When Google stock hit $1,000 a share last October, the financial milestone didn’t go unnoticed on the 14th floor of Honolulu’s City Financial Tower, headquarters of the Hawaii Employees’ Retirement System, the state’s $12.5 billion retiree piggybank.

As newly minted Google millionaires in California’s Silicon Valley rushed to their local Lamborghini and Maserati dealers, pension officials in Hawaii were trying to calculate just how much the windfall might contribute to reducing their unfunded liability – that growing shortfall between the money it has, or expects to earn, and the billions it will need to make good on guarantees of financial security for current and future retirees.

On paper the ERS had made a tidy profit of $35.7 million on its Google stock, not a bad return in just three years. But this was mere pocket change when compared to the retirement system’s $8.5 billion long-term debt, a financial burden projected to get larger before it gets any smaller.

If estimates are anywhere near accurate, the ERS liability will grow to $9.6 billion over the next decade before it begins to shrink – but only if ERS investments pay off as hoped. Google shares split two-for-one in April and today are trading at about $562, resulting in no loss to the ERS.

Right now ERS investments are simply numbers on a spreadsheet, more fully described in detailed reports presented to the pension fund’s eight-member board of trustees but not widely distributed to public employees and average citizens.

What ERS participants and the public can’t see are the big investment bets being made — 77,000 acres of forest lands scattered over seven states thousands of miles away; or the shopping centers in Atlanta and Oklahoma City; or the apartment buildings in Hoboken, New Jersey, and Scottsdale, Arizona; or the $5.8 billion in stock the ERS owns in Facebook, Amazon, Apple, Microsoft, Google and another 1,539 companies around the world. Not to mention hundreds of millions more invested in high-tech start-ups, biotechnology firms, power plants and dozens of other investment partnerships created by private equity firms, hedge funds and venture capitalists that are supposed to increase ERS returns.

Benefits Payments and Total Contributions (in Millions)

In 2011, the most recent data available, the ERS paid $107.6 million in fees for managing these investments, including more than $4 million buying and selling stock. This lucrative source of income is why Wall Street spends considerable time and effort wooing state pension fund officials.

But even with all that high-powered financial talent, no matter how much the ERS investments earn over the next 30 years, there’s virtually no chance they’ll generate anywhere near enough to cover the cost of providing pensions and eliminating the huge deficit the pension fund has run up. That means taxpayers will have to pay the bill — and it will cost them a bundle.

Current projections suggest taxpayers will have to cough up at least $35 billion just to put the pension fund in the black. That’s the minimum amount state and local government will be required to contribute between now and 2043 – payments that must be penciled in to every annual budget and paid out of already overburdened general funds that must also pick up the tab for police, fire and other community services.

Today, the magnitude of Hawaii’s growing pension obligations poses the very real possibility that state and local governments could be forced to reduce services or increase property and other taxes.

Over the years, as the ERS crossed its fingers on investments, public officials failed to make their full share of payments toward pensions, choosing to procrastinate instead which exacerbated the problem.

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Hawaii was not alone. Many hard-pressed state and local governments across the country ignored warnings of future financial problems by failing to make sufficient contributions to their pension funds in an effort to balance budgets. These unfunded retirement obligations have played a major role in the bankruptcies of several municipalities, notably Detroit and the California cities of Stockton and San Bernardino.

“It was such a big issue,” said state Sen. Roz Baker, who introduced reform legislation in 2007. “There were places on the mainland going bankrupt. We’d met with our ERS actuaries. They were laying out a big ugly picture. We needed to fix this because it was only going to get worse.”

Taxpayers, too, were having a difficult time getting an accurate handle on ERS finances because weak state open meeting and public records laws have created the appearance of a culture of secrecy surrounding actions by the pension fund trustees. Large portions of the trustees’ monthly meetings are conducted behind closed doors. The public’s only glimpse of what’s going on at the ERS has been through periodic upbeat news coverage of how it’s doing better, quarterly summaries of investments released months after the end of reporting periods and newsletters to retirees.

Hawaii’s growing pension obligations could force state and local governments to reduce services or increase property and other taxes.

Wes Machida, the ERS executive director, said there is nothing secret about what goes on at the ERS. He believes a majority of the decisions are made in public, but acknowledges that privacy concerns require some closed-door discussions.

“Obviously the more information that’s out there, the better off everyone will be,” he said. “For now it is working as well as it can.”

