Other States are Worse, Says Treasurer

By Erik Smith

Staff writer/ Washington State Wire

OLYMPIA, July 12.—Talk about your half-full glass!

            State Treasurer James McIntire says the Washington pension system is one of the best in the nation. And phooey on Wall Street. He says a new report from a bond-rating agency just isn’t fair when it ranks Washington with bottom-of-the-barrel states like California, Arizona and Illinois.

            Eleven of the state’s 13 pension funds are doing fine.

            The only problem is that the other two are doozies. The state’s two oldest retirement funds are in such desperate shape that lawmakers are going to have to spend billions of dollars over the next 10 years to keep them from going broke. State pension spending is going to have to double next year and triple by 2013, to nearly $2 billion every two years. Half the money will have to go to the two troubled funds. To pay for it, state and local governments will have to cut programs, lay off workers, raise taxes – or all of the above.

            Sounds like sort of a disconnect, doesn’t it?

            How can a major chunk of the state pension system be on the verge of collapse – and yet the system as a whole can get a clean bill of health from the state treasurer?

            Turns out it’s all how you look at things.

            A Mixed Message

            There are really two messages coming from Olympia when it comes to the state pension system. 

            The first has it that the state pension system is in deep trouble, and lawmakers and local governments are going to have to spend big money for the fix. State actuary Matt Smith has been sounding the warning ever since Wall Street crashed and took $15 billion of state pension-fund investments with it.

Like a parent warning a child about the consequences of bad choices, Smith has been reminding lawmakers about the decisions that got them into trouble over the last 20 years. He has been telling them about the tough decisions they will have to make. And he’s been pointing out that making no decisions will cost them even more.  

            The story is well-known within a certain circle at the state Capitol – lawmakers, state budget writers, state-employee unions and retiree groups, lobbyists, a few reporters. Awareness may not run much further than that, but it’s bound to be different next year. Not only will the state have to double its pension payments, from $770 million this budget cycle to $1.48 billion in the next, but the local governments that participate in the state system will see their contributions rise right along with it. Their payments will rise from $950 million to $1.7 billon. That’s going to bring howls from across the state.

And yet – there’s another message coming out of the state capital these days. That one has it that the pension system is doing fine; it’s one of the best in the country, and the financial managers at the state investment board have a splendid record. So maybe lawmakers made a few bad decisions along the way. Who hasn’t? But in the aggregate, on the whole, in the scheme of things, Washington’s pension system is sound as a dollar.

That’s the message McIntire wants Wall Street to hear.

            S&P Report Raises Ire

Actually, the treasurer isn’t the only one saying it, but his attack last week on the Standard & Poors agency called attention to the apparent contradiction. Late last month S&P released a report about the financial condition of state-managed pension funds nationwide. The report pointed out that pension funds everywhere found themselves in deep trouble when the stock market tanked and wiped out hundreds of billions of dollars in wealth. State pension funds were among the biggest losers.

The report included a table that showed Washington’s pension obligations were only 73.5 percent funded. That put Washington down toward the bottom of the pack, 38^th in the country.

That’s a mistake, McIntire argued in a blistering letter to S&P. The agency was looking only at the state’s two worst funds, the Public Employees Retirement System Plan 1 and the Teachers Retirement System Plan 1. Both were closed to new enrollees in 1977 when the state finally decided the financing had gotten too far out of whack. Other pension funds, most of them launched since then, are at or near full funding.

If you look at the pension funds as a whole, the way S&P did for other states, Washington’s pension plans are 88 percent fully funded. The state ranks fourth.

In his letter, McIntire stated that the report threatens “irreparable harm to the state’s reputation if your report stays in the public eye while your agency struggles to find a remedy. As a credit rating agency, you are responsible for assessing the state’s reputation, not destroying it.”

            Good Name at Stake

Standard & Poors has issued a correction to the report, upgrading Washington’s status, but McIntire said he is worried that a correction just isn’t good enough. Bond houses look to reports like that one when they decide what sort of interest rate the state should pay. He argues the state has to guard its good name because its high bond rating saves it millions in interest charges.

“When somebody publishes something like this, it goes out in news stories,” McIntire said in an interview. “You can’t pull back these things once they’re out there. Not everyone sees the retractions. It’s been my experience that the stories run on page one and the retractions run on page two or three.”

But how can he argue that the state pension system is healthy?

“The reality is that on the whole the pension funds are doing well,” he said. “The two oldest funds have had some underfunding for some time, and they have had challenges, but to present the picture that that’s what going on for all the pension funds is simply not true. The two funds have been closed for years and they cover only a fraction of the people who participate in the system.”

Of course the state needs to find a way to pay off its massive unfunded pension liabilities, McIntire said. But what happened is that Washington saw the need for pension reform 33 years ago when it ended new enrollments in the old programs. The state made a commitment to fund new pension liabilities as they occurred, and it has been paying on time ever since. It’s just that the state still hasn’t managed to catch up with all the payments to the old funds that it missed generations ago. Meanwhile, other states are just starting to learn the lessons Washington did in the ‘70s. That’s why they’re in trouble now, McIntire said.

“Washington state is in much better shape than a lot of those other challenged states,” McIntire said. “It’s just night and day.”

So it’s a good-news story. And it’s been popping up in the darndest places. A piece on the Crosscut website last May, for instance, detailed the state’s good record in funding the newer plans and largely dismissed the problems with the older ones. McIntire conceded there are serious unresolved problems with the two Plan 1 funds, and then the story quoted Senate Majority Leader Lisa Brown, D-Spokane, who declared McIntire was “overreacting.” She said, “We have a challenge ahead. But we are ahead of most other states.”

            And Now the Bad News

That’s certainly one way of looking at it. But the specter of the half-empty glass looms large over next year’s Legislature. The problem might be limited to just two of the state’s pension funds, but the healthy funds can’t be commingled with the sick. And the problems with those two funds are big enough to overshadow all other state pension spending.

McIntire is right as far as he goes, said state Actuary Smith. On the whole the pension system might be said to be healthy. But the pension system doesn’t operate as a unit.

“The treasurer’s comments referred to the pension system in aggregate,” he said. “That’s an important selection of words. When you are summarizing and totaling them, our plans look very good and compare very well to other pension systems. But the reality is that the pension funds exist on their own.”

The problem with the two Plan 1 funds is that the state never managed to catch up on its payments. In 1989 lawmakers adopted a 35-year catch-up plan and declared victory. But later legislatures didn’t stick to the payment schedule. They deferred payments in bad times and in good ones, they increased benefits and adopted financial assumptions that failed to anticipate the worst recession in 80 years. The run-up in the market came close to correcting things, and then the crash wiped out 10 years of gains.

The bottom line? Twenty years ago, when the Legislature fixed things, the state’s unfunded liability was a little over $5.6 billion. Today it is about $6.9 billion and getting bigger. Because of the way the state calculates pension contributions, Smith estimates PERS 1 will slip to a 47 percent funded status over the next five years; TRS 1, 51 percent. Anything below 60 percent is considered at risk.

And what it means is this. If the state doesn’t step up to the plate and make the long-overdue payments, the Plan 1 retirement funds may run out of money before its final participants breathe their last. The state can’t default on its obligations, so the money would have to come from the state general fund. That’s far more expensive than setting money aside as the liability occurs and letting the money ride in the stock market. The way Smith puts it – you pay now, or you pay more later.

            “Washington deserves a lot of credit,” he said. “Its investments have been strong and the state has been on track for reforming its pension system. We’re seeing some desire to compare our plans to other plans, and we can say we’re in relatively better shape than other states. But that needs to be balanced by saying we still have our own challenges with these two pension funds.