ANALYSIS: The Pension System Reform Bill

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After months of deliberations and expert testimony, the Joint Committee on Pension Systems Review finalized its recommendations on identical bills filed in both the House (H.3726) and Senate (S.394). These bills change both the funding and the governance structure of the pension system and its administering agencies.

The system’s funding

These bills would make several significant changes to the current funding structure of the pension system. Under current law, the employer and employee contributions are linked so that an increase in one mandates an increase in the other. The legislation strikes that provision and increases both the taxpayer, or employer, and employee contributions. The employee contributions would be capped at 9 percent for the South Carolina Retirement System (SCRS) and 9.75 percent for the Police Officers Retirement System (PORS).

The employer contributions, however, would increase incrementally until being capped in fiscal year 2026-2027 at 18.56 percent (SCRS) and 21.24 percent (PORS). The General Assembly could replace part of the taxpayer increase with a line-item budget appropriation, and in fact some lawmakers have insisted this is a necessary “safety net” for situations in which an employer (a state agency or municipality) was unable to fund the required employer contribution increase.

It is important to remember that whenever the employer contribution is increased, either state or local taxpayer money is committed to the pension system. There are only two ways to increase employer contribution: either cut government services and programs and use the consequent revenue, or raise taxes. And politicians rarely cut programs and services.

According to one presentation given to the Joint Committee, the 30-year amortization period is one of the key contributing factors to the pension deficit. Currently the pension runs on an open 30-year amortization schedule, meaning that only interest payments are made – and even then not all of the interest is being paid off. If a household ran on a similar schedule, every year the 30-year mortgage would reset to a new 30-year mortgage while the interest-only payments wouldn’t be fully paid. It would be an ill-advised way to run a household, yet South Carolina’s massive pension system has been run in essentially the same way for years. We’re now dealing with the consequences.

What should be done? The amortization period should be shortened to a 15-year amortization period, yet these bills fall short and instead shift to a 20-year amortization period by fiscal year 2027-2028. If by June of 2027 the pension system is 85 percent funded (as opposed to 90 percent under current law) the employer and employee contribution rates could be lowered by the Public Employee Benefit Authority (PEBA).

Most notably, the bill lowers the assumed rate of return for pension fund investments to 7.25 percent. Under current law, the assumed rate is 7.5 percent. Starting in 2021, PEBA would suggest a new assumed rate of return to the General Assembly every four years. This suggested rate would automatically become law if the General Assembly took no action. Lowering the assumed rate of return is a good move, but the bill does not go far enough. In 2016 South Carolina saw returns of 0.0 percent. While the returns are expected to rise, 7.25 percent is still unrealistically high. Because the assumed rate is set so high, the unfunded liabilities are artificially low. One group calculated a more realistic rate of return and the unfunded liabilities were over $70 billion as opposed to the now $20 billion. Until the assumed rate is reasonable the pension debt will be underreported and we will be facing the same problems in a few years.

The bill would also eliminate the State Fiscal Accountability Authority (SFAA – formerly known as the Budget and Control Board) as a co-trustee of the pension system assets. The state treasurer would no longer have custodianship of the assets; this role would fall to the PEBA board, although the RSIC would select the custodial bank.

The commission’s structure

The bill adds one member to the Retirement System Investment Commission, increasing the number from six to seven voting members. The addition would be an active member of the pension system and would be appointed by the speaker of the House. Current law requires one of the commissioners to be a retired member of the system, but this bill would give the appointment of that member to the Senate president pro tempore (instead of being unanimously elected by the other commissioners). Finally, the treasurer would no longer be an ex officio member of the commission; he would instead appoint a commissioner. The new commission structure would be as follows:

  • One member appointed by the governor
  • One member appointed by the treasurer
  • One member appointed by the comptroller general
  • One member appointed by the Senate Finance Committee chairman
  • One member appointed by the House Ways and Means Committee chairman
  • A retired pension system member appointed by the Senate president pro tem
  • An active pension system member appointed by the House speaker
  • The executive director of PEBA (a non-voting member)

Worth noting is that this gives Senator Hugh Leatherman two appointments since he’s both Senate Finance chairman and Senate president pro tem, whereas under current law he has only one. The bill also adds additional qualifications for commissioners and limits them to two consecutive terms.

Equally troubling is the move towards a more opaque and less accountable board. The legislature oversaw and even contributed to the failure of the pension system and now wants more control and less accountability. The legislation would create the position of RSIC chief executive officer, who would oversee the chief investment officer rather than having the latter position answer directly to the commission. The commission could delegate authority to the CIO to invest up to 2 percent of the total value of the portfolio’s assets for each investment, under the oversight of the CEO.

Under this bill, lobbyists would be prohibited from contacting anyone with the RSIC to solicit the investment of funds with any entity, and the commission would be prohibited from investing in any asset or entity in which a commissioner has any interest. The commission would also be prohibited from investing in a fund if a placement agent would receive a commission from the investment. The statutorily required audits would be conducted every four years instead of annually, and would be under the office of the state auditor instead of the inspector general.

Finally, under the bill the commission’s annual report must include extensive details about manager fees and expenses, which would also be posted conspicuously on the RSIC website.

Public Employee Benefit Authority

The changes to the PEBA structure are less extensive but otherwise similar. Board member terms would be lengthened from two years to five years, and members would be limited to two consecutive terms. Board members could only be removed for cause (instead of at will, as current law provides) and would be personally liable for losses occurred by breaches of duty.

The audit schedule for PEBA would be moved to a four-year schedule instead of being conducted annually and would be conducted under the oversight of the state auditor’s office.

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