ERS board members said they feel comfortable with how they have been running their meetings and their overall openness to the public.

“We try to be as transparent as the circumstances allow,” said Colbert Matsumoto, an insurance executive and ERS trustee. “One of the things we’ve tried to work on is making our proceedings more accessible, both in terms of people attending if they were interested and posting our minutes publicly.”

Yet at a time Gov. Neil Abercrombie is touting his administration’s progress in “improved accountability” by making the timely release of Comprehensive Annual Financial Reports, or CAFRs, a “top priority,” it appears the ERS hasn’t gotten the message. Its financial reports have been habitually overdue in recent years.

Key Reports Lag Behind

Like many states, Hawaii operates on a fiscal year (July through June) instead of a calendar year. After the books are closed it requires several weeks for auditors to certify that financial statements are correct.

Most governments have financial reports completed and released within six months. The Government Finance Officers Association, a professional organization of more than 17,000 public finance officials in the U.S. and Canada, recommends as a “best practice” that some form of basic financial report “should be issued on a timely basis, no later than six months after the close of the fiscal year, so that information it contains is still relevant.”

But the ERS has not produced a timely CAFR for years. In January 2012, for instance, ERS trustees were still discussing the fund’s 2009 report behind closed doors. As late as April 2013, trustees were debating the 2011 financial report.

Machida attributes the delay in financial reporting to other pressures on his 96-member staff. But he says that’s going to change.

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“We directed staff to do other things,” he said, explaining that pension reform, changes in benefit calculations and revamping the ERS computer system sapped resources.

Some of those changes were required to be finished by a certain time so the ERS had to meet those legal mandates, Machida said.

Matsumoto thinks Machida is being too “diplomatic” when he explains the tardy financial reporting.

“It’s been quite to the consternation to the trustees and our embarrassment that the condition exists.” — Colbert Matsumoto

“At one time it was our job as trustees to commission the auditor to conduct the audit of our financial reports. The Legislature took that away from us — I don’t know how many years ago — and gave it to the legislative auditor’s office,” Matsumoto explained. “Subsequent to that the process got bogged down and we haven’t been able to get our CAFRs out on time.

“It’s been quite to the consternation to the trustees and our embarrassment that the condition exists,” Matsumoto said. “We’ve put a lot of pressure on Wes to get it current and so he and his staff have been working hard with the auditors to try to get that done.”

However, Gabriel Roeder Smith & Company, the fund’s actuary, apparently has no problem obtaining current information even if the public can’t.

Each year the firm issues an actuarial valuation containing many of the same numbers that would appear in the more detailed ERS financial reports. The firm’s 2013 report was released Dec. 31, about the same time the ERS finally published its 2011 financial report.

Machida said the 2012 financial report will be out this month and the 2013 report will be drafted this summer, which should catch the ERS up so its CAFRs will be timely going forward.

An Even Bigger Problem Coming

Pensions are only part of the looming Hawaii public retirement crisis. In addition to monthly pension payments, Other Post Employment Benefits such as health, life and dental insurance must be provided to retirees.

When the soaring costs of these additional benefits and the unfunded obligations of the Hawaii Employer-Union Benefits Trust Fund — a separate fund providing these benefits — are considered, the financial burden on taxpayers can become staggering. The EUTF estimates its unfunded OPEB liability alone is $18.1 billion — more than double that of the ERS — and is likely higher because EUTF data is more than two years old.

Combined, the outstanding debt for both pensions and OPEB is at least $27 billion. If the obligation had to be paid in full today, it would cost every resident of Hawaii about $19,230.

The Holy Grail for public pension and other retirement benefit plans has always been full funding – having 100 percent of the assets needed to cover current and projected future payments. Few of the nation’s public retirement plans have reached this goal, with most falling seriously short and many experiencing significant increases in liabilities due to the recent financial crisis, or because public officials have reduced or postponed payments into the funds.

If the obligation had to be paid in full today, it would cost every resident of Hawaii about $19,230.

In recent years an increasing array of experts have been sounding alarms about the threat these growing retirement obligations pose to the financial stability of state and local government because of their potential to drain financial resources sorely needed for other public purposes.

