The debate in Annapolis about whether the state should immediately shift from the "corridor" method for determining its annual contributions to its main pension systems for government employees and teachers back to the "actuarial" method doubtless sounds pretty esoteric and confusing. It is. But the political principle at work is pretty simple: When the corridor method allowed lawmakers to justify saving less to cover long-term liabilities and spending more in the short term, that's what they used. Now that the actuarial method is cheaper in the short term and worse in the long run, they're eyeing it instead.
Actuarial funding is the traditional way Maryland funded its pension system. A somewhat simplified explanation is that it requires the state to annually figure out the cost of the pension benefits its workers have earned and how much of that expense has been covered by investment returns and employee contributions. The state kicks in the difference. But in 2002, Maryland adopted a different model, known as the "corridor" method. It froze state pension contributions at their levels at the time, unless the system fell below 90 percent of the funding it would need to meet its obligations. Then, the state's contributions would have to be increased to cover 20 percent of the difference between the previous year's rate and what would be needed under a traditional actuarial system.
In theory, the corridor method smooths out the state's contributions even more than standard accounting practices would allow, but that wasn't why the state adopted it. In 2002, then-Gov. Parris N. Glendening flat-funded the state's pension contributions in his budget proposal despite the need, under the actuarial method, to increase them. The legislature cannot increase spending in a governor's budget, so it couldn't make up for the under-funding. But what it could do was adopt a new funding theory that had been floating around Annapolis, which had the effect of making the problem go away, at least on paper.
In reality, though, it led to years of insufficient state contributions, and Maryland's main pension funds fell far below the level they needed to cover projected benefits. In 2011, then-Gov. Martin O'Malley pushed a series of pension reforms through the legislature that cut workers' eventual benefits and increased their current contributions. He pledged to reinvest some of the savings — $120 million in each of the first two years and then eventually as much as $300 million annually — back into the system, with the goal of restoring it to 80 percent funding by 2023 and to 100 percent funding about 15 years later.
But as time went on, those over-payments proved too tempting for Annapolis appropriators. Last year, Mr. O'Malley proposed siphoning off $100 million a year to help balance the state's books. Legislators did him one worse, grabbing $200 million to spend now rather than save for later. The justification was that doing so wouldn't push back the state's goals for achieving 80 percent or 100 percent funding by much, and the legislature proposed gradually ramping the overpayments back up to $300 million.
We opposed the idea at the time, saying that once the state broke its discipline in restoring its pension funds, it would forever be tempted to do it again. Well, guess what? That's exactly what's happening now.
Democratic legislators are, quite rightly, looking for ways to restore some of the funds Gov. Larry Hogan cut in his budget, and they've found another tempting justification to raid the piggy bank. Because of recent strong stock market performance, the difference between the cost of full actuarial funding and corridor funding has shrunk and is now less than the amount of the planned over-payments; thus, the Department of Legislative Services has recommended an immediate shift back to the actuarial method and the abandonment of the over-payments. By their reckoning, that would save the state $71 million next year and substantially more during the several years after that. The bond rating agencies have been tut-tutting the corridor method since its inception, the thinking goes, so dumping it now is a win-win.
Here's why it's a bad idea. The DLS plan may save money during the next few years, but over the course of the pension system's 25 year amortization, it would cost the state an added $2.5 billion. Making matters worse, the current thinking is that the pension switch would be used to restore the 2 percent cost of living increases state workers had been given by Mr. O'Malley, which Mr. Hogan took away. While there is a nexus between the issues of employee compensation and benefits, such a move would triply increase the state's long-term costs: higher eventual pension contributions because of the abandonment of overpayments; higher pension benefits down the road because of higher salaries; and higher state operating costs from now on.
More fundamentally, what legislators are contemplating — and Mr. Hogan, to his credit, is resisting — is a breach of trust with state employees. They swallowed the 2011 pension reforms on the promise that they would help secure workers' retirement. As much as we want the legislature to find ways to reverse some of Mr. Hogan's cuts, there must surely be some way to do it that doesn't involve breaking the same promise twice in two years.