The PERA Fire Sale, The Gift That Keeps On Taking


Over at the Denver Post, Vince Carroll details the price that PERA has been paying for its “fire-sale” of pension benefits from 2001-2005:

There are many PERA beneficiaries like Coffman who bought years of service — often at a very advantageous discount — and who now receive pension checks larger than you would expect based upon the span of their careers.

A large number of those transactions occurred over a three-year period a decade ago, when “PERA conducted what one executive called, in retrospect, a ‘fire sale’ on the service credit,” according to a 2005 analysis by the Rocky Mountain News.

The administration of Gov. Bill Owens, in a major blunder, lobbied for the fire sale as a shortsighted way to encourage early retirement and infuse new blood into the bureaucracy.

As Carroll notes, this problem was known as early as 2005, when David Milstead of the late, lamented Rocky wrote about it:

But the deal got sweeter. Gov. Bill Owens, then in the early part of his first term, wanted to streamline government and bring new employees into the state work force. In 2000, with his encouragement – some say pressure – PERA cut the already-low price of purchasing extra years by 14 percent, to 15.5 percent of salary.

Owens said he doesn’t recall the specifics of what was said to PERA, but “I thought it was valuable to have the flexibility to get new employees into some of the positions in the state bureaucracy.”

Service-credit purchases kicked up by 38 percent in 2001, topping $100 million.

PERA decided to raise the price back to 18.1 percent of salary for members under 50 and increase it to 22.1 percent for older members. But they told employees it wouldn’t happen until November 2003.

Given that window, thousands of employees raced to the sale.

Indeed they did.  In 2002, PERA’s income to its State and School Division from Purchased Credit exceeded its income from regular employee contributions.   In 2003, PERA got almost half of its income from Purchased Credit, according to its own CAFRs:

It also calls to mind an excellent article by Josh Barro in National Affairs,Dodging the Pension Disaster,” where he suggests a way (perhaps) to actually reduce the unfunded liability after a defined benefit-to-defined contribution transition:

A working paper by Maria Fitzpatrick, a fellow at the Stanford Institute for Economic Policy Research, attempts to determine just how highly some public employees value their pension benefits. She examined Illinois teachers’ choices when, in 1998, they were offered a chance to make a one-time payment up front in exchange for more generous benefits in retirement. The terms of the purchase varied significantly depending on a teacher’s salary and years of service. Using reasonable discount rates, the up-front purchase cost was lower than the present value of benefits for nearly all teachers — 99% could expect at least a 7% annual return on investment, with no risk so long as the state did not default. But the deal was sweeter for some teachers than for others, a variation that made it possible to estimate the subjective present value that teachers placed on future benefits.

Fitzpatrick’s finding is, in a way, depressing: On average, teachers were willing to pay only 17 cents on the dollar to obtain a pension-benefit increase. This suggests that defined-benefit pensions are a highly inefficient form of compensation, costing taxpayers far more than they are worth to public employees.

But it also suggests an appealing policy solution: Governments can offer to buy back promised pension benefits at a discount, and employees may be inclined to take the deal. Admittedly, the proposal presents a political problem to lawmakers, in that it requires them to produce an immense sum of cash up front in order to eliminate a long-term liability. To alleviate some of that pain, however, governments could responsibly issue bonds to raise the money — since this would mean simply substituting explicit debt for a larger amount of implicit pension debt. Governments would incur an obligation to pay interest on the bonds, but in most cases that amount would be more than offset by the reduction in required employer pension contributions.

In Colorado’s case, the price was about 15.5 cents on the dollar, but there was huge interest, so a fair price may be considerably higher than that.  Add to that the fact that people are often less willing to let go of a perceived cash benefit than they are to buy it in the first place, and there’s reason to think we can’t possibly buy it back for 15.5%.  Still, having a limited-time “open season” market, or Dutch auction, with a declining price, might be a way of disposing of some of the liability.

Barro goes on to note that there’s a federal early-withdrawal penalty for taking such a buyout, but that it can be avoided by rolling the payout over into an IRA.  Given that many of these purchases were made with IRA, 401(k), and 457(b) money in the first place, waiting to see retirement money until retirement hardly seems unfair.

PERA’s the price for purchasing service credit has since returned to reasonable levels, we’ll be living with the cost of selling long-term debts cheaply for a long time to come.  At this point, it’s almost impossible to tell how much of PERA’s long-term debt obligation comes from this sale; I can’t find aggregate numbers in the CAFR, and the charts above show only the price paid, not the goods sold, but it certainly warrants further investigation.