State pension fund must plug huge hole

OLYMPIA — Just as lawmakers are starting to tussle with the biggest budget deficit in decades, more bad news: During the next six years, the state will likely have to pump hundreds of millions of dollars into public employee-retirement funds to make up for huge losses on Wall Street.

As the stock market soared through the late 1990s, huge investment gains enabled the state to sharply reduce pension-fund contribution rates, both for government and its employees.

That meant big budget savings for the state and de facto pay raises for public employees, including teachers and state and local government workers.

But the party's over. After two straight years of retirement-fund losses on the stock market, the state must start cranking up pension rates.

In the next six years, many public employees will see their contribution rates grow more than fivefold and the state's retirement-fund costs will balloon by more than 1,000 percent, according to new projections by State Actuary Matt Smith.

"It's staggering," said House Appropriations Chairwoman Helen Sommers, D-Seattle. "These are very, very large increases."

Gov. Gary Locke wants to ease the blow by adopting a new method of calculating contribution rates. But under either that method or the old one, Smith said, the rates at which the state and employees contribute to the pension funds will soar.

During the next two-year budget, which begins July 1, the state will pay $100 million to $200 million to cover its retirement-fund obligations.

The costs will grow to more than $700 million in the following budget, and then to more than $1.2 billion in the budget after that. These projections assume average historical investment returns from the stock market.

The figures were particularly jolting for some lawmakers, who are still in the early stages of trying to plug a $2.4 billion shortfall in the next budget.

Meanwhile, news of the increases is not likely to sit well with state workers and school employees. Thanks to the budget mess, state workers did not get cost-of-living raises this year, and Locke has proposed suspending raises for teachers in the next budget. Public employees also have been forced to pay a bigger share of their own health-insurance costs, and many face possible layoff.

"It's like a quadruple whammy," Greg Devereux, director of the Washington Federation of State Employees, said after hearing about the pension projections.

The state oversees 10 separate public-employee pension funds.

To make sure it will be able to cover each employee's retirement benefits in the future, the state relies on a combination of investment earnings and employer and employee contributions. More than 40 percent of all the retirement money is invested in U.S. and foreign stocks.

Any changes in contributions would affect most of the 283,000 current employees, not those already retired and collecting their pensions.

To some extent, the public-employee pension rates are now simply returning to normal.

The rates held steady throughout much of the 1990s.

During that time, for instance, the state's contributions to Public Employee Retirement System (PERS) plans averaged slightly more than 7 percent of each employee's salary. Employee contribution rates hovered between 4 and 5 percent of pay.

Then the stock market surged during the last half of the decade, and the average annual returns for the pension funds were more than double the 8 percent the state assumes it needs over the long term. By 2000, fund assets had grown to a combined $47 billion.

So the state began reducing contribution rates in 1999. By 2001, the state's share for PERS had fallen below 2 percent. Many employees contributed less than 1 percent of their pay.

The reduced rates freed up hundreds of millions of dollars for state budget writers to use elsewhere and meant more take-home pay for workers.

"Unfortunately, now we're on the other side of the coin," Smith said yesterday during a briefing for the Senate Ways and Means Committee.

During the past two fiscal years, the pension funds suffered back-to-back losses of more than 6 percent — their first losses since 1984. Assets have fallen to $37 billion.

Nationwide, state employee-retirement funds lost more than $150 billion in the fiscal year ending June 30, according to Federal Reserve data.

To make up for losses and keep future retirement benefits on track, Smith says the state's share of PERS contributions will have to rise to about 8 percent within six years, and employee rates will climb past 4 percent.

Teachers face even steeper contribution increases because of the way their plans are structured.

Many teachers who now pay barely anything in pension costs — in some cases less than a quarter of 1 percent — will see contribution rates grow to nearly 6 percent, Smith said.

Devereux and Charles Hasse, president of the state teachers union, said Locke and lawmakers blew it by reducing the state's contribution rates so far when the stock market was surging.

"They used hundreds of millions of dollars in pension gains to cover budget holes," Devereux said. "Now they're paying for it."

Devereux said lawmakers also used the big investment earnings to cut employee contributions rates, hoping it would dampen employee anger over not getting pay raises.

Though the looming contribution increases won't add to the state's budget crisis, it will likely affect lawmakers' approach to solving the deficit.

"With this news, I don't see how they can get out without raising (taxes)," said Devereux.

Senate Ways and Means Chairman Dino Rossi, R-Issaquah, agreed the state probably shouldn't have drawn its pension contributions down so far.

But instead of being a reason to raise taxes, he said, the pension problem adds urgency to what he views as the Legislature's top priority — to rein in spending.