Addressing State Pension Liabilities

The pensions of Vermont’s teachers and public employees are ailing. In the 1990s and early 2000s, the State failed to contribute required funds into the pensions and the 2007-09 recession harmed the pensions’ return on investments. Over the past 13 years, the Vermont legislature has been contributing extra funds into the pensions to make up for the earlier underfunding and the suppressed investment returns.  Nevertheless, the pensions are still deficient, as we learned earlier this year when the State Treasurer produced a report showing that the systems are in much worse shape than we thought. 

The two pension plans do not have enough assets to pay for the expected costs of the retirement benefits they must pay out in the future.  The gap between the amount of future retirement benefits that must be paid and the value of the assets in the plan is called the unfunded actuarial accrued liability. This gap has grown substantially in recent years and it is expected to worsen in the future unless action is taken.

Projections from earlier this year show that the unfunded liability for the teacher and state employee pensions will grow by another $604 million just in the coming year, bringing the total unfunded liability to nearly $3 billion.  The state employees’ pension is 34% underfunded while the teachers’ pension is 49% underfunded. Plans that approach a 50% funding level are considered to be in critical condition. To address this increasing shortfall, the State’s contribution to the fund has substantially increased.

Every year, the State contributes funds to the pension plans. The amount contributed is determined by actuaries using assumptions regarding current and future demographics such as the ratio of current employees to retirees, life expectancy, investment returns, payouts to beneficiaries, and other variables. Trends in these variables have required an ever-increasing State contribution. More and more retirees are drawing from the plans relative to the number of current employees paying in.  Life expectancy has increased.  The number of beneficiaries and the amount they are being paid is increasing. And investment returns have not met projections.

Due to these factors, the State must contribute an increasing amount of funds to the teacher and state employee pension plans to address current and anticipated payouts to beneficiaries. An additional contribution is required to pay down the unfunded liability.  All told, the State’s contribution to these pensions increased this year from about $200 million to over $300 million. That payment represents 13% of Vermont’s general fund for Fiscal Year 2022.

            There are consequences if we do not get a handle on the State’s burgeoning pension liabilities. The State’s bond rating could be downgraded, leading to increased costs for capital projects such as updating wastewater treatment plants or building a new women’s correctional facility. In addition, growth in the unfunded liability means that more money must be paid into the pension system from the State budget. This, in turn, will drain resources from other areas. If the current trend continues, we will not be able to fund other key spending priorities. And if the State does not bolster the position of its pensions now, when a recession inevitably hits we will be unable to meet the State’s pension obligations without significant cuts to services or an exorbitant tax increase.

            The Vermont House is not sitting idly by. Earlier this year, the House Government Operations Committee floated a proposal that would provide additional funding to the pension plans and make structural changes to those plans. To allow more time for other stakeholders including the Senate, the Governor, and representatives of the teachers and state employees to work with the House on a solution, the Government Operations Committee dialed back its initial proposal.  Last week, the House passed a bill that requires these stakeholders to work together to recommend changes to stabilize the pension systems.  Such action is necessary to honor the State’s commitments to Vermont’s active and retired teachers and State employees while also fulfilling other State priorities and recognizing the limits on our taxpayers’ ability to pay. In addition, the bill makes immediate changes to the entity that makes investment decisions for the pensions, bringing more expertise and independence to the governance of the retirement funds.