Rhode Island red
The Ocean State did the math on pensions and boldly went where no state had gone before
little rhody was in big trouble. That much Gina Raimondo knew when she pumped her fist in victory on election night two years ago. It wasn’t until the new Rhode Island state treasurer set up shop in her cavernous offices in the Ocean State’s majestic State House that she found out how close the ship of state was to the fiscal rocks.
Pension contributions for Rhode Island’s employees were already the fastest growing line item in the state budget, but the problem was that the funding still wasn’t keeping pace with pension outlays. The pension system’s unfunded liability —the money required to support payments to retirees and current employees already vested in the pension system—was spiraling out of control.
If no changes were made to the current pension system, Ocean State taxpayers would have to contribute about $615 million in 2013 to pay retiree benefits. By fiscal 2022, taxpayers would find themselves on the hook for more than $1 billion.
Raising taxes to solve the state’s pension problem was not an attractive option politically or economically. With an aging population and a decimated manufacturing sector, Rhode Island was on the ropes even before the 2001 and 2007 recessions. The August unemployment rate was 10.7 percent, the second highest in the country.
The treasurer stepped up to the plate with a deceptively simple strategy to get political consensus on rescuing the pension system: Sketch out the seriousness of the problem in way that ordinary Rhode Islanders would understand; develop a consensus among state officials, lawmakers, union officials, and pension experts on the fixes that need to be made; and knuckle down to get lawmakers on board with those changes. That formula earned Raimondo national headlines and international acclaim in influential publications such as the Financial Times and The Economist.
Raimondo developed a consensus around a fairly radical solution. Most states grappling with pension deficits tweak the benefits of existing retirees or reduce the benefits awarded to new hires. Raimondo decided more drastic action was warranted. Rhode Island became the first state in the nation to scale back the benefits previously promised to current employees.
“Our mantra was we wanted a system that provided retirement security for everyone…so we took 60,000 employees and retirees, and everybody gave a little bit,” says Raimondo. “No one group shouldered a disproportionate burden.”
It was a bold proposal for a newcomer to state politics. Raimondo, 41, is a Democrat, but cut from a different cloth than the old-school types who have long dominated the state party in Rhode Island. The petite, Rhode Island native with an Ivy League pedigree (Harvard University, Yale Law School) was a co-founder and general partner with Point Judith Capital, a venture capital firm that specializes in software and technology investments. Campaigning on a slogan of “new leadership, a fresh approach,” Raimondo breezed into office in 2010 after the incumbent treasurer ran for higher office and her primary opponent dropped out of the race.She defeated her Republican challenger by a margin of 62 percent to 38 percent.
Raimondo began laying the groundwork for her pension proposal in April 2011, when the state retirement board she chaired voted to lower the forecasted rate of return on pension investments from 8.25 percent to a more realistic 7.5 percent. “We thought that gave a more accurate picture of how big the pension hole was,” says Raimondo. “When we did that and reflected [on] the problem more accurately, we realized the system was under 50 percent funded [the recommended minimum pension funding benchmark is 80 percent] and the bill to taxpayers was quite literally unaffordable.”
Using the lower rate of return meant that the state’s unfunded pension liabilities increased to nearly $7 billion, up from $4.3 billion in 2009. When it comes to state pension liabilities, only Illinois was in worse shape.
In May 2011, Raimondo released “Truth in Numbers,” a report that detailed the pension conundrum in plain English. Using an easy-to-digest primer on accounting rules, the treasurer laid out how she came up with the price tag for the unfunded liability, along with a clear rundown of five major problems plaguing the system, such as the state’s failure to make full contributions into the pension fund over the years.
“The pension system challenges are so great that it will be mathematically impossible to fix without dramatic changes that will affect all stakeholders, not just the youngest and most recent employees,” the report concluded.
To get the word out about what was at stake, the treasurer held statewide public forums. Raimondo says she wanted to explain to residents that they would lose services or end up paying higher taxes if they didn’t support the reforms. “I think the turning point was when we translated the math into a set of numbers that answered the question for the everyday Rhode Islander, ‘What does this mean for me?’ ” she says. “If you have a mentally disabled daughter whose aide is going to be cut if you don’t get behind this…then the math becomes real for people.”
Gov. Lincoln Chafee and Raimondo convened a pension advisory group in the summer of 2011 to figure out how to chip away at the unfunded liability. It included labor and business leaders, government officials, and academics. Labor leaders “were involved in every single step of the process,” says Raimondo. In fact, she says, the union leaders succeeded in moderating some of the proposed cost-of-living adjustments in the meetings.
