In 2011, Florida’s legislative leaders thought Senate Bill 2100 would fix Florida Retirement System’s (FRS) $18 billion funding shortfall. Then-Gov. Rick Scott praised the law as a means to guarantee public workers’ benefits. “I want to be sure that in the state of Florida, we know what our commitments are, and we can live up to our commitments,” Scott said at the time.

But in the years since, FRS’s pension debt has more than doubled and the state’s funding shortfall is $43.3 billion as of the end of fiscal 2020. Legislation aimed at improving FRS is again circulating in Tallahassee — but lawmakers have to make sure they focus on the real problems if they want to avoid repeating mistakes of the past.

There is a way to fix all of FRS’s problems with one large plan that gives a little something to everybody and requires shared sacrifice. No one is going to love the plan, but balancing the interests of all stakeholders involved can often be a sign that it’s the best path forward.

First, though, here are the problems that actually need to be solved.

Florida Retirement System’s Three Main Issues

The principle problem at FRS is the lack of realistic assumptions about the future. Florida actually does a good job of making sure it pays its pension bills on time each year, but the actuarially-recommended contribution rate necessary to ensure FRS’s Pension Plan is appropriately funded have been based on 7% investment return assumptions. That hasn’t happened frequently enough, and it isn’t likely to be the case in the any time soon.

Actually, until two years ago, FRS’s investment assumptions were so unreasonable that the state’s actuaries refused to sign off on them. The state has made a few small steps toward improving this, including a recent decision to lower the investment assumption to 7%, but even that has at best a 50/50 shot. (And when the actuaries for FRS measure the value of benefits, they use an even lower investment forecast of 6.8% long-term average returns.)

Another problem for FRS is there are no built-in tools for pension fund managers to modify costs in case of a crisis. The best funded pension plans in America (see Wisconsin or South Dakota) have “risk-sharing” tools that allow pension boards to modify the value of benefits when investment returns are poor, and share the upside when they’re strong.

Finally, there’s the budgetary pressure created by retirement costs right now. School district managers and local leaders reflected this last year when FRS’s contribution rates went up again, and they shouldn’t expect anything different in the coming years. School districts, which make up nearly half of FRS, and state agencies are scheduled to see their contribution rates increase this coming fiscal year to 10.68% of payroll.

So How Do You Improve the Florida Retirement System?

Start by creating a statutorily-set maximum investment assumption for FRS. The State Board of Administration should still have authority to determine the exact rate, as what is a reasonable assumption can change over time, depending on interest rates and financial market forecasts. But establishing a maximum rate would be the legislature setting a ceiling on the amount of risk it believes is warranted in having investment returns underperform expectations, leading to pension debt. The Michigan Legislature recently made 6% the maximum investment assumption for its new hire pension plan—that would be a good place to start.

The next step is bringing in more money—quickly. Adopting a more realistic investment assumption is going to reset FRS’s books. What looks like a $43 billion funding shortfall based on 6.8% investment returns is really a $69 billion hole, at least assuming a 5.8% average annual investment return. The 10.7% of payroll contribution payments on “regular workers” — ranging from teachers to county clerks — probably need to be more like 17% of payroll. For Miami-Dade County, that increase next year could be as much as $5 million and for Orange County School District, the additional payments might cost nearly $75 million more just for next year, increasing every year for 30 years after that. All of which defeats the point of trying to manage resources effectively through a pandemic.

The most efficient way to avoid this improvement in accounting from further adding to budgetary woes is for Florida to borrow money. And yes, we get that’s not going to be a popular idea. But consider this: If the state raised $50 billion in pension obligation bonds and deposited the money into FRS it would reduce the pension debt levels by the same amount — i.e. the cash infusion would reduce the most realistic estimate of $70 billion down to $20 billion. Still a significant funding shortfall, but a more manageable amount to ask cities, counties, and school districts to help with paying down — none of which had any control over the investment practices that led to the current pension debt mess. The required contribution rates to FRS employers in this scenario could fall below 10% of payroll.

Taking out such a loan and spreading the payments (using the state’s general fund) over several decades would balance the interests of today and tomorrow’s taxpayers, the latter of which is going to get stuck with an even larger bill if the FRS pension debt isn’t dealt with now. And a pension bond (so-called POBs) would be able to take advantage of historically-low interest rates, making the costs of the loan more manageable than perhaps any other time in state history.

Addressing Concerns from All Sides

There are going to be very reasonable concerns raised about this concept, the most common of which is that it is risky to borrow money, even at 2% or 3%, and then invest it. What if the markets crash shortly after depositing the money? That could happen in our uncertain world, though such risks can be mitigated by layering in the money over a period of time so as to not take a hit all at once. More important, the status quo is already a bigger risk — thinking the state could earn 7% over the next several years and decades on average.

Republicans typically don’t like government borrowing, and often with good reason but it’s worth remembering the status quo is definitely not fiscally conservative. A low-interest loan is more like taking on a mortgage; running a pension plan that assumes 7% investment returns is like managing a casino.

And, critically, closing the pension fund to new members won’t fix the funding shortfall. The pension debt will still be there, and people already earning benefits will keep doing so, with FRS trying to get 7% investment returns to fund them, only to turn to the state to ask for higher contribution rates when they can’t get that on average.

In addition to taking out a historically large POB to finance lowering the investment assumption — probably by dropping the FRS inflation assumption, as well as the expectation on “real returns” — the Florida Legislature should then reset the clock on paying down existing unfunded liabilities. In any other circumstance, this “reamortization” wouldn’t be a good idea. It would just be kicking costs down the road to future taxpayers, teachers, and local governments. But in exchange for adopting better funding policies, the state could set a new 25-year schedule for paying down any unfunded liabilities that remain after the POB is deposited.

Improving FRS Also Helps School Districts and Local Governments

The net effect for Orange County School District under this plan would be as much as $20 million in savings for the next fiscal year — depending on the timing of raising money through the bonds and exactly how investment assumptions are adjusted. Local governments participating in FRS could see their contributions reduced, too. If the state legislature wanted to, it could even lower employee contribution rates in lieu of passing all of the savings on to governments and taxpayers. The state could structure the POB to start repaying it annual installments in a few years when there is more certainty around state tax revenues.

It’s not often that the most fiscally responsible plan involves realizing higher debt levels already incurred, then taking out a loan to finance that debt, and reamortizing the remaining debt — but in the case of FRS, that’s exactly what state leaders should do.