A 2013 study by Morningstar, a respected independent investment research firm in Chicago, found the pension funds in Hawaii and 25 other states fell below the 70 percent funding level, its threshold for being “fiscally sound.” Hawaii’s ERS, whose funding level rose from 59 percent as of June 2012 to 60 percent the following year, displayed several of Morningstar’s “potential red flags” indicating the “solvency of a pension plan is deteriorating.”

Those danger signs included reduced annual government payments into the funds; a subsequent, and rapid, increase in the amount of those payments; and pension costs being a significant part of government spending.

In addition, Morningstar warned that a high unfunded liability per capita – the amount of pension debt divided by the number of residents – was another indication of trouble and estimated the Hawaii per capita pension fund debt at about $6,300.

Another 2013 study of funding levels at the 100 largest U.S. public pension funds — including Hawaii’s — by Milliman, a Seattle actuarial consulting firm, found that based upon 2011 and 2012 data just two, the New York State Teachers Retirement System and the Washington State Police & Firefighters Retirement System, were fully funded.

The other 98, including Hawaii, had unfunded obligations totaling $1 trillion. Milliman found 22 of the funds surveyed were above the 70 percent threshold established by Morningstar and only 19 funds were 80 percent or more funded.

“We’re not out of the woods yet in terms of the unfunded liability issue,” Matsumoto said. “It’s a challenge that’s going to take many years for us to fix. And because our unfunded liability is as large as it is, it does dictate that we need to be a lot more prudent in terms of how it’s managed.

“Hawaii doesn’t face the kind of crisis that other states like Illinois are facing, but we’re going to have to continue working at it on an ongoing basis,” he said. “It’s going to require tweaking in the years ahead.”

‘Cause for Serious Concern’

An extensive analysis of 2010 pension data from all 50 states, released in 2012 by the non-profit Pew Center on the States, acknowledged Hawaii lawmakers were making strides toward lowering pension costs by reducing benefits for newly hired employees, cutting retiree cost-of-living increases and boosting contributions by both government and employees.

Still, Pew concluded: “Hawaii’s management of its long-term liabilities for pensions and health care was cause for serious concern.”

Despite this criticism, and the inclination of some public officials to conveniently ignore the potential financial Armageddon posed by pension debt, not everybody was wearing blinders. Over the past decade the Hawaii Legislature has tried to address some of these concerns by enacting a dozen laws designed to contain the cost of future public pensions and provide adequate funding.

Please scroll from left to right to read the timeline.

Change is always difficult, and it’s particularly hard in a politically charged environment where labor unions believe they are being stripped of benefits hard-won at the bargaining table.

“The public-worker unions were resistant to change, which is understandable,” said state Sen. Clayton Hee, who was directly involved in many of the key reforms. “But what became very clear was that the path that the old rules presided over would only increase the unfunded liability, which would mean the burden would be passed on to the future generations. That’s simply not right.”

Hawaii’s situation may not have been as dire as that of other states, but something obviously had to give.

“We needed to do something sooner rather than later or the system wouldn’t be sustainable over the long haul,” said state Sen. David Ige, another lawmaker instrumental in pushing pension reform. “We wanted to make sure (retirees) could count on that pension being funded through their retirement years. There’s a lot more awareness that these kinds of changes don’t come free.”

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Ige is running against Abercrombie in the Aug. 9 Democratic primary. Both have worked to reduce the state’s unfunded liability in recent years by supporting changes to the law and setting money aside for it.

As Senate money committee chair, Ige fully funded Abercrombie’s 2013 budget request to start paying down the EUTF’s unfunded liability more aggressively. The Legislature approved $217 million over two years.

“Reforms have been put into place and money is being set aside that put both systems on a trajectory of financial strength as long as we remain committed and vigilant to meeting the obligations of the past,” Abercrombie said in a written statement.

But as Matsumoto, the ERS trustee, points out: “Pension reform is not an easy thing.”

“It’s a politically very sensitive subject,” Matsumoto said. “It’s zero sum. Somebody’s going to have to give up something. Either the taxpayers are going to have to pay more or the employees are going to have to give up something.”

Hawaii’s Reform Efforts

A landmark law in 2004 – Act 179 – created a new Hybrid Plan covering most employees hired after July 1, 2006, and allowing those hired before that date the option of joining. All Hybrid Plan members are generally covered by Social Security and must contribute to both the ERS and Social Security.

