BY KELSEY WINTHER – Imagine this scenario: You live next-door to a man with a nice job promising nice retirement benefits. Yet when he decides to retire, you are the one who will pay the bill. This is the situation for the retirement benefits of almost 14 percent of workers in Hawaii. While it seems logical for taxpayers to cover the benefits of public employees, this arrangement has given the state government a moral hazard to invest retirement funds in unwise and risky investments. There is little incentive for the managers of the Hawaii Employees Retirement System to insure solvency. Decisions are made by individuals with no interest in the financial success of the fund and the taxpayers who cover the losses have no say in the way funds are invested.
The Employees’ Retirement System (ERS) of the State of Hawaii provides pensions to state and county employees. In 2009, there were almost 68,000 active members in the plan[i]. The fund is managed by a board of trustees who calculate payouts and invest the funds. The Hawaii ERS obligates taxpayers to provide government employees a benefit defined solely in terms of their salary and years of service. It assigns taxpayers 100% of the investment risk, but gives them no investment control. The HERS plan is the opposite of individual account plans, like 401K plans. They obligate employers to make a specific contribution, and give investment control and risk to the employee.
At present the plan is woefully underfunded and the accrued liability has consistently grown each year. Though several factors could be blamed for this mismanagement, the shortfall is fundamentally the result of a systemic flaw in the structure of incentives. This paper will analyze how Hawaii’s retirement system got into this situation and how to halt the growth in the funding shortfall.
Unfunded liabilities are not a problem unique to Hawaii; states around the nation are accruing significant deficits in their state pension plans. Throughout the nation, state pension funds are underfunded by a total $3.23 trillion[ii]. This burden is falling on states with ever increasing budget shortfalls that are scrambling to keep up.
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Kelsey Winther is a former Summer Policy Fellow at the Grassroot Institute.