Either Insolvent Now or Will Be Soon – Business Couldn’t Get Away With It, They Say

By Erik Smith

Staff writer/ Washington State Wire

OLYMPIA, Feb. 22.—If state government was a business, the state might have to shut it down.

            Over the last three months, three official watchdogs have said essentially the same thing about three enormous state funds. Either the funds are insolvent now or they will be within a few years.

            And the watchdogs all draw the same conclusion. If the state had to comply with the same rules as business and the balance sheets looked this bad, regulators might have to step in.

            Of one agency, the state Health Care Authority, state Insurance Commissioner Mike Kreidler said last week:  “If we had a company this far gone, we would be talking about liquidating it.”

            There’s a key difference, though. The three funds – pensions, state-employee health insurance and worker’s compensation – are all public programs. They are exempt from the regulations that aim to ensure financial responsibility in business. That’s because they are backed by the credit of the taxpayers of the state of Washington. But it also means that if they run out of money, taxpayers are on the hook for the state’s obligations – running into the millions and even billions of dollars.

            Three at Once

            The idea that three of the state’s biggest funds would run into the same kind of trouble at the same time is enough to make one think there might be a common cause. But while the nation’s tough economic times have something to do with it, the problems aren’t just a matter of bad luck. Reports from the three state oversight officials indicate that the Wall Street meltdown and the state’s unprecedented budget shortfall contributed to the troubles. But bad judgment calls and the Legislature’s tendency to put off difficult decisions into the future also played a part.

n      State-employee health insurance. State Insurance Commissioner Mike Kreidler maintains the state Health Care Authority already is insolvent by any private-business standard. The agency is starting to burn through its reserves, he said, and trends are spiraling downward, from a positive fund balance of $185 million at the beginning of last year to a negative $4 million balance at the start of this one. By June 30, 2011, the agency is projecting a deficit of $220 million unless the Legislature allocates more money this year and state employees pick up a greater share of the cost of their health benefits.

n      Worker’s compensation. State Auditor Brian Sonntag reports that the Department of Labor and Industries has significantly understated the scope of problems in the state’s worker-compensation funds. The state’s accident fund, one of the three major funds administered by the department, stands a 90 percent of running out of money within five years, said a year-end report from Sonntag’s office. Actuarial soundness would require a 33 percent increase in business premiums. But business complains that this year’s average 7.6 percent increase has already brought it to the breaking point.

n      State pensions. The collapse on Wall Street and the Legislature’s longtime reluctance to fully fund its pension obligations have created a perfect storm in the state’s pension system, reports state Actuary Matt Smith. Over the next five years the state must triple its payments to nearly $2 billion every two years, an unprecedented level, in order to make the program actuarially sound. And it will have to keep up those payments for 10 to 15 years. Otherwise the funds covering the state’s oldest pensions could “run out of money,” Smith says. That means the state general fund would have to pick up the $2.4 billion annual tab in the 2020s – which would be even costlier.

            ‘Trifecta of Failure’

            In the Legislature there doesn’t seem to be much awareness yet that watchdogs are pointing out remarkably similar problems with three of the state’s largest funds. Several lawmakers contacted over the weekend said the situation catches them unaware.

            But awareness of the critical reports is higher among conservative Republicans who have been using them in their arguments against tax increases. They say the pattern is not a surprise. “For me this shows fundamentally why we are in a crisis right now,” said state Rep. Bill Hinkle, R-Cle Elum. “You have people collecting government paychecks who have never worked for a business in their lives, and most of them have no concept of sustainability. They like to regulate the private sector and excuse themselves from their own regulations. It’s not a new problem, but it’s getting worse.”

            Said state Rep. Doug Ericksen, R-Ferndale, “The bad economy is highlighting all these quasi-illegal practices. It’s really a ‘trifecta of failure.’ ”

Bad Time for a Snapshot

            Those responsible for the funds point out that the state’s finances haven’t been so bleak since the Great Depression. That means it’s the worst time for a snapshot. Any financial report based on figures from 2009 is bound to look awful, but things can’t help but get better.

            About half of the problem with the state’s worker-compensation program, for instance, is related to the Wall Street meltdown. The fund lost about $1 billion between mid-2008 and mid-2009. Judy Schurke, director of the Department of Labor and Industries, told a Senate panel this month that the auditor’s report was based on data collected during the worst of the recession, and that the value of state investments is already beginning to recover. Further increases in premiums will be necessary next year, she said, but the department doesn’t have to raise rates to the point where they are considered actuarially sound by business standards. The state isn’t required to do so—and it has gotten through similar crises that way before, she said.

            Whistling in the Dark?

In the state pension system, state officials likewise are banking on a turnaround. There the problem was decades in the making, and lawmakers concede they have some big balloon payments coming due in the next few years. Long-ago Legislatures deferred costly investments in the pension system whenever state budgets got tight. Lawmakers adopted a 35-year catch-up plan in 1989 that required them to make small payments at the time and big ones later. But when state investments took off during the boom years, lawmakers expanded benefits and put off payments again. Contribution rates dropped to what Actuary Smith called “historically low and unsustainable levels.” Then Wall Street laid its egg—the state lost $15 billion and 10 years of gains were wiped out.

            The result, Smith said, is that the PERS 1 plan for state employees will slip to a 47-percent fully funded status; TRS 1, 51 percent. Federal standards for business consider any figure below 60 percent to be “at risk.”

Lawmakers are still counting on Wall Street. Last fall Smith, preaching conservatism, urged the panel that oversees the system to reduce its expectations for state-investment performance. It said no. That would have required even higher payments over the next few years, at a time when the state is expecting huge shortfalls. State budget director Victor Moore said the State Investment Board has managed to make an 8-percent return over the last 20 years, despite everything, and it ought to be able to keep it up. 

             “I know that this, coming off the performance we have had in the stock market for the last couple of years, may not give people confidence that they are able to do that, but we’re really looking at a long-term look here,” he said.

            Smith maintains the chance of an 8-percent return is less than 50 percent. “The only thing that gets them out of this is investment returns, and that’s not likely,” he said.

            A Vicious Cycle

Problems in the state Health Care Authority aren’t directly related to Wall Street, but they are connected with the state economy. When the state ran $9 billion short last year, lawmakers deliberately shorted the state-employee health programs, providing only a 3 percent increase for inflation when 7.5 percent was expected. Then the modest increase they provided for inflation was wiped out by unexpectedly high claims costs and internal budgeting problems. At midyear the state Public Employees Benefits Board decided to boost copayments and deductibles for 2010, triggering another rush by state employees to use their more generous 2009 benefits. Some also may have been worried about layoffs, agency officials say. Result was that costs rose 10.5 percent while state spending stayed flat.

The agency has reserves to cover the trouble, but when operations run in the red, that’s a red flag by any standard, Kreidler maintains. To balance the books the agency is asking the Legislature for another $96 million this year, about $51 million of that from the state general fund and the remainder from the agency’s reserves. That money, plus another rate increase in 2011, ought to solve the problem, agency officials say. But the 2011 rate hike will likely be just as steep as in 2010. When the rate increase is announced this summer, it raises the specter of another reserve-draining rush on the insurance program.