Hawaii lawmakers are doing more this session than ever to plug a multi-billion-dollar hole in health and retirement benefits promised to thousands of county and state workers.

For years, officials watched the state’s unfunded liabilities surge as they skimmed big investment returns to fund new programs and give employees raises.

Now they’re playing catch-up, but the question is how to dig out of such a deep deficit without raising taxes or cutting spending. There’s no clear direction yet, but innovative approaches are being considered.

Hawaii has fallen so far behind in financing its Employees’ Retirement System and Employers-Union Health Benefits Trust Fund that budget analysts are worried the state’s credit rating may soon take a hit. If this happens, it could reduce the state’s borrowing power and increase the cost of public projects.

The Legislature significantly reformed the ERS over the past few years, alleviating some of the concern credit raters noted in recent bond rating reviews. So this session lawmakers are working to make similar headway with the EUTF, which has $16.3 billion in unfunded liabilities — twice as much as the ERS.

Several bills to put the state back on track were introduced this year and the level of discourse on the subject is at an all-time high, state Finance Director Kalbert Young told Civil Beat.

That’s not to say anything will come of the heightened awareness, as the legislation has to clear high hurdles over the next several weeks before becoming law.

Indeed, several measures have already died in House and Senate committees, including the governor’s proposals. But two significant bills are still alive, slugging their way through finance and labor hearings.

State budget officials have expressed tepid support for Senate Bill 946 and serious concerns over House Bill 1459. But others say the former is in line with what the governor wants to do and the latter creates an outside-the-box approach that would cut costs.

Gov. Neil Abercrombie used his State of the State address to urge lawmakers to put down $100 million a year toward unfunded liabilities to get a handle on the problem.

Hawaii would have to spend more than $500 million a year for the next 30 years to make the ERS and EUTF viable again, Young said, which the state can’t afford.

Senate Bill Creates Carrot-and-Stick Approach

The Senate bill, introduced by Ways and Means Chair David Ige, would over a five-year period transition the state from a pay-as-you-go system to a pre-funded one.

The bill gradually increases the amount the state would pay toward EUTF unfunded liabilities. It would start at 20 percent for the next biennium, which is roughly $100 million a year, and then up it to 100 percent by 2018.

Young likened the bill to a roadmap to bring the state up to where it needs to be with the EUTF, which manages and administers the health and life insurance plans for 93,000 state and county employees, retirees and their dependents.

The legislation contains unique provisions to make sure each employer pays its fair share. The counties, for instance, whose share of the unfunded liabilities totals almost $3 billion, would have to meet their obligations or else the state can take it out of their portion of hotel taxes.

The bill is more comprehensive than anything the Legislature has considered, but may be too aggressive, Young said.

“We are concerned that the specified contribution levels and timetable is not affordable at the present time without drastic reductions in other areas of the State’s budget or significant measures to increase State general fund tax revenues,” he said in his testimony.

Abercrombie’s proposed operating budget is $6.1 billion for 2014, up 8 percent over last year, and $6.3 billion for 2015, an 11 percent increase. Aside from addressing unfunded liabilities, he wants to restore pay cuts that employees took during the recession and fund new technology and education initiatives.

Ige said unfunded liabilities will definitely be a factor as lawmakers work on the financial plan for this biennium. He said his legislation would make it an increasingly bigger part of any state spending plan going forward.

“The bill makes the unfunded liabilities a priority rather than an after-thought,” Ige said.

Lowell Kalapa, president of the Tax Foundation of Hawaii, said the Legislature needs to be proactive about funding the liabilities but should be careful about earmarking portions of the general fund.

He is concerned that if counties can’t pay their share of unfunded liabilities and don’t have enough hotel tax money to cover it, then lawmakers will use this as an excuse to raise taxes.

“We really need to underscore to our elected officials to meet your obligations first and then reduce spending on programs that we should never have started in the first place,” Kalapa said. “Don’t blame me, the current taxpayer, and take it out of my hide.”

