In a January 2010 letter, three members of the state pension fund’s board of directors sent a stark warning to state lawmakers: Any attempts to water down a proposed reform package could leave the retirement system, which 1 in 10 Coloradans depend on as a replacement for Social Security, in grave financial peril.
“To be frank, there is little to no room in this bill for error or modification,” the trustees wrote. “…any changes … may very well lead to further underfunding of the plan and to putting employees, employers, and taxpayers at greater risk in the future.”
It was the first in a long line of warnings that went ignored.
A Denver Post review of thousands of pages of financial reports and hours of public meeting recordings found that state lawmakers and the pension board alike ignored numerous red flags after the landmark pension reform was passed in 2010, opting time and again for political expediency at the expense of the Public Employees’ Retirement Association’s long-term financial health.
Now, PERA is barreling toward its second watershed moment in a decade. PERA has only 58.1 percent of the money it owes in future retirement checks. Its funding gap has ballooned to $32.2 billion by one accounting measure — and $50.8 billion by another.
But unlike in 2010, when PERA’s looming insolvency was triggered in part by a global financial crisis, the latest fiscal crunch was arguably self-inflicted, brought on by wishful thinking and a consistent pattern of putting hard choices off to the future.
PERA today isn’t projected to run out of money, as it was in 2010. But its financial position has grown so precarious that another economic downturn could plunge the fund back into insolvency.
As a result, the state’s credit worthiness is now at risk. At least one major school district’s rating has already been downgraded. And eight years after public workers, retirees and taxpayers embarked on a “shared sacrifice” that was sold as a long-term solution, every Coloradan is now being asked to pay an even steeper price.
The simplest explanation of today’s need for reform is that the financial assumptions used to craft PERA’s 2010 rescue plan, Senate Bill 1 in the Colorado General Assembly, were wrong. Retirees are living and drawing benefits longer than projected at the time, and investments aren’t expected to grow as quickly. But the pension’s finances didn’t need to deteriorate to the point that they have.
“Everyone has failed the citizens of Colorado and members of PERA on this — the legislature, the PERA board, and (Colorado’s) governors,” Lynn Turner, a member of the PERA board of trustees, told The Post in an interview.
“There is plenty of ‘shared blame’ to go around, just as there will need to be ‘shared sacrifice.’ ”
A house of cards
In the months that followed, even as lawmakers were proclaiming success, there was already reason to believe the reforms were a house of cards.
At a November 2010 meeting, board members were offered two dramatically different forecasts of the U.S. economy.
The rosier view, from the board’s actuarial firm, Cavanaugh Macdonald, assumed that there would be 3.75 percent inflation, and used that prediction to affirm the 8 percent rate of annual projected growth used in the creation of Senate Bill 1.
That rate was critical to PERA meeting its financial goals — the more that PERA’s investments are expected to grow, the less that taxpayers and employees need to contribute to the fund to make it solvent. But PERA’s investment consultant, Hewitt EnnisKnupp, predicted inflation would be significantly lower — about 2 percent a year.
Board members raised concerns that in hindsight have proved well-founded. Not only has the U.S. consumer price index not averaged 3.75 percent inflation since 2010, there hasn’t even been a single year of 3.75 percent inflation dating to 1991.
“I think most of the data that we saw raised questions,” Turner said. “That fell on deaf ears.”
If the board had averaged the two inflation assumptions together, it would have dropped the rate of return to 7.125 percent — a difference of billions of dollars in investment returns. A motion to reduce the rate to 7.5 percent was defeated 10-4 by board members.
Opponents of the change cited political considerations as well as financial ones in making their decision.
“I just do not want to be complicit in what’s going to happen down the road if we pass this,” board member Carole Wright said at the November meeting. “We are going to be a target for the media. The politicians are going to feel that they were betrayed by what we stepped up to the plate and said we would do.”
The uncertainty over the long-term direction of the financial markets is why the three gubernatorial appointments to the PERA board — Turner, Susan Murphy and Howard Crane — sent lawmakers a letter warning them not to stray from the bill as it was proposed in January.
Instead, compromises were made to win over votes and interest groups. The retirement age for teachers and other school district employees stayed at 58 instead of rising to 60, as it did for other public employees. Retirees were spared a two-year freeze on cost-of-living raises, and lost a single year, instead.
The PERA board endorsed the bill as amended, with a lone dissenting vote from Turner. A market rebound in 2009 had given the pension some financial breathing room, and lawmakers used every bit of it. But by 2011, the market had swung back the other direction — and the 30-year fix was already several years off course.
Chronic underfunding
By 2013, reality had set in. The assumptions Senate Bill 1 was built on? PERA’s leaders no longer believed they were correct.
That year, the board reduced the assumed rate of investment return to 7.5 percent. That added $3.1 billion to PERA’s projected funding gap and extended the time PERA needed to pay it off to 2048 — a full 10 years later than the 28-year fix that was projected at the end of 2010.
But consistently, PERA’s message to lawmakers was unchanged: Wait for Senate Bill 1 to work before tinkering with the plan.
Trouble is, Senate Bill 1 itself had a glaring flaw. The government, even under the original assumptions, wasn’t contributing enough to cover the cost of benefits.
And there was more at play than just the political compromises of 2010. It’s a trend that dates to 2003. Each year, PERA’s financial advisers calculate what public agencies should contribute to afford the benefits they were promising their employees. And each year, the government had been underfunding it.
Back in 2000, PERA was actually overfunded. Then, state lawmakers and former Gov. Bill Owens, a Republican, boosted benefits and cut contributions.
