On Monday, July 17, the legislative oversight subcommittee for Colorado’s Public Employees Retirement Association (PERA) held its first meeting in the interim between legislative sessions. I’m fortunate enough to be the appointee for the House Minority Leader. There were some interesting and even some optimistic developments, but also some worrisome ones. There is also some reason to believe that the subcommittee is failing to operate as intended.
First, let’s look at PERA’s 2023 investment returns and what that means for its financial position. Last year was not a good year; PERA lost 13.4%, leaving its division trust funds 69.9% funded at the end of the year, yet claimed during the subcommittee meeting that it remains on track for full funding by 2048.
But wait, wasn’t PERA funded at 67.8% at the end of 2021? How did it lose over 13% and be better funded? That’s because PERA uses actuarial smoothing in its asset calculation, recognizing gains and losses over four years in order to smooth out the year-end reading of assets under management. The fair falue of those assets is $54.7 billion rather than $60.9 billion, and the funded ratio is 62.7%, down from 76.8% the year before.
The annual Signal Light Report, issued by PERA’s auditor is based on market values as well, and uses a statistical model to determine the likelihood that PERA will meet its funding goals. Both the state employee and school employee divisions, far and away PERA’s largest, fell from the very desirable ‘dark green’ rating to the less attractive ‘yellow.’ In terms of probability, this means that they now have a less-than-even chance of being fully-funded by 2048, although they will likely be fully-funded a generation later, in 2068. Contra PERA’s assertion in the subcommittee, this is not “on track,” and certainly is not an improvement.
The inflation factor
The Signal Light Report also sheds some light on the elusive topic of inflation, and how that affects PERA. Inflation has been the single biggest economic story of our time (although the downgrade of banks threatens to displace it), but information about how that affects PERA’s long-term funding prospects has been hard to come by. Last year, when pressed, PERA said that it couldn’t estimate the effects of inflation because it didn’t know how the member agencies would respond to it. The subcommittee also refused to commission changes to the model or an addition to the Signal Light Report to add a sensitivity analysis of inflation.
However, the report does estimate PERA’s sensitivity to salary increases, which PERA itself cited as one of the key unknowns. It turns out that if salaries increase faster than expected, this helps PERA in the long run. And we also know that the average state employees division salary increased 8.2% in 2022, and the average salary in the much smaller local government division was up 10.6%. The school division, bound by multi-year contracts, didn’t increase nearly as much, but we can expect union-backed school boards across the state to make up for that in coming years. In short, governments are reacting much as they did during the last big inflationary period in the 1970s, and raising salaries faster. On the whole, this is good for PERA – inflation is usually good for debtors – although bad for everyone else.
PERA needs a new boss
At the same time, for a panel whose purpose is to use its expertise to keep tabs on PERA’s performance and position, the lack of curiosity around certain other topics is worrisome. For example, the only questions surrounding the recent firing of PERA’s executive director, Ron Baker, were on basic issues of the process for finding a replacement. It looks as though PERA will not be hiring from within this time; acting Executive Director and CIO Amy McGarrity has stated that she does not want the job, preferring to stay in charge of PERA’s investments.
But nobody on the subcommittee sought to extract any information about the circumstances of Baker’s dismissal. While the event has elements of a personnel matter, it’s also clearly a governance question: it involves the executive director, not some guy in accounting. Given that he was let go without cause – we know this because he received 30 days’ notice – the lack of curiosity from a panel charged with PERA’s oversight is baffling.
In an effort to keep tabs on potential changes in policy, I extracted a promise after the meeting – and have pursued it in follow-up questions – that the subcommittee be kept apprised of any policy questions that the PERA Board asks of candidates, and the candidates’ responses.
Likewise, in 2021, the subcommittee made two recommendation to the board, one concerning the colors on the Signal Light Report and the other concerning the amortization of pension obligations. Since then, to the best of my knowledge, the board hasn’t responded, and the subcommittee hasn’t asked them about it. Since of the main purposes of the subcommittee is to make those recommendations, if we simply let them drop, we’re doing everyone a disservice. I have asked the PERA Board what action has been taken on them.
Inching towards defined contribution
We’ll close with one revelation that offers a tantalizing possibility concerning PERA’s future. PERA has created an investible fund based on actual bond holdings in its portfolio, and made that available to members enrolled in the defined contribution (DC) plan. What’s more, it has begun very preliminary discussions about how it might create a similar fund that mirrors all of its investments, including real estate, alternative investments, and private equity.
Such a fund might never come to pass. But if it did, it would mean that a PERA member could participate in PERA’s returns – which have been pretty good over the years – without having to join the perpetually-troubled defined benefit option. New members are paying the normal cost of their own pensions, and not paying off the previous unfunded liability. PERA doesn’t need their contributions to get to full funding.
That means that such an option could pave the way to the best possible long-term solution to the state’s public pension problem, the holy grail of pension reform – a gradual transition away from a defined benefit plan altogether, and to a defined contribution plan.
Joshua Sharf is senior fellow in fiscal policy at the Independence Institute, a free market think tank in Denver.
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