by Andrew Walden
As Governor Neil Abercrombie describes it, his administration’s efforts to fill a $700M or $841M budget gap constitute “salvag(ing) what we could of the wreckage left from an administration with a fundamentally different view of the proper roles and responsibilities of government.”
Pointing the finger of blame at Governor Lingle may be politically expedient, but it is plainly false. When it comes to the biggest hole in the State Budget—pension shortfalls--the blame lies with Act 100. Beginning in 1999, Act 100 allowed the Legislature during Cayetano’s second term to skim off the top of the Hawaii State Employees Retirement System (ERS) by cutting back on the State’s Annual Required Contributions (ARC) in years when investment income was high.
Hawaii Business Feb, 2011
In 1999, 2000, 2001 and 2002 the ERS was raided for hundreds of millions of dollars. The practice stopped when Lingle took office.
Act 100 irreparably damaged relations between the Cayetano administration and the government employee unions whose members elected him—a dynamic which now appears to be unfolding again under Abercrombie. In October, 1999, the UPW, HGEA, HSTA and Firefighters sued to challenge Act 100’s two year pay freeze and collective bargaining ban.
Two years later, Act 100 pension provisions became the subject of another lawsuit. Accusing the State of “skimming” from their pension fund, retired and active police officers on April 23, 2002 filed a class action lawsuit demanding return of $347M taken from the ERS. The plaintiffs would be joined by the ERS board itself in November, 2002. The ERS board was represented by Honolulu Attorney James Duffy who would later become Governor Lingle’s first Supreme Court nominee.
The class action filing drew a sharp response from State Senator Colleen Hanabusa, as reported in the April 24, 2002 Honolulu Star-Bulletin:
…State Sen. Colleen Hanabusa (D, Waianae) said she was perplexed by the lawsuit since state lawmakers, not the ERS or federal pension officials, set the level of funding for the retirement system.
Hanabusa said the retirement fund is not in financial danger, and there is no threat of reduced benefits for retirees and state workers as a result of the 1999 law.
"We determine how much people will be paid, we determine whether people have collective bargaining rights, we determine the whole gamut," Hanabusa said.
Hanabusa told the Advertiser:
"If retirees haven't gotten their benefits because of an act of the Legislature, that would be something else ... but as far as I know, all retirement benefits have been paid. The bottom line is we can always sell assets or raise taxes to fund it (ERS) if it ever became necessary, but I don't see that happening at any time."
While Hanabusa was “determining the whole gamut” and claiming the fund and its beneficiaries were in no danger, the police officers’ attorney described the problem in terms which today appear prophetic:
(Peter) Gruenstein, an Alaska-based attorney who specializes in pension fund litigation, noted that the ERS's unfunded accrued liabilities (benefits owed but not funded) have grown to about $991 million from $543 million largely as a result of the 1999 law.
He said the law also has deprived the ERS of a sufficient level of funding that would allow employee pension contributions to be terminated or decreased.
"It's not far-fetched to believe that in five, 10 or 15 years, the system will be in jeopardy," he said.
"It would be naive to believe that state of Hawaii could, year after year, raid this fund and use the assets of the fund without ultimately jeopardizing its integrity."
The Act 100 pension raids were not the first time that “pro-labor” Hawaii Democrats had looted ERS. Under a 1967 law repealed in 1997, the Legislature could skim anything over 8% ERS investment gains in any given year. As retired police officer Earl Arakaki explained in a June 4, 2001 letter to the editor of the Honolulu Advertiser:
It doesn't take an economics genius to figure that the ERS could weather economic hard times had politicians, prior to 1997, not balanced the state's budget by skimming $1.3 billion from ERS investments.
In 1997, politicians promised to halt the skimming, only to return in 1999 with Act 100, allowing the skimming to continue one more time, further weakening the ERS.
The weakening effects were felt last year by retirees when Gov. Cayetano eliminated their five-year pension adjustment. This year, claiming that changes were needed to continue funding healthcare, politicians passed the Employer-Union Health Benefits Trust Fund bill to balance the state budget. This may cause retirees to increase their co-pay or have to accept less medical coverage.
Gruenstein’s analysis is finding an echo nine years later. Wes Machida, the current ERS Administrator, interviewed by Hawaii Business February, 2011, lays most of the blame for the ERS shortfall on Act 100 and describes how Governor Lingle put an end to the raids:
(ERS Administrator Wes Machida) ascribes most of the increase to an old rule that allowed legislators to seize any annual earnings over 8 percent and apply them to the state’s Annual Required Contribution (ARC). In 2001, the worst year, the state used approximately $150 million of these “excess” earnings to help balance the budget. Between 1999 and 2003, according to Machida, more than $350 million in excess earnings were diverted from the pension system. “In 2004, with the assistance of (then) Governor Lingle, we introduced legislation to take that away,” Machida says. But the damage has been done. “If that money had not been taken,” he says, “the system today would be almost fully funded.”
Hanabusa and Cayetano’s investment in failure has paid off 20-fold. The initial $350M shortfall is now estimated at a minimum of $7 billion dollars. How did the shortfall multiply? By selling assets, just as Hanabusa suggested in her 2002 comments to the Advertiser. Hawaii Business explains:
…the effect is a vicious circle: When current income and contributions aren’t enough to pay current benefits – a condition that began in 2006 and is projected to accelerate rapidly for the next five or six years – the only option is to sell off portfolio assets to cover the difference. In 2011, the ERS is projected to cannibalize nearly $200 million in portfolio assets; by 2020, that figure could reach $600 million a year. That’s the opposite of a “pre-paid pension fund.”
… because of the arcane rules governing actuarial accounting, those figures don’t fully incorporate the system’s huge market losses in 2008 and 2009. Consequently, an additional $1.5 billion will be added to the state’s unfunded liability over the next two years. This means the state’s legally required contribution to the pension system will increase to more than $671 million a year by 2015….
…the actuary’s report to the ERS board in December included some startling language. Under the heading, “What does this all mean?” the report states: “If the assumptions are met for all years beginning July 1, 2010, and the current contribution policies remain, the system is not expected to run out of money. But it is very close.” Worse still is how long the actuary says it will take to fully fund the system, given the same set of assumptions: never.