After years of elected officials treating the Maryland state pension system like a bottomless trust fund, it is $20 billion underfunded with no plan to fix it save a market miracle.

Last fiscal year the fund returned 1.16 percent — well below its target 7.55 percent. And over the past 10 years it’s achieved an average annual return of 4.85 percent, which begs the question why after a decade the target return remains so much higher than real ones. (The latest results for the fiscal year ending June 30 will be available in August.) Compounding the problem are years of underfunding annual contributions, and the fees the state pays to investment managers, which have totaled over $300 million annually since 2014.

At the Maryland Public Policy Institute  we have argued for years that the state should invest in index funds tied to the broader market, instead of using money managers, to save on expenses and achieve higher returns.

As Jeff Hooke and Marco Orsimarsi wrote in a 2016 Maryland Public Policy Institute report on manager fees, “Given that U.S. public equity has outperformed private equity over the last 15 years, and that an equity/fixed income blend beats most hedge funds, we believe an expansion of public stock and bond indexing is preferable for the (Maryland) Fund, which performs below its peer group.” They added, “The diversification and hedging benefits of private equity and hedge funds are often touted, but they seem illusory in Maryland’s case. To date, Nevada is the only state pension fund to fully index its portfolio to public securities, and Maryland may want to look at Nevada’s experience.”

Other issues

Management fees aren’t the only problem, though. Aside from reorganizing how Maryland’s pension fund invests, it also needs to restructure how it provides benefits to state employees. To prevent state taxpayers from sinking into an even larger debt hole, the state should shift new employees into 401(k)-style plans that shift market risk from taxpayers to state employees. It has been politically impossible in the past, with state unions and Democrats vehemently opposed to any changes that impact their core constituency.

But, as Pennsylvania illustrates, it is only a matter of time before economic reality forces a new political one. In an almost astonishing act of bipartisanship, especially for those of us used to decades of one-party rule in Maryland, Republican state legislators and a Democratic governor in Pennsylvania approved a pension reform bill earlier this month that will limit its staggering $62 billion pension debt by moving most new employees into a 401(K)-style plan similar to that used by private sector workers.

In a statement, Gov. Tom Wolf — again, a Democrat — said, “This pension compromise achieves my foremost goals: continuing to pay down our debt, reducing Wall Street fees, shifting risk away from taxpayers, and providing workers with a fair retirement benefit, while providing long-term relief to school districts.”

While unions didn’t get behind the changes, neither did they fight them. The (Harrisburg) Patriot-News reported that the bipartisan backing for pension reform forced the unions into a “strategic retreat.”
In a June 5 article Charles Thompson wrote, “Major public-sector unions like the American Federation of State, County and Municipal Employees, Service Employees International Union (both state workers) and the Pennsylvania State Education Association (schoolteachers), have all agreed to stand silent on this bill.”

Preventing surprises

While the legislation does not provide a path to pay for that $62 billion deficit, at least it prevents it from ballooning even further out of control.

If similar legislation were passed in Maryland, it would also prevent surprises like the one popped on city taxpayers last week when the auditor of Baltimore City Public Schools said the $100 million gap in funding between what is owed system employees and what is in its account is not BCPS’ responsibility.

Maryland should not wait until its pension deficit matches Pennsylvania before it acts to secure the retirement of state employees and protect state taxpayers from massive unfunded liabilities. Instead, state legislators should join their peers to the north in being a beacon to states around the nation in how to solve crippling pension deficits by working together. What’s a given is that waiting will only make the problem a larger burden on the generations forced to pay for decisions they didn’t make.

Christopher B. Summers is president and chief executive officer of The Maryland Public Policy Institute.