Hawaii Employees Retirement System $6.2 Billion in the Hole – Will Taxpayers Have to Make Up the Difference?

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By Laura Brown and Malia Zimmerman

David Shimabukuro, head of the Hawaii public Employees Retirement System (ERS) for 28 years, spent his last hours on the job June 30, 2010 reminiscing on the ups and downs he’s faced for nearly three decades as the administrator for what has become a $10 billion trust.


The trust has made all of the pension payments since opening in 1920, overcoming challenges through several major world events, including wars, economic downturns as devastating as black Monday in 1987, the September 11 terrorist attack and the current recent recession.

While Shimabukuro emphasizes that the fund is stable for now, he and his replacement, administrator Wesley K. Machida, note there are great challenges ahead, particularly because the Hawaii Employees’ Retirement System (ERS) is facing $6.2 billion in unfunded liabilities.

According to the Pew Center of the States, The Trillion Dollar Gap: Underfunded State Retirement Systems and the Road to Reform, the Hawaii ERS has one of the greatest burdens in the nation relative to the size of its payroll and population, with an unfunded liability of one and one-third times the amount of its payroll in fiscal year 2008.

This incredible unfunded liability burden has landed Hawaii on public retirement watch lists, including CNN Money, which noted in a May 2010 article, “Pension funds in at least seven states — Illinois, Louisiana, New Jersey, Connecticut, Indiana, Oklahoma, and Hawaii — could dry up by 2020.”

Both the former and current administrators maintain they have a plan to catch up to ensure they can continue to cover the retirement benefits for some 38,000 retirees and the more than 110,000 eligible people in the public retirement system.

So What’s The Problem?

The fund’s unfunded liabilities burden exploded in recent years, but in reality, this has been an ongoing battle says Shimabukuro since the ‘60’s, in large part because of the unique way Hawaii’s government has affected the fund.

For example, the state legislature has raided and transferred money while the city and county of Honolulu did not make required payments to the fund.

In 1967, a unique funding formula set up by Hawaii lawmakers and approved by the governor, began to drain the State and County’s contributions for the general fund, leaving just the 8 percent of investment returns in the fund as mandated by law.

The “excess” interest earnings went to cover a ballooning city and state operating budget instead of remaining in the fund so investments and interest could be optimized.

So while every other retirement fund across the country was using the economic good times to boost revenue for their retirees through returns on their investments, the ERS managers and board watched as their fund was depleted each year for 38 years, with $1.687 billion skimmed, according to ERS administrators.

The money was used for everything from building parks, paying salaries, to funding lawmakers’ favorite social programs and charities.

Then a combination of factors, including a poor investment market, a Hawaii State law that mandates the actuarial assumption at 8 percent return on investments, the generosity of benefits provided, and accounting practices that don’t record pensions when earned, worked against the best intentions of the trustees in charge of the fund.

Now they have to play catch-up to cover the $6.2 billion in unfunded liabilities.

The good news, administrators say, is the legislature and Gov. Linda Lingle addressed in 2005 the financial pension crisis by passing another law that says the fund can no longer be raided to balance the state budget.

Balancing the Budget on the Backs of Future Generations

For decades, the Legislature claimed to have a “balanced budget” according to State law, but legislators actually were using “excess” interest earnings from the public sector pension fund to supplement the general fund.

This is the way it worked: the State would expense, on the books, 100 percent of the total amount due to the fund as the employer contribution, while employees would pay their proportional share.

But then, the general fund would be “credited” all ERS investment income over the legislatively mandated interest rate – currently at 8 percent.

For example, if the State owed $200 million in pension contributions to the fund and excess interest earnings that year were $100 million, the cost to the State for contributions would only be $100 million.

Put simply, the State and Counties – the “employers” – were paying their legally mandated share of benefits.

But the government then, in essence, got a “kickback,” which lessened its overall costs and allowed those funds to be used for other purposes.

ERS administrators say that if total earnings on investments had been retained by the pension fund, the $1.687 billion taken over the years would have been the equivalent of over $4 billion today and the pension fund would be much closer to being fully funded.

Now, taxpayers, who fund the State’s portion, must pay higher costs to cover unfunded liabilities. And active public sector employees must pay a higher percentage of their wages to help pay for their predecessors’ retirement as well as their own.

Public Sector Employees Fight Back, Forcing Changes in Pension Funding

In 2005, the State and Legislature voluntarily stopped diverting ERS’ excess investment earnings and adopted a new funding methodology.

Public employees sued the State over Act 100, passed in 1999, that authorized the State to take the excess of 10 percent investment earnings from 1997-98 and diverted $347 million in contributions.

The Hawaii Supreme Court ruled in the plaintiffs’ favor in 2007.

However, the court did not issue an injunction against the State’s practice. And the State vowed to fight the court’s ruling.

Former administrator Shimabukuro notes in the 2009 report, “The new percentage of payroll funding methodology that was implemented in July 2005 and the moratorium on retirement benefit enhancements will strengthen the ERS financially over the long term. “

The ERS management has its critics including some lawmakers and outside actuary experts.

Some of the criticism includes that the annual required contribution (ARC) from the 1930s to 2005 was based on an Accepted Actuarial Funding Method (AAFM).  After 2005, the legislature eliminated that requirement.

The Government Finance Officers Association (GFOA) recommends that the cost of benefits should be reported in accordance with generally accepted accounting principles (GAAP) and public employers should pay100 percent of the annual required contribution.