At the same time a companion law – Act 181 – required annual payments made to the pension fund by state and local government to be a percentage of employee compensation rather than a fixed dollar amount. The initial contribution rate was at 15.75 percent for police officers and fire fighters and 13.75 percent for all other public employees.

In 2007 lawmakers made another major change, giving the ERS Board of Trustees the power to determine the assumptions used to set government contribution rates.

That year the Legislature also boosted contribution rates for government pension fund payments to 19.7 percent for police and fire fighters and 15 percent for all other employees as well as imposing a three-year freeze on any benefit enhancements, including a reduction in retirement age, if the ERS reported an unfunded liability.

And in 2011 the Legislature made additional modifications affecting employees hired after June 2012 that included raising the retirement age, changing the formula for calculating pensions and substantially increasing the amount both government and employees would have to contribute.

“Somebody’s going to have to give up something.” — Colbert Matsumoto

Depending upon the plan, state and local government contributions for police and fire fighters would reach 25 percent of payroll by 2015 and 17 percent for all other employees. Contributions by employees would increase from 8 percent to 14.2 percent depending upon their occupation. Only employees in the non-contributory plan would make no contributions. The three-year moratorium placed on increased pension benefits in 2007 was extended until the ERS unfunded liability is eliminated, something not expected to occur until 2041.

“The actuarial numbers just didn’t add up,” said state Rep. Karl Rhoads, who played a lead role in negotiating the final details of the 2011 law. “My sense was that without reforms it was going to be very difficult to get the ERS back to true solvency.”

Many of those reforms affected only new public employees, something Rhoads said made passage “more politically palatable” and probably avoided legal challenges by workers already in the system and the state’s labor unions.

“The union leadership can read the actuarial tables as well as anybody and they didn’t want to be in a position 30 years from now where their pensions weren’t getting paid,” he said. “They understood the necessity and really didn’t resist that much.”

Civil Beat file photo

Hawaii Government Employees Association Executive Director Randy Perreira said HGEA, the state’s largest union with more than 44,000 members, begrudgingly accepted the changes.

“While none of us stood up and cheered and said we wholeheartedly support this, we chose to stay away and allow the legislative process to do its thing and they came up with a package of changes that ultimately altered the benefit for new hires,” he said.

Joan Lewis, the vice president of the 13,000-member Hawaii State Teachers Association, said the union appreciates how challenging it is to predict what resources will be needed to fund the pension promises.

But, she said, it’s a commitment that must be honored.

“It’s not like we want everybody’s money, but we want to know that the contract we engaged in at the point of hire is going to be honored 30 years later,” she said. “If you’re promising me candy and I get to the end and you’re giving me broccoli, I’m not going to be happy about it.”

What the unions — and even some lawmakers involved in the initial reforms — say they won’t tolerate is further “nickel-and-dime” cuts to their benefits, proposals the ERS has pushed the past two legislative sessions.

“We want to know that the contract we engaged in at the point of hire is going to be honored 30 years later.” — Joan Lewis

An effort to curb a longstanding practice of employees saving up their sick leave until they retire so that it effectively spikes their pension is one example. That measure, which Machida estimates would save the state anywhere from $600 million to $1.5 billion over 20 years, died again this past session.

“The changes that the system made that the trustees proposed a few years ago were necessary, but I think it’s time for them to quit fine-tuning and allow those changes with the passage of time to result in the kind of savings we had anticipated,” Perreira said.

Hee, who is running for lieutenant governor this year, isn’t inclined to make any further broad reforms to the ERS at this time. He would rather see how well the system works now and give the past reforms a chance to kick in before looking to see if there’s more “tweaking and tinkering” necessary.

Still, Machida said the board will try to push the sick-leave measure again next session.

“We have to be prepared,” he said. “When you look at our contribution needs, because of our funding situation, our needs are much greater percentage-wise than what the general fund is expected to grow.”

It appears legislative changes in Hawaii may ultimately reduce the state’s future pension costs, but by how much remains unknown. The December report from the state’s actuary says the unfunded liability rose to $8.49 billion at the end of fiscal 2013 from $8.44 billion the previous year, yet the fund was supposed to be solvent a year earlier than expected, by 2041 instead of 2042.

PF Bentley/Civil Beat

Abercrombie has no doubt that administration proposals and legislative action will go far to reduce the state’s looming debt.

“We are on a track to reverse — literally reverse — the downward trend slope of funding,” the governor told Civil Beat in a recent interview.

