As Gov.-elect Larry Hogan and his team begin tackling the state's budget, they will soon turn their attention to one of its most pernicious challenges: Maryland's underfunded employee pension system.
The $45.4 billion system, which provides monthly benefits to about 143,000 retired teachers, state police, judges and other former employees, is expected to gobble up a growing share of the state's budget in the coming years. The Maryland State Retirement and Pension System had only about 69 percent of the assets needed to pay for future and current retirees' pensions in the last fiscal year — well below the at least 80 percent target that many experts consider healthy.
Robert Neall, Hogan's fiscal adviser, called the nearly $20 billion unfunded liability in the state retirement system "an area of concern." Hogan's team has been busy putting together a budget to present to the Maryland General Assembly on Jan. 23, but Neall said the administration will soon begin examining the health of the pension system.
"That's going to require higher pension contributions [from the state] probably for two decades, that's why it's a concern," Neall said. "They are just facts that we have to contend with as we put together a fiscal '15 closure and a fiscal '16 budget to present to the General Assembly.
Maryland's pension system, fully funded in 2000, is now in worse shape than many across the country. State pension systems were 75 percent funded on average in 2013, according to investment advisory firm Wilshire Consulting.
And while the Maryland plan posted investment returns minus fees of 14.37 percent in the fiscal year ended June 30, earning $5.7 billion, it also underperformed the national average return for large state pensions of more than 17 percent. The state has set an annual target rate of return of 7.7 percent.
The state contributed $1.7 billion to the fund in this fiscal year, up from $670 million in 2005. The state's projected payment is expected to rise above $2 billion as soon as the 2018 fiscal year.
Many public pension systems across the nation took a hit in the recession, prompting cuts to retiree benefits or extending the length of time employees must work before they are eligible to get benefits. In Detroit, public pension liabilities shared much of the blame for the city's declaration of bankruptcy. In Baltimore, Mayor Stephanie Rawlings-Blake introduced a pension overhaul in 2010 that included cuts to existing police and firefighters' benefits.
Underfunded pension systems "lead to higher costs in the long term," said Greg Mennis, who analyzes public pension systems across the country for Pew Charitable Trusts. "It can also impact employees in terms of future benefit cuts and can put a strain on government resources overall."
"Paying for unfunded liabilities puts pressure on state budgets and even with strong stock market returns in the last couple years ... it's still a much higher level of debt than we've seen in recent memory," Mennis said. "The first order of business is that the states pay their bills and make the full recommended contributions by actuaries."
Critics have taken aim at the investment plan's performance, including Jeff Hooke, an investment banker and a visiting fellow at the Maryland Public Policy Institute, who argues the fund has too much money in alternative investments such as hedge funds and private equity, which are considered risky. Hooke has testified before the General Assembly in the past for a switch to indexing the portfolio to stock and bond markets, instead of paying fees to multiple Wall Street money managers. In 2014, the state spent more than $329 million on investment expenses.
"The underperformance has been a minor disaster for the state budget," he said. "You have the ironic situation of the fund spending these huge sums of money to these managers to beat the market, and instead of beating the market it's underperforming it. It's a sad situation that I think the new administration should address."
Michael Golden, a spokesman for the state pension system, said reforms made to the pension system in 2011, including requiring most employees to contribute 7 percent of their salaries into the fund instead of 5 percent, put it "on the road to stability."
"We feel like were on track to get to the 80 percent funded ratio by 2024; we think that's a good track to be riding on," Golden said. "We have no plans at this moment to do anything differently."
Robert Burd, the retirement system's acting chief investment officer, said the board chose to reduce the percentage of money invested in stocks — about 39 percent was invested in stocks in 2014, less than most other states — after the recession because of concern about risk. While Maryland has not enjoyed as much of a benefit from the rebound in the stock market, Burd said, the change leaves the fund less exposed to future downturns.
"That's why we don't look as good as some of our peers do when it comes to rankings," Burd said.
The 2011 reforms also included a promise that the state would contribute an extra $300 million to the fund annually. Last year, legislators approved a move by Gov. Martin O'Malley to divert $100 million of that promised money to plug other budget holes, but mandated that the state eventually return to making the full $300 million payments.
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Maryland Treasurer Nancy K. Kopp, who chairs the board overseeing the pension fund, declined to comment though an aide, who referred questions to Golden. Last year, she and Maryland Comptroller Peter Franchot, the vice chair of the pension board, spoke out against the proposal to divert the promised money from the pension fund.
Union representatives criticized the cut and believe the full payment should be restored, but Jeff Pittman, a spokesman for the Maryland chapter of the American Federation of State, County and Municipal Employees, said he was not alarmed by the health of the pension system, which pays an average monthly benefit of $1,324 for an employee with 15-20 years of service.
His advice for Hogan regarding the pension system? "Do nothing. Leave it alone."
"It has grown over the last few years," Pittman said. "They should find a way to keep putting more and more of our money in it and let it grow. We all want to see our pension fund more robust but it's not unhealthy right now."