When the dot-com bubble burst, PERA’s balance sheet cratered. Officials responded, but slowly. Instead of immediately paying the full amount the government owed to meet its funding goals, contribution hikes were phased in. Before the contributions caught up, the stock market crashed, wiping out 26 percent of PERA’s portfolio.
Senate Bill 1 was designed in much the same way. At the depths of the housing crisis in 2010, cash-strapped governments resisted the higher payments needed to shore up the fund. So the bill front-loaded the cuts to benefits, and backloaded the contribution hikes, phasing them in over the next eight years. That spared governments a cost they could ill afford in the midst of the Great Recession.
At board meeting after board meeting — even as trustees mulled reductions to the rate of return — they acknowledged the political reality. Such decisions would make PERA’s funding look worse, and they couldn’t count on the government to make up the difference. And just like in the 2000s, the chronic underfunding put PERA at greater risk when market and demographic conditions changed.
“(It’s the) same reason you should care if you get behind on your 30-year mortgage,” said Turner, a former chief accountant for the Securities and Exchange Commission. “The further you fall behind, the greater the pain trying to catch up, and the sooner you face foreclosure.”
A partisan divide
At the legislature, Democrats consistently agreed with PERA’s decision to wait for the 2010 reforms to ramp up. Republicans didn’t. And Gov. John Hickenlooper largely stayed out of it.
State Treasurer Walker Stapleton, who is now running as a Republican for governor, led the fight for reform, saying the board’s assumptions were akin to wishing for “lollipops and rainbows.” Year after year, he supported bills offered by Republican lawmakers to change the makeup of the board, raise the retirement age, cut benefits and freeze taxpayer contributions.
Many of the GOP proposals were deemed extreme and fiscally irresponsible by opponents — derided as political statements that ignored financial reality. But even moderate tweaks to benefits — some of which mirrored the board’s own suggestions in 2009 — were dismissed as unnecessary.
“It was always that everything was OK,” said Sen. Kevin Priola, R-Henderson, who is in bipartisan talks to craft this year’s reform bill. “What frustrated me was I kind of got the feeling it was a scene out of ‘The Wizard of Oz.’ ‘Don’t look behind here, everything’s OK.’ ”
Sen. Daniel Kagan, a Democrat from Cherry Hills Village, was among those who supported Senate Bill 1 but opposed efforts to make changes afterward without PERA’s support.
“We have to be careful not to overburden taxpayers and not overburden employees and not overburden retirees — and it’s a (delicate) balance,” Kagan said. “…It’s very important for the state to not try to time markets or overreact prematurely to changes.”
Another warning, glossed over
By 2015, it was clear that more changes were on the horizon.
In January, the board’s auditor, Milliman, passed along some sobering recommendations. The takeaway: PERA would have less money, yet owe more more in benefits.
That fall, five board members pushed for a review of PERA’s investment assumptions. But a majority on the board voted to wait until 2016 to do so.
Nevertheless, PERA still had an opportunity to sound the alarm — a five-year progress report on Senate Bill 1 was due to the legislature by the end of 2015. But rather than stressing that PERA was projected to miss its 30-year goal, the report highlighted that Senate Bill 1 was arguably ahead of schedule — under more optimistic assumptions that its financial experts no longer believed.
“As a result of the innovated shared sacrifices and reforms made to PERA by SB 1, PERA is once again sustainable for the long term,” the report concluded.
The board’s chairwoman at the time, Maryann Motza, echoed that sentiment in her letter to PERA members in the annual financial report released the following summer, writing that the report’s “main takeaway” was that the reforms “provide PERA with the resources it needs now and into the future.”
The financial statements in the 232-page document told a different story. An anemic 1.5 percent investment return had pushed the path to full funding out to 42 years for most state agencies and 44 years for school districts. The reforms were expected to miss their 30-year target badly — and that was before the board in 2016 adopted the new mortality tables and lowered the rate of return to 7.25 percent.
“They would always point to the five-year report: Let’s not do anything until five years,” Priola said. “…But things were looking great for the five-year report.”
Ron Baker, PERA’s interim executive director, acknowledges there was a disconnect between the report’s positive message and what PERA knew was coming. He says the report was designed to be a look back instead of forward, and PERA didn’t yet know how dramatically the changes would affect the system’s funding.
“Yeah, we knew (that changes were coming) … but we were not ready yet to say ‘fire,’ without having some solution that would not have everybody in an uproar,” Baker said. “…I’ll agree the report didn’t do that — probably purposely.”
“Lessons learned”
Today, PERA views what transpired over the last 18 years as “lessons learned.”
“With the benefit of hindsight, could we have spoken louder about this? Absolutely,” said Tim O’Brien, the board’s current chair. “I think we are where we are, and I don’t think anybody wants to see it deteriorate.”
The reform package the board recommended to state lawmakers this fall mimics Senate Bill 1 in substance, raising the retirement age and cutting benefits, while increasing contributions from public employees and taxpayers. But it diverges in its implementation. Higher contributions would take effect all at once, instead of ramping up over time. And it would automatically adjust contributions and benefits as needed if the system strays from its funding targets.
If adopted, that would sidestep the dilemma that has vexed PERA in the past. Fiscal prudence demands a swift response to changing market conditions. But convincing lawmakers and 566,000 members that changes are needed is a slow process.
“I think that we’ve been bitten by (our messaging) a little bit,” Baker said. “Because I think the perception of folks is ‘Well, you fixed it in 2010. You said it fixed it.’ And well, we fixed it from running out of money — not that it was never to be adjusted again.”