Public Pensions And Other Post-Employment Benefits In Hawai‘i Are Taking Up An Ever-Increasing Portion Of The State Budget.
Public workers and retirees make up 11 percent of the adult population of Hawai‘i. Nearly one out of every five adults aged 65 and older is a public worker retiree. Hawai‘i’s state and county governments employ more than 66,000 people who, if they meet eligibility requirements, will eventually receive pension and “other post-employment benefits” (OPEB) such as health insurance coverage in retirement. Over the years, Hawai‘i’s public retirement liabilities have grown as current and promised benefits have outpaced contributions and asset growth to cover them. These retirement costs are sometimes referred to as “unfunded liabilities,” which means that our obligations exceed the funds currently available to pay them.
In July 2018, the Hawai‘i Budget & Policy Center released its “Hawai‘i Budget Primer,” which pointed out that obligated, or “fixed,” costs are consuming an ever greater portion of the state general fund. These costs are made up of pension and other post-employment benefits, debt service, the state’s share of Medicaid costs, and active employee benefits. In Fiscal Year (FY) 2019, about half of all general funds were budgeted for these obligated costs, and retiree benefits will make up 40 percent of them.
In this report, we examine the public retirement benefits as a budgetary issue of interest to all Hawai‘i residents, and one that is crucial for policymakers to understand and address effectively. We also identify strategies available to meet public obligations responsibly and equitably.
Paying Public Retirement Costs
The number of public retirees that the State of Hawai‘i is responsible for is increasing, while the number of active employees contributing to the retirement fund has plateaued. Hawai‘i, like many other states, did not completely prefund retirement costs as it hired workers, and did not ensure that funds and earned income were left in place to accrue and offset future costs. Hawai‘i also did not adjust contributions soon enough to account for increased longevity (that is, costs to cover retirees who are living and consuming benefits longer), or for the escalation in health benefit premium costs.
To address mounting retirement obligations, Hawai‘i’s public employers have agreed to make actuarially determined payments over 30 years to pay down unfunded liabilities and grow the pension and health fund trusts that help fund future public contributions. These payments, which are largely supported by state and county taxes and fees, will be a sizeable burden in a small state like Hawai‘i. See Table 1, on page 8 of the report, for details on annual required contributions for all employers. The amount of money needed for retiree costs for FY2019 is $2.1 billion and is forecasted to reach about $4.5 billion in 2042 before easing back down to $1.5 billion in FY2045.1
Paying off accumulated benefit obligations reduces public spending in the long-run, since contributions increase assets that earn income to offset rising costs. They also reduce public spending by improving state and county financial ratings and borrowing rates.
Another Point of View
Accounting standards for pensions and other post-employment benefits increase uniformity and transparency for a significant public budgetary responsibility. However, the practices have been applied as if governments might be liquidated (like a private business) and charged with responsibility for paying off pensions for a defined set of workers currently on the books. However, unlike private businesses states and counties are established to operate indefinitely, with continuous pension contributions coming from workers and ongoing collection of revenues from taxes and fees.2
Governments can make good on pension and OPEB obligations indefinitely if annual contributions to the fund meet or exceed annual distribution (i.e. pension payments and retiree premiums). Contributions come from government employers, active employees and net investment income.3 The U.S. Government Accountability Office (GAO) reported that many pension experts identified a funded ratio of 80 percent as sufficient for public plans since public employers are not in danger of defaulting on pension obligations through bankruptcy.4
This point of view does not endorse abandoning the discipline of building retirement fund assets. We should continue to make payments that go beyond meeting annual distributions as much as possible because those assets are designed to lighten public contributions in the future. However, it is important to take an approach that balances sustainable retirement benefits with other crucial investments in the wellbeing of Hawai‘i residents.
We must never lose sight of the importance of covering pension and OPEB costs for the individuals involved, for the benefits to the state’s economy and for the sake of fairness. These are obligations we have made that add to a secure retirement for people who worked for us in the public sector.
Nearly all compensation benefits, whether salary rates, salary increases or fringe benefits, were established by agreement of the public worker unions, government employers, and the legislative branches of the public employer (that is, the state legislature and county councils). All of the benefits are obligations, historically promised. Moreover, since the money provided is most likely to be spent for short-term needs like rent, food, health care, and other consumable goods and services, it circulates through the economy and supports many other jobs. A recent study shows that 2014 Hawai‘i expenditures stemming from state pensions supported 9,000 jobs that paid $432.7 million in wages, $1.4 billion in total economic output, and $327.3 million in tax revenue.5
Over-Investing In Retirement Costs
Placing such a heavy and increasing burden on public funds is concerning for several reasons: Retiree costs are not the only important consideration for government budgets. Spending such a large portion of state and county funds on retiree costs makes it challenging to invest in other public needs such as affordable housing, education, infrastructure like roads and sewers and the environment. These latter investments help Hawai‘i’s economy and people thrive, so ensuring adequate contributions to them may yield a greater return than reducing unfunded liabilities.
Our currently healthy economy will slow down again someday and, when it does, tax revenues will be affected. Income tax collections will suffer if joblessness increases or wages stagnate. A recession will certainly affect tourism which generates an estimated 20–38 percent6 of general excise tax (GET) revenue and nearly all of the transient accommodation tax (TAT) revenue. In addition, during a recession, more state residents will need the support of public benefits, putting further pressure on reduced revenues.
Even without considering a recession, the projected annual increase in total personal income between 2015 and 2045 is expected to be between 1.8 percent and 2.1 percent.7 This will put a damper on tax revenue needed to support the annual required contributions (ARC) for retirement costs. Starting in 2020, these ARC payments are scheduled to increase by an average of 3.3 percent every year until 2043, when the liability will be largely amortized—that is, paid off—and rates will start to drop. At the high point of 2037, the contribution for both pension and health costs will equal 51 percent of payroll. However, by 2043 pension as a percentage of payroll will decrease to less than 5 percent and, by 2045, health care costs will decrease to less than 10 percent.8
It’s not just the longevity of retirees to consider. In addition, the proportional growth of Hawai‘i’s retirement-age population will outpace the increase of those of working-age. Between 2015 and 2045, the state population is projected to increase by 18 percent. However, the working-age group between the ages of 18 and 65 is set to increase by only five 5 percent, while the over-65 population will expand by 61 percent.9 As the ARC grows and the proportion of working-age residents shrinks, the burden of paying taxes and fees to support the ARC may exceed capacity. In combination with Hawai‘i’s continuing high cost of living, this could lead to further out-migration for well-qualified workers and limit economic growth. Figure 1 shows the projected annual per capita contributions required to meet actuarially determined payments over the 30-year span.
Dedicating a large part of state and county general funds to cover unfunded liabilities also leaves less money for active public employee salary increases and benefits. Hawai‘i’s state workers are paid less than their national peers: the average U.S. state worker pay is $48,436, while Hawai‘i’s is $37,999 after adjusting for the cost of living.10 (Hawai‘i’s county workers are paid on par with the national average after adjusting for cost of living differences.)
The promise of post-employment benefits may have served as a recruitment and retention tool in the past, but in a competitive employment environment like Hawai‘i’s, benefits 30 years in the future may not make up for low salaries in the present. Unfortunately, paying higher salaries not only adds to current payroll costs but increases liabilities since higher wages result in larger pensions. State and county budgetary commitments to annual required contributions may make it more difficult to fill positions with qualified workers who can efficiently and effectively carry out crucial public functions.
Finally, the experience of other states shows that overfunding retirement costs can result in an enrichment of benefits that cannot be sustained over time, or a reduction in or skipping of contributions.11