When the Employee Retirement System (ERS) was setup a “fund” or a “lock box” was created into which the State could deposit money to pay for the future liabilities to the beneficiaries. The thought generally is that one should deal with pension costs in much the same way one buys an annuity or contributes to a 401k i.e., fund it with contributions over time.

What has not been considered, however, is that:

*(1) a “fund,” by its nature, must be filled to a level beyond the normal expected expenses since the “fund” must always remain solvent and have a positive balance after expenses; and

*(2) a “fund” that is invested broadly in market financial instruments, such as the ERS, will make gains some years and have losses in other years (in fact, the legislation related to the ERS investment policy sets an 8 percent p.a. return as the expectation).

With a “fund” that has large balances there is also the temptation to “raid” the fund and use the monies to cover other short falls. In Hawaii, Act 100 (effective June 30, 1999) actually did “raid” the fund, depending on the definition of “raid.”

This Act used investment earnings by the ERS assets in excess of a 10 percent actuarial investment yield rate to reduce the state contribution requirements by $147 million and $50.6 million for fiscal years ending June 30, 2000 and 2001, respectively.

This “raid” of $197.6 million was, technically, not taking money but reducing contributions. Large fund balances can create incentives to use imaginative legislation to avoid a tax increase or an expenditure cut.

In lieu of a “fund” if the state elected to instead pay yearly just what the pension obligations totaled; then the annual budget cost would be a clear and predictable number each year neither subject to political whim (e.g. raid) or investment outcomes (beneficiaries are known and expenses can be easily forecast one or two years out with great accuracy).

Annual retirement payments to retiree