A recent report by analysts at J.P. Morgan has ranked Hawaii among a handful of the most financially stressed states, mostly because of unfunded pension and health care obligations to public workers.
However, state Director of Finance Laurel Johnston said Hawaii’s solid credit rating with national bond rating agencies demonstrates the state is properly managing its obligations.
The state projects it will have a large unfunded $9.6 billion pension fund liability at the end of the current fiscal year, and another $9.53 billion in unfunded health care obligations for current state workers, retirees and future retirees, but the state is on track to pay down those obligations over the next 26 years, Johnston said.
Those totals do not include the unfunded liabilities for Honolulu and the other counties.
The authors of the J.P. Morgan Private Bank report called “The ARC and the Covenants 4.0” calculate that Hawaii now commits 21 percent of its revenue to pay off the state’s debt, pension and health care obligations.
The authors estimate that committing 15 percent of state revenue to service those obligations is generally “manageable” for the states, but to wipe out Hawaii’s unfunded liabilities, the state would need to commit 37 percent of state revenue each year, according to the report.
According to the JP Morgan research, only Illinois and New Jersey would need to commit larger shares of their revenue than Hawaii to pay off their pension, health care and debt obligations.
The report also warns that states such as Hawaii that now commit more than 20 percent of their revenue to pay off debt and unfunded liabilities may find “this may not be feasible forever, given competing needs related to public services, infrastructure and education.”
Another concern is that investment income for the public employees pension and health funds could decline in the years ahead, which would require that the state commit an even larger share of its revenue to pay down its obligations, according to the report.
In Hawaii the Employees’ Retirement System public pension fund and the Employer-Union Health Benefits Trust Fund currently assume a 7 percent rate of return on their investments, and are on track to meet that target, Johnston said.
Johnston pointed out the major bond rating agencies actually upgraded Hawaii’s credit rating in 2016. Moody’s ranked Hawaii’s general obligation bonds as AA1, while Standard & Poor’s ranked the bonds as AA+, and both of those grades are one notch below the highest possible rating, according to Johnston.
Comparing Hawaii to states like New Jersey and Illinois may not be fair because Hawaii state government is highly centralized, and state government here takes on responsibilities such as education, public hospitals and jails that are generally handled by municipalities in other states, she said.
That means Hawaii state government is required to manage and pay down pension, health and debt obligations that would be distributed among other government entities in mainland jurisdictions, Johnston said.
The J.P. Morgan report also appears to assume governments should be banking 100 percent of the funding they will eventually need for their employees’ future health care and pension payments, but Johnston said that is the subject of increasing debate in public policy circles.
If the state commits more money than is truly necessary so that it can accumulate tens of billions of dollars in pension and health fund reserves in the years ahead, that will obviously limit the services or other benefits that state government can provide.
“The problem is, there’s not enough research … on what should it be. Should it be 70 (percent funded)? Should it be 80? Should it be 90?” she asked. “You realize that 100 percent funding means that at that point in time the fund has enough money to pay off everybody.
“I don’t know how realistic that is,” especially since since all public employees won’t retire at the same time, Johnston said.
Wesley Machida, a former state budget director and former executive director of the state public pension fund, cautioned that while the state is executing a plan to pay down its unfunded liabilities, that plan makes a number of assumptions that could later prove to be incorrect.
For example, the actuaries who calculate the state’s annual contributions for the pension fund make assumptions about how long most retirees will live, but average life expectancy has been increasing. If life expectancy continues to grow, that will increase the state’s retirement costs.
The major reason the state has such a large unfunded pension liability today is that in 1965 the Legislature began reducing the state’s and counties’ required contributions into the pension fund when the fund’s investment earnings were high.
That practice reduced the state’s and counties’ contributions into the pension fund by more than $1.68 billion over a 37-year period, Machida said. Several years ago an actuary calculated if that money had been deposited into the pension fund, the system today would be 95 to 100 percent funded.
Today Machida said his own research suggests that state pension contributions are increasing more quickly than state revenue is increasing.
If that continues, “things are going to need to be done,” he said. “Either other programs are going to need to be looked at to generate more revenues, or programs are going to have to be reduced in terms of funding, but something’s got to give.”
The state’s contribution levels for the pension and health fund are set by law. Those laws can be changed, Machida said, but the unfunded liability will remain because public workers retirement benefits are protected by the state constitution.
State health and retirement obligations projected for fiscal year 2019:
Employer-Union Health Benefits Trust Fund
Unfunded liability: $9.53 billion
Minimum annual state contribution, FY 2019: $787 million
Employees’ Retirement System
Unfunded liability: $9.56 billion
Minimum annual state contribution, FY 2019: $743 million
Source: State Department of Budget and Finance