Pension perk may cost state billions

OLYMPIA — A state pension perk passed by the Legislature nearly eight years ago, with the expectation that it would cost nothing, could sock taxpayers for billions of dollars.

The cost has become too big for lawmakers to ignore, and a push is expected this coming legislative session to either eliminate the benefit, which rewards pension members after a hot streak in the stock market, or replace it with something cheaper.

The state actuary estimates that Washington has about a $4.9 billion hole in its pension system. State and local governments are on the hook to make up the shortfall. Nearly half of what's owed can be tied directly to the benefit in question, called gain-sharing.

The Legislature, which reconvenes in January, may set aside several hundred million dollars to help deal with the overall pension shortfall. It's one of the biggest expenses lawmakers face and represents money that could instead go to education, health care and other programs.

The cost of the gain-sharing benefit irks legislators because they thought it would be free.

Gain-sharing "seemed like a good idea at the time. For some reason, we did not understand it was going to cost us," said House Appropriations Chairwoman Helen Sommers, D-Seattle.

"Given my background and experience, I must say I don't know how I could have ever believed that it wouldn't cost something. ... It's expensive," said Sommers, one of the sponsors of the law creating gain-sharing and an expert on the state pension system.

State worker and teacher unions are lining up to defend the benefit, which beefs up retirement checks when pension-fund investments do better than expected. The pension system has paid out more than $1 billion since 1998 because of gain-sharing.

Union leaders say that if the Legislature gets rid of gain-sharing, it needs to come up with a good replacement or lawmakers will have a fight ahead. "It's not appropriate to be looking at ways to diminish those benefits," said Charles Hasse, president of the Washington Education Association.

Gain-sharing was approved by lawmakers in March 1998 near the peak of the stock-market boom, when double-digit returns from pension-fund investments seemed commonplace.

So the Legislature OK'd a proposal that increased public-pension benefits when investment returns exceeded expectations. Basically, the law says that when the average rate of returns exceeds 10 percent over four years, half of any excess over 10 percent goes to state workers through the pension system.

For some workers, that means a bump in their pay if they're already retired, or an increase in their future pay if they're still working. For example, some retirees with 30 years of service received a $137 annual boost after the last gain-sharing benefit in 2000. And that extra benefit goes up each year.

The other half of the excess cash gets plowed back into the pension fund to help protect against future downturns in the market. At the time the bill became law, proponents thought the stock market was performing so well the state would never be on the hook to cover gain-sharing benefits.

A bunch of things happened that proved them wrong, including the dot-com bust in 2000 and the economic turmoil that followed the Sept. 11, 2001, terrorist attacks.

Investment returns plummeted far below what the state expected. That created a shortfall in the amount of money needed to fully fund the pension system.

The way the gain-sharing law was written also created problems. Instead of making any excess cash a one-time distribution, lawmakers essentially allowed it to become part of the base pension benefit for certain public employees.

In other words, for thousands of workers, the money wasn't sent out as a one-time bonus. It became a permanent part of their retirement check. Even small increases can add up to big costs because of the number of public employees involved and the number of years they collect a pension.

So, gain-sharing creates a double whammy for the pension system. When the stock market is hot, gain-sharing skims off cash that could otherwise be used later when the market turns cold. In addition, it increases the amount of money needed to keep the pension system fully funded.

The state pension system has more than $40 billion in assets. It covers around 114,000 retirees and more than 300,000 people still working, including teachers, state employees and city and county workers.

State and local workers contribute part of their regular paychecks into the pension fund. The state and local governments are responsible for contributing money into the system as well, at least in theory.

The Legislature hasn't always contributed enough to keep the pensions fully funded. That also led to the current shortfall.

Lawmakers have struggled for years about what to do with the multibillion-dollar hole in the pension fund.

Gov. Christine Gregoire wants the Legislature to put $176 million this coming year into the fund to help close the gap. Some lawmakers are talking about setting aside even more money.

Getting rid of gain-sharing would make a much bigger dent, by eliminating a projected $900 million in costs between now and 2024. Taking that step would reduce the hole in the pension system to $4 billion.

But axing it would also invite a lawsuit from public employees, said Rep. Bill Fromhold, D-Vancouver, chairman of the state Select Committee on Pension Policy.

"If the Legislature were simply to eliminate gain-sharing with no quid pro quo, then quite frankly I expect the state can expect legal action," he said.

Fromhold said his committee will discuss a compromise proposal today that would replace gain-sharing with a less-expensive benefit.

Regardless of what happens next, taxpayers still face paying millions because of past gain-sharing costs.

There's no easy fix, short of a long boom in the stock market. The state assumes its investments will return 8 percent on average every year between now and 2024. If the investments do better, that could reduce or eliminate the hole in the pension system.

Andrew Garber: 360-943-9882 or agarber@seattletimes.com