Robert Walsh, executive director of the National Education Association Rhode Island, the state’s largest teachers union, says the advisory group was “good theater,” but it was not the type of bargaining process he envisioned. The recommendations that came out of the meetings were very similar to the ones in Raimondo’s report, he says. He would have preferred state officials to sit down and negotiate with labor leaders to restructure retiree benefits as Providence Mayor Angel Taveras did when the city faced bankruptcy earlier this year.
But Raimondo’s proposal carried the day. The Rhode Island General Assembly hammered out a pension reform package in November that reduced the state’s unfunded liability by $3 billion immediately and about $4 billion over the next 24 years. The package will also sharply cut what the state will have to set aside for pension payments in the coming years. The package passed easily, 34 to 2 in the Senate and 57 to 15 in the House. The program went into effect on July 1.
Some of the changes have already been implemented in other states. The retirement age, for example, was increased to 67 for many employees, just as it was last year in Massachusetts. Rhode Island also lengthened the time frame for paying off its unfunded pension liability from 19 to 25 years. Annual cost-of-living adjustments for retirees were eliminated, at least until the pension system hits the 80 percent funding benchmark. Until then, cost-of-living adjustments will be paid every five years, and they will be applied only to the first $25,000 of pension income instead of the first $35,000.
The most controversial change involved basic retirement benefits for current workers, a move that no other state in the country has ever attempted. Previously, Rhode Island offered its employees a so-called defined benefit plan: A worker paid a portion of his salary into the pension plan and the state was responsible for providing the agreed-upon benefits when the employee retired. Rhode Island, like many other states, was having difficulty making those benefit payments since retirees were living longer and requiring more benefits. Those problems were compounded by underperforming pension investments and lawmakers failing to set aside enough money to cover future payouts.
Under Rhode Island’s pension reform, most state employees will pay 3.5 percent of their salary into a defined benefit plan and 5 percent into a defined contribution 401(k)-like vehicle, to which the state will contribute another 1 percent. The state will continue to be responsible for the pension owed under the defined benefit plan, but the employee will be responsible for overseeing his or her own investments in the 401(k)-style account. In essence, the state is shifting a large chunk of its pension risk on to employees.
Other states have shown a keen interest in Rhode Island’s approach, but some of the more dramatic changes may not be able to be duplicated elsewhere. In many other states, including Massachusetts, pension benefits are negotiated with unionized workers and incorporated into contracts. A 1973 Massachusetts Supreme Judicial Court advisory opinion found that state pension benefits for current employees are contractual obligations, meaning any changes must be negotiated and not legislatively imposed.
Rhode Island has statutory pension and benefits rules, meaning they are written into law and can be altered by changing the law. Even so, the changes in Rhode Island are facing court challenges.
Labor leaders argue the changes violate the Rhode Island constitution because they alter an implied contract between the state and its vested employees and retirees. Walsh, the National Education Association leader, says some of his members “say a promise is a promise, let the state pay; states can’t go bankrupt.”
Walsh says the case will turn on whether the courts hold that workers were harmed, and to what degree. “You can’t brag about saving $3 billion without someone being substantially impaired along the way,” he says.
Raimondo believes the reforms will pass constitutional muster. “There is no contract [because] the General Assembly in its judgment decided that there was a necessary public purpose served by changing the law,” she says. “Even if there was a contract, which we don’t agree with, the state had reason to break it.”
In a blue state like Rhode Island, Democratic leaders are probably the only ones who could have pulled off cutting benefits for state workers without producing the type of uproar that Scott Walker, Wisconsin’s Republican governor, caused when he went up against state unions over collective bargaining rights.
Yet Raimondo says that having a Democratic majority in the legislature actually made the process more difficult. “Historically, Democrats are more reluctant to change public employee benefits than Republicans, and so they dug into the numbers to really make sure that this was necessary,”she says.The pension deal damaged Raimondo’s standing with union members, but she remains popular overall with residents. In February, a Brown University poll found that she is the second most popular politician in Rhode Island behind Taveras, the Providence mayor. With her tenacity in helping to steering the reform drive, it’s not surprising that Raimondo’s name comes up, along with Taveras, in the mix of candidates for the 2014 governor’s race.
Raimondo is noncommittal. “A lot of people are en¬couraging me to think about it, which I’m doing,” she says. “But it’s way too premature for me to have an answer.”