As of FY2009, taxpayers owed government employees $17.6 billion for benefits earned to date.

In 2007, the Legislature increased employers’ contributions and enacted a moratorium on retirement benefit enhancement proposals through January 2011.

Hawaii Delegation Pushed for Amendment to the Federal Pension Protection Act of 2006

A new hybrid contributory plan was implemented by the ERS in July 2006 to provide members with enhanced benefits as compared to the noncontributory plan.

Administrators say they worked with several national public pension plan organizations and the Hawaii Congressional delegation to secure federal legislation to allow for the upgrade of members’ past Noncontributory Plan service credits from the 1.25 percent benefit multiplier to the 2 percent benefit multiplier under the Hybrid Plan.

An IRS ruling against the practice gave impetus to these changes. “Our efforts were successful as a special amendment was included in the federal Pension Protection Act of 2006, which enables Hybrid Plan members to use their deferred compensation and tax-sheltered annuity monies to pay for the upgrade,” say ERS administrators .

By collecting enhanced payments now from Hybrid Plan members electing to upgrade their membership service, fund assets will increase. However, benefit payments will be higher once those members retire.

Despite Improvements, Pension Fund is Decreasing

The newly released 2009 ERS Actuarial Valuation Report reveals that the fund’s net assets decreased from 10.8 billion to $8.8 billion in fiscal year 2009.

The trust fund provided $839 million in pension payments to retirees last year and is projected to pay out $1 billion by 2012 to keep up with Hawaii’s aging work force.

On March 31, 2008, the ERS’ total membership of 108,696 was comprised of 66,589 active members, 36,260 retirees and beneficiaries, and 5,847 inactive vested members.

Despite an increase in the both State and employee contribution rates, payouts exceeded contributions by over $75 million last year.

Other factors beyond the diversion of assets by the Legislature have put the fund on shaky ground, according to the report.

  • Hawaii’s retirees live longer than average and so receive benefits over a longer period of time.
  • Funding future payments are based on estimated annual pay increases, but the Legislature has funded much larger worker pay increases than anticipated.
  • The number of retirees is growing, along with increased payments.

The report also states that the fund carries $534 million deferred investment losses, which will decrease the funded ratio and increase the funding period over the next three years without an offsetting actuarial gain.

Administrators also note that despite severe investment losses of as much as -17.5 percent in FY2009, the period between July and December 2009 posted gains of 15.3 percent, helping to offset the earlier decline in stocks.

So What’s the Plan?

Part of the strategy ERS administrators say is to hire qualified investment companies to act on their behalf (they have 34) and to continue to diversity their portfolio.

The diversification aspect is important especially in light of the sometimes-volatile stock market.

For example, in recent weeks, a number of pensions across the country including Hawaii have come under criticism because of their holding of BP Oil and other petroleum stock, which are taking a significant hit since the April 2010 gulf oil spill.

In Hawaii, the BP investment was at $19,912,533, but now as of June 14, 2010, amounts to $11,845,090. However, since that is less than 20 percent of 1 percent of the ERS’ $10 billion portfolio and they expect the value will rebound before stocks are sold, they maintain the loss is on paper, and not actual.

What does this have to do with the Taxpayers and Why Should They Care?

The ERS plan and strategy relies heavily on a hands-off policy by the Legislature and counties, or the unfunded liability and their ability to pay retirees without raising taxes or raiding special funds will be in jeopardy.

Ultimately, whether or not investments return a positive yield, taxpayers are obligated to pay all government workers’ pension benefits as promised through collective bargaining agreements.

Taxpayers will pay benefits when they become due, regardless of whether the fund is solvent or not.

Legislators are able to promise benefits to public sector unions. But to pay for those promises, they mandated a high return on investments, which allowed for a lower state annual contribution.

Also, the Legislature increased the percentage of payroll on today’s workers to help pay for retirees. However, deferring costs to future taxpayers means that the bill will ultimately become due.

Hawaii isn’t the only state with underfunded liabilities. A new joint study released by the Foundation for Educational Choice and the Manhattan Institute for Policy Research, “Underfunded Teacher Pension Plans: It’s Worse Than You Think,” by Josh Barro and Stuart Buck, reveals nearly $1 trillion in unfunded teacher pension liabilities in 59 funds nationally.

The study shows Hawaii at 67 percent funded, but after adjusting for the discount rate and figuring market value the fund is only 47 percent funded.

The solution for states, the authors say, could be to put employees into a hybrid or defined contribution model like a 401(k).

Hawaii Gov. Linda Lingle said during the April 2010 Milken Institute Global Conference in Los Angeles said, “Until the public rises up and says, ‘Enough is enough, you have to stop this spending,’ it won’t stop, and our quality of life will degrade.”

Laura Brown and Malia Zimmerman of Hawaii Reporter co-authored this report





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  2. What a ponzie scheme this was. Very reminiscent of what our Progressive Federal Congressional Representatives did under the Social Security Act of 1965.
    This scheme is on the same level of the convicted financial planner Bernie Madoff milking billions of dollars from investors’ retirement savings. So, why are we not seeking indictments of our State Legislators or for that matter, Congress?

  3. Three years and no comments, sounds like all the employees are walking on egg shells. I believe when the program was developed that it had stipulations. To bad Beijing does not have rule here, all those guilty of removing funds shall receive death sentences. Confiscate all their assets and their beheadings will take place in 30 days. What are the odds of the money returning or will Hawaii become a gambling state in the future.

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