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State Retirement Costs Eat Bigger Piece of Funding Pie

As a funding gap in the state retirement system has opened up in recent years, the burden of narrowing the gap has been placed disproportionately on South Carolina taxpayers, records from the state comptroller general’s office show.

This has resulted in retirement costs consuming more of the dollars available for roads, education and other state government services.

For their part, state employees have not been held totally harmless as this has happened.

But as the retirement system’s funding problem has worsened, taxpayers have been forced to pick up an increasingly larger share of the tab for keeping the system financially sound.

This has further strained state services already stretched by the Great Recession.

Three sources fund the retirement system: a multibillion-dollar investment portfolio and whatever money it makes; contributions from state employees; and contributions from state agencies, or taxpayers.

Under state law, the General Assembly sets the contribution rate for state employees.

But the five-member Budget and Control Board – the governor, state treasurer, comptroller general and the chairmen of the House and Senate budget-writing committees – determines the rate for agencies.

In both cases, the rates are a percentage of an employee’s gross income, and the employee’s contributions are taken out of each paycheck.

Since fiscal year 2004, the employee rate has been increased twice – from 6 percent to 6.25 percent in 2005; and then to 6.5 percent in 2006, according to the records from Comptroller General Richard Eckstrom’s office.

That’s a total increase in the employee contribution rate of 8.3 percent since fiscal 2004.

By contrast, the state’s contribution rate has been raised five times in that same period, from 7.7 percent to 8.2 percent in 2006; then to 9.21 percent in 2007, 9.39 percent in 2008, 9.54 percent last fiscal year and 9.68 percent this budget year.

That’s a total increase in the state’s contribution rate of 25.7 percent since 2005.

Thus, in addition to the state’s rate being upped five times compared to twice for employees, the state’s rate has been increased more than three times that of employees’ – 25.7 percent versus 8.3 percent.

Given those numbers, Eckstrom asks, “Why does the state not require a little more of the beneficiaries?”

That is just one of many questions facing state lawmakers as they contemplate ways to get the retirement system’s funding problem under control. With the Legislature adjourned until January, House and Senate panels are meeting off and on to try to come up with proposals to address the issue.

Last week, they learned that the picture is much worse than many had believed.

In a recently released draft report, the Michigan-based Gabriel, Roeder, Smith & Co. actuarial consulting firm said the gap between the state retirement system’s assets on hand versus benefits promised – its unfunded liability – totaled more than $17 billion at the end of fiscal 2010.

That’s $3.63 billion more than what another actuarial consulting firm, Cavanaugh Macdonald, has reported – $13.37 billion.

The unfunded liability stood at just $178 million in 1999, according to the data from Eckstrom’s office.

State law requires an annual evaluation of the retirement system’s assets and liabilities.

The Budget and Control Board (BCB), whose five members act as trustees of the retirement system, most recently has been using Cavanaugh Macdonald to conduct the reviews. The firm has offices in South Carolina and three other states.

But after Cavanaugh Macdonald’s report for 2010 came in, Eckstrom says he questioned the firm’s numbers and pushed for the BCB to recruit an extra set of eyes to take a second look.

The state is paying $250,000 for the second-opinion study, plus $285 per hour for any extra work Gabriel, Roeder, Smith performs at the BCB’s request, according to Budget and Control Board spokeswoman Lindsey Kremlick.

“It was worse because of assumptions that Gabriel, Roeder, Smith recommended against,” Eckstrom says of the firm’s draft report.

The two biggest assumptions that the two consulting companies differed on are the expected rate of return on the retirement system’s investments, and expectations for how long retirees will live and continue drawing benefits.

Gabriel, Roeder, Smith recommends lowering the projected rate of return from 8 percent to 7.5 percent while extending life expectancy estimations for retirees.

Revising those two calculations accordingly accounts for more than $2.2 billion of the $3.63 billion increase in the retirement system’s unfunded liability, according to the Gabriel, Roeder, Smith report.

Governmental accounting standards say the payoff period to cover the funding gap should not extend beyond 30 years.

South Carolina’s $17 billion unfunded liability would take more than 60 years to cover, the Gabriel, Roeder, Smith report says.

This is where employee and state contribution rates factor into the equation.

The increases in the rates have pumped more money into the retirement system and helped keep the amortization period for its unfunded liability at the 30-year mark.

But state taxpayers have shouldered the majority of the load as this has occurred.

The result is that retirement costs have consumed a bigger and bigger share of the funding pie that gets divided among state agencies each year, because once the Budget and Control Board sets the state’s contribution rate, it is locked in and the Legislature must budget accordingly.

Take the Department of Mental Health as an example.

The department’s total retirement costs went from $20.4 million in fiscal 2007 to $22.4 million in 2008 to $23 million in 2009, according to figures from the agency’s general counsel, Mark Binkley.

Mental Health’s retirement costs dropped to $21.4 million in 2010 as the department’s funding, like that of most if not all agencies, was reduced during the recession.

But in 2011, the Department of Mental Health again saw its retirement costs go up. It was a nominal amount – about $43,000 – but it increased even as the department’s funding went down for the second consecutive year.

Higher retirement costs can have a more dramatic impact on an agency like the Department of Transportation.

While the DOT is grappling with its own self-inflicted cash management problems, the agency nonetheless receives only a tiny fraction of its more than $1 billion annual budget from the Legislature in the form of appropriated general funds.

“So, for every dollar the state increases, say, employer (retirement) contributions, then DOT has to take that out of, say, our highway funds,” says Transportation spokesman Pete Poore.

Eckstrom says the fact that the state’s contribution rate has been increased repeatedly in recent years indicates that the retirement system “has some structural problems – that the current costs can’t be managed.”

The question is: What, if anything, will the Legislature do about it?

Reach Ward at (803) 254-4411 or eric@thenerve.org.

State Retirement System