Trouble Looms For State Pension And Health Plan

Apr 4, 2017

North Carolina Treasurer Dale Folwell
Credit North Carolina State Government

As North Carolina's new treasurer, Republican Dale Folwell has two key jobs: run the pension and health care systems for state employees and retirees.

Both, Folwell says, are in trouble.

The pension is underperforming while paying hundreds of millions of dollars in fees to Wall Street. And the state health care system is looking at $42 billion in unfunded costs.

If you think these problems only affect state employees and retirees, you're wrong. Here's why, before the state of North Carolina can spend money on things like roads or schools, it first must pay its bills. And Dale Folwell says there's a pecking order for that. Paying off bonds is at the top of that list, explains Folwell. "The state has an obligation to first fund what we call debt service payments. And then pension and health care. And that's why these are so critical."

Folwell is a certified public accountant who ran on being more transparent as treasurer. He's spent the last few months running the numbers. And what he's found is troubling. "This is not emotional, it's not political, but it's mathematical." And that math, Folwell says, is showing headwinds coming on two fronts.

First, there's the pension system. An $89.1 billion behemoth. It's the 26th largest reservoir of public money in the world.

But like all reservoirs it's not stagnate. Money flows in from current state workers and flows out to retirees.  As more and more people retire, and live longer, the reservoir starts to dip.

The pension fund relies on investments to make up for that. Those investments must return seven and a quarter percent per year for that to work. In the last fiscal year, Folwell says, the pension saw returns of less than one percent. And "over the last 15 years we've earned just a little bit over six percent."

Part of this underperformance is due to bonds, which can be managed in house. These once were safe bets for a pension system but their yields are linked to interest rates. Historically low interest rates have led to historically low yields.

In order to compensate for that Folwell's predecessor turned to what's known as alternative investments. It's a move Folwell doesn't like. "These alternative investments, approaching over $25 billion, these alternative investments aren’t something you can open the Wall Street Journal up and see what the price is."

Because they're owned or controlled by private firms which don’t have to make their financials public. Things like private equity and hedge funds, real estate and other things you're not likely to find in your 401(k). "We own close to a billion dollars' worth of timber," says Folwell dryly, "raw timber."

The true value of which can only be known when it's sold.

The same is true with determining the value of investments in private equity and hedge funds. Since these investments aren’t traded publicly their dollar value is not set by the market but by the managers of the funds themselves.  

And some, in turn, can profit from that directly since they're paid a percentage of the paper value of that investment.

But all these funds are financially complicated and already come with hefty fees. "Over the last 15 years the fees that the state treasurer's office has paid Wall Street have gone from $50 million to over $600 million per year."

Folwell campaigned on cutting these fees by $100 million in his first year. So far he says he's cut $15 million.

Overall, Folwell says, state retirees would be much better off if the pension had invested not in alternatives but in simple, low fee funds, the kind you would find in a 401(k). Which have shown much better returns. Retirees he says "would have been better off by billions and billions of dollars."

Now remember, the pension is just one of the mathematical headwinds Dale Folwell is trying to navigate. The other is the state's health plan. And there the numbers are even more troubling. "We just received an actuarial report that shows that our unfunded health care liability just for state employees is $42 billion dollars." And no, Folwell says, this has nothing to do with Medicaid or Medicare.

North Carolina directly pays the health care costs of more than 700,000 state employees, retirees and their dependents.

The $42 billion in unfunded liability – which is really expected debt – is not owed now. But that bill will eventually need to be paid.

How the state got here is simple says Folwell. North Carolina just paid the bill that was due each year. Last year that amounted to roughly $3 billion. But, over the years, lawmakers in both parties did little else even though they knew this cost was coming. "There was nothing being put aside for over 30 years into the state health plan. So when you're not properly putting money aside for something and the cost of that something is going up, doubling every six or seven years, you can see how very quickly you can get to a $42 billion problem."

It's a startling number to most but not all. "I'm not shocked by it I guess," says Jean-Pierre Aubry, the director of State and Local Research at the Center for Retirement Research at Boston College. They maintain a database of 160 of the largest pension plans in the country including North Carolina's. And they also track additional retirement benefits like health care. Aubry says North Carolina lawmakers have a decision to make. "Those watching this space need to give governments time to make adjustments to either pre-fund the promises they've made or change the promises."

Pre-fund means pony up cash to eventually cover that $42 billion health care bill which will come due. Or they need to cut back on what is offered to state workers.

State Senator Andy Wells, a Republican from Hickory is trying to do both. He introduced a bill last week to put $100 million a year for the next 15 years into  the state pension system. But it would also significantly change the benefits for future state workers. Those hired in 2018 would not get a pension but a 401(k), though the state would match the employee's contribution.

Well's bill would also only offer these future state workers health coverage while they are employees. Once retired, they're on their own.

These kinds of changes though have a cost. They may be good for the balance sheet, but they harm recruiting says Aubry. "Public sector workers get less in wages and more in the other benefits. And private sector workers get more in wages and less in other benefits. So they're getting about the same in total package."

If you tip that scale against public sector workers, Aubry states, "you'll get lower quality workers" in state jobs.

But something must be done says Treasurer Dale Folwell. He knows that when you think of what the state spends money on, you're likely not thinking about health care and pensions. "They wake up thinking about public education, universities, community colleges, the roads, the zoo, the museums, all those other core functions of state government."

But if nothing is done all those key functions could be effected if all the money is gobbled first by pension and health care costs.