SB 946 cleared two key committees last week and is headed for a vote before the full Senate.

House Bill a Question of Risk

Another bill, which Young called “convoluted and complex,” is advancing in the House.

HB 1459 would create a so-called captive insurance company to manage public employee health benefits.

Young said the bill has the potential to bring down costs by letting the state assume more risk, but it provides no guarantee the state will actually fund its liabilities.

Using an analogy to explain the bill, he said it works as if you quit paying a certain amount of each paycheck to a health insurance company for your benefits and instead put money in your savings account for future medical needs.

It’s a gamble because if you stay healthy, then you could save thousands of dollars, Young said. But if you get really sick, then it could cost you a lot more.

The bill creates a reserve account of $1.5 billion, which the state and counties would have five years to fund and then maintain at that level. The legislation claims this reserve account has the effect of fully funding the liabilities, but Young said he doesn’t see how that amount satisfies a $16.3 billion obligation.

If the state goes this route, Young and others want to know how much risk is in the pool of beneficiaries. He urged lawmakers to study this aspect more before passing the law.

Luis Salaveria, who wears two hats as deputy budget director and an EUTF trustee, said the bill needs further evaluation.

“It’s a pretty innovative approach worthy of discussion as it relates to risk management,” he said.

The state insurance commissioner, Gordon Ito, agreed. The Department of Commerce and Consumer Affairs, which his office falls under, took no position on the bill but did say a feasibility study should be performed first.

HB 1459, introduced by Rep. Romy Cachola, cleared the Finance Committee Wednesday and is headed to a vote before the full House. He could not be reached for comment.

Cachola said in his written testimony on the bill that the feasibility study could still be accomplished before the July 1, 2014, effective date.

The general discussion of HB 1459 has been part of a larger trend this session that makes it different than past efforts to address unfunded liabilities. Young said even bills that didn’t get a hearing caused committee chairs and others to talk about the issue.

“In the past, you’d get a smattering of bills but wouldn’t get a hearing and no one would be discussing them outside,” he said.

Another positive sign Young said he has seen this session is the House creating a special subcommittee on unfunded liabilities, chaired by Cachola.

Young spent the past two and a half years working with legislators and others to educate them on the issue. He said that effort is paying dividends now, which is why he remains optimistic that needed reforms may become law this session.

Ultimately, the real trick is seeing what bills actually make it through the Legislature. This session is heating up too, with some big deadlines coming up in early March that result in hundreds of bills dying.

One Down, One To Go

Ige said he has been trying to meet with actuaries and others about what approaches might be most successful.

“Nobody across the country has settled how to address unfunded liabilities,” he said. “We’re all trying to figure out what makes the most sense.”

Ige said it is important that the state has stopped the free fall in the percent the ERS is funded.

The retirement fund was 95 percent funded in 2000, dropping to 78 percent in 2010 and on down to 59 percent in 2011. The latest actuarial report shows the state held the funded ratio at 59 percent in 2012.

The brakes were put on through legislative initiatives that stopped pension-spiking and increased the contribution requirements for future members of the system. Lawmakers also reduced benefits and extended the retirement age.

This legislative session, the state is looking to make the ERS run cheaper and generate more money, Young said. There is a bill, for instance, that would let the ERS board hire investment officers so it has that expertise in-house instead of having to contract it.

The ERS unfunded liability crept up to $8.4 billion in 2012, but a consulting firm has told the state that it has regained control of the situation and could make the fund solvent again within 30 years.

The goal is to replicate this effort with the EUTF, officials said.

“We’ve made significant enough changes that I think the unfunded liabilities on the pension side is in good hands,” Ige said. “If we don’t start to address the annual recurring cost then the EUTF liabilities will grow every year.”

Young has advised that the state will be bankrupt, on paper anyway, within five years if lawmakers don’t take swift action. The total amount of unfunded liabilities is on track to surpass the state’s overall net assets.

“That’s not a good situation to be in and we don’t want to get there,” Ige said.

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