Compass: Alaska has a massive pension obligation, but also the means to meet it

The unfunded pension liability for the Public Employee Retirement System and teacher Retirement System (PRS/TRS) is a hot topic in Juneau. That's because the number is so big and heading in the wrong direction. The gap is around $12 billion.

PRS is 57 percent funded and TRS is even lower at 49 percent. These are among the lowest of the 50 states.

It looks like the state's ongoing contribution to close the gap will soon be close to $1 billion per year. That should be seen in the context of a budget in the neighborhood of $6 billion. That's right; pension payments will soon take about 17 percent of the state's annual budget.

In the late 1990's both plans were close to 100 percent funded. But a faltering stock market, increased benefits offered up during the good times, and changing actuarial assumptions have led to the predicament we are in.

I say "we" because participating local entities, including the state, are constitutionally obligated to pay the promised benefits. The PRS/TRS Trustees note that "funding for the retirement systems and the increasing amounts to pay down the unfunded liability compete with other needs for the residents of Alaska."

How do you close this kind of funding gap? Increase contributions, cut benefits or throw the Hail Mary pass.

First, Mary. One alternative is to just invest in riskier and higher returning assets. But both plans have an 8 percent assumed return in their calculations already and that is fairly aggressive given very low bond yields. And they have a current asset mix (and historical returns, by the way) in line with many public plans across the nation already.

Another Hail Mary idea is to issue Pension Obligation Bonds at say 4 percent and invest the proceeds in a diversified investment portfolio and earn 8 percent. In the "long run" the net 4 percent that results after paying the debt service on the bonds can help close the gap.

But in the interim, stocks might fall and the scheme could go upside down quickly.

Besides, here is Wikipedia on the Hail Mary as it pertains to football:

"A Hail Mary pass is a very long forward pass in American football, made in desperation with only a small chance of success, especially at or near the end of a half."

Hmmm...maybe getting out the rosary beads and praying would work better.

Option two is cutting benefits. The Legislature did bite the bullet in 2006 by switching to a 401k defined contribution plan for new employees.

Benefits have been negotiated in good faith and people are counting on them. They are protected by the state constitution and until recently considered untouchable. I say recently, because events in Detroit have opened up the possibility of federal bankruptcy law trumping state law. A federal judge has ruled that pension cuts are acceptable in the city's bankruptcy even though they were thought to be protected by the Michigan constitution. The judge's ruling is a bombshell in the world of public pension funding.

Illinois is another case in point. Recently legislators voted to overhaul the state's hugely underfunded pension plan. They want to raise the retirement age, adjust cost of living clauses and offer a 401k plan to new employees.

Now Detroit and Illinois are a long way literally and figuratively from Alaska. Our state is AAA rated and has close to $20 billion in reserves and rainy day funds that are the envy of all the other forty nine states. And then there is the $48 billion Permanent Fund. In the short term we are in great fiscal shape.

The governor just chose his solution -- increase contributions. He suggests a $3 billion contribution from reserves. That would increase the pension funding ratios by about 10 percent immediately. And because the new money would get invested in stocks and bonds, and not low yielding reserves, the state's annual contributions are expected to drop to a more manageable $500 million per year.

This recognizes the "pay me now or pay me later" nature of the problem. It is an important first step. Still, legislators in Juneau have their work cut out for them.

Jeff Pantages is an investment advisor. He lives in Anchorage.