to a wave of interest in retirement among public employees who are eligible.

Another proposal, pushed by the right-wing Cascade Policy Institute and opposed by labor, would end PERS for new employees and replace it with something like a 401(k) retirement fund. A proposal to terminate PERS for new employees was introduced in the most recent special session of the Legislature but didn't make it to a vote.

While the task forces meet, other issues are being sorted out in court: Did the Public Employees Retirement Board sock away too little for a rainy day? Was it too generous in using fund earnings to increase benefit levels?

Employers won a preliminary judgment, but the case is expected to go to trial in late summer or early fall, said attorney Greg Hartman, who represents a coalition public employee unions.

As the political and legal showdown approaches, many public employees are praying for a stock market turnaround to take the pressure off. "If we get back to the point where investments can return 8 percent," Hartman said, "the problem will get taken care of."

August 16, 2002 issue

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