He points to the fact that credit rating agencies have responded favorably to Hawaii’s efforts.

Over the past few years, Hawaii’s credit rating has gone from negative to stable to positive, something Abercrombie touted in his State of the State address in January.

In October, Standard & Poor said it sees “Hawaii’s credit quality poised to strengthen” due in large part to its formalized commitment to addressing its retirement liabilities.

“I’m quite content with the way it’s working,” Abercrombie said. “And the reason I am is the credit rating agencies are content with it. They’re ruthless. They have no mercy, and rightly so. Their credibility … the Moody’s and the Standard & Poor’s and the Fitch’s … their credibility is based on whether their prediction (of a jurisdiction) is able to do what they say they are.”

New Hires Receive Less

There is no question that the changes will reduce pensions received by new public employees.

A joint study released in April by the National Association of State Retirement Administrators and the Center for State & Local Government Excellence examined 24 states making significant alterations to their pension plans, including Hawaii. The study found that changes to the way the ERS calculated pension payments will reduce benefits for employees hired after June 30, 2012, by about 14.6 percent.

Public employees preparing for retirement have a dizzying array of pension payment choices depending upon the plan in which they participate, when they were hired, how long they worked and how much they earned.

The complexity of calculating how much a retiree will actually receive is due in part to legislation aimed at reining in pension costs and the fact there are three separate plans offered by the ERS – a non-contributory plan where state and local government makes the entire pension contribution; a contributory plan where employees contribute a percentage of their salary along with what the government pays in, and the hybrid plan where participants are also covered by Social Security, something that impacts the amount of state pension payments.

One significant change made in calculating pensions was prohibiting the inclusion of salaries paid in lieu of vacation as part of overall compensation – something that frequently increased pension payments for retirees who cashed out unused vacation time. Now, only employees hired before July 1, 1971, are allowed to include unused vacation payments in calculating their total compensation.

Unlike mainland states where many public pensions can top $250,000 a year — amounts that have generated considerable public outrage — Hawaii has just 82 retirees receiving $100,000 or more annually, which is less than one-tenth of one percent of its total 43,129 retirees and beneficiaries. According to ERS data only five of those receive more than $130,000. Nearly 90 percent receive pensions of $50,000 or less. Last year the ERS paid out slightly over $1 billion in pension benefits.

Most of those pensions are spent in the islands, Machida said.

“Ninety-five percent of the retirees stay in Hawaii,” he said. “They spend their money here. They’re able to help the whole economy.”

Taxpayers’ current share of the annual pension expense alone runs into the hundreds of millions of dollars. Last year state and local governments collectively ponied up $581.4 million. Employees kicked in $185.8 million.

Still, these contributions fell far short of the $1.06 billion paid out in benefits to 35,812 retirees and beneficiaries.

The most recent ERS projections show annual minimum payments to the pension fund by state and local government will skyrocket in the future, reaching $692 million in the current fiscal year ending June 30, $732 million next year and topping $1 billion by 2026. Future labor contracts could substantially increase these payments.

“Everyone pays attention to the benefits, whether it’s the employees or the elected officials who grant the benefits. It’s something people have a much easier time relating to,” says Matsumoto. “But quantifying the cost of giving those benefits is a more difficult thing. As a consequence, there’s a tendency to give away things because it’s a deferred liability. Nobody has to pay for it upfront. But in time you do end up having to pay for it.”

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The state’s new contract with HGEA Bargaining Unit 9 representing professional nurses includes an 8.3 percent wage increase over two years.

And last year the United Public Workers Bargaining Unit 1, representing blue-collar workers, hammered out a four-year contract providing for raises of 4 percent annually, in addition to restoring the 5 percent reduction in wages made in previous years to help the state balance its budget. These contracts and recent settlements with other HGEA bargaining units and HSTA have an as-yet undetermined impact on state payments to the ERS.

Machida said the new Unit 9 contract will not immediately affect contribution rates, but the actuary would likely propose an increase in employer contributions at some point.

“People are finally understanding you can’t just get something for nothing,” said ERS Board Chair Pili Lee Loy, a middle-school teacher at Aliamanu in Salt Lake. “If you don’t have a system that’s funded and the funding level keeps going down, it affects everything. Everyone wants more benefits. Well, you can have more benefits, but who’s going to pay the piper for those benefits?”