Este informe no está disponible en español.


A Multibillion-Dollar Pension Pinch

The local government’s employee retirement pension plan has reached the point that it is in a financial crisis. It has an estimated $7.9 billion deficit to pay out future pension benefits.


September 26, 2002
Copyright © 2002 CARIBBEAN BUSINESS. All Rights Reserved.

A time bomb? As the government steps in to rescue its retirement system, government employees could see larger deductions out of their paychecks and taxpayer may have to chip in to cover the giant deficit that has built up.

The government has a $7.9 billion problem that just won’t go away. In fact, it just keeps getting worse.

It’s the deficit of the Government Employees Retirement System (the System), which provides retirement benefits to public employees.

There are currently an estimated 169,700 active government employees–including those in central government, in municipal government, and in most public corporations–in a defined-benefit pension plan, whereby pensions are linked to salary and years of service. Another 90,000 employees already retired are covered by a defined-benefit plan, which guarantees them and their beneficiaries retirement benefits for life.

Every year an average of 5,000 employees retire. At that rate, the number of retirees receiving pension benefits from the System should more than double in the next 15 years. But by 2017, the pension fund will run out of the money it will need to pay full retirement benefits to future retirees.

If one considers the 169,700 active government employees that will eventually receive pension benefits from the System upon retirement, the projected shortage amounts to a whopping $7.9 billion.

The pension fund now pays government retirees $50 million annually more than it receives in contributions to the fund from both the active employee and his or her government employer.

"If no preventive action is taken to offset yearly shortfalls in the retirement system, the government will have to resolve the problem," said Marisol Marchand, administrator of the Government Employees Retirement System. "The government must take measures to cover the deficit in order to have enough money to pay the future pension benefits to employees."

So how is this multibillion-dollar problem going to be solved?

You guessed it. Taxpayers may have to pick up the tab.

Governments can’t declare bankruptcy to get out of their pension obligations, and their pensions aren’t insured. If there isn’t enough money in the plans to provide for retirees, the local government will have to make up for the losses by increasing taxes.

An employee and the government together currently make a combined contribution to the fund that’s equivalent to 17.55% of the employee’s salary (8.275% by the employee and 9.275% by the government). That’s a little above the average contribution to retirement funds in state governments.

Nonetheless, the combined contribution by both the employee and the government isn’t enough to cover the benefits currently being paid.

The System’s board is analyzing a contribution increase, Marchand said. According to her estimates, another 20% would have to be withheld from each public employee’s paycheck to bring in enough money to solve the problem. But it’s highly unlikely that the government would make that deduction because it would be tantamount to political suicide.

"The government and the System are doing the best they can with their scarce resources. The obvious problem here is that the system doesn’t have enough assets to cover the amount of its current and future liabilities," said Hector Mayol, president of Santander Asset Management. "The government will have to take measures that aren’t necessarily investment oriented in order to close the pension plan’s underfunded gap. It must find a way to supply more funding to the retirement fund by either reducing the benefits to employees or freezing the hiring of government employees."

First in, first out

Aggravating the underfunding situation in Puerto Rico is a demographic reality. The number of people retiring from the System is growing faster than the number of employees contributing into it. During the past 13 years, the number of employees contributing to the System has remained at about 160,000 while the number of retirees receiving retirement benefits has doubled to about 90,000.

Compound the static contribution of active employees and increasing retiree beneficiaries with the paltry returns–and losses for the past year–on investments (a dramatic contrast to the good yields of the stock market of the roaring 1990s) and Puerto Rico’s System is poised for disaster.

For example, the System received a profit return on investments of 15.32% in fiscal year (FY) 1998 and of 22.8% in FY 1999. However, it lost 8.64% in FY 2000 and 11.4% in FY 2001.

From July 1, 2001 to June 30, 2002, close to $212 million was wiped from the investment portfolio by the dramatic drop in stock prices. In the prior fiscal year, the portfolio lost $300 million, for a total $512 million lost in the past two years.

In recent years, the retirement system has depended on investment income to bolster the fund. When the stock market took a dive in March 2000, so did investment income.

Rather than increasing earnings, the stock market eliminated 15% of the available funds in Puerto Rico’s retirement fund portfolio, which is over 70% invested in stocks & bonds.

"The losses are on a par with what is happening in the market; everyone is witnessing a drop, but ours is more noticeable because the System is highly invested in stocks," Marchand said.

Edmundo Garza, executive vice president of Consultiva Internacional, said the government’s retirement system has always been unhealthy.

Garza, a former administrator of the Employees Retirement System, pointed out that from 1951 to the mid-1980s, all of the System’s funds were invested in the Government Development Bank through the Treasury Department in fixed income, practically earning interest equivalent to certificates of deposits. Therefore, its assets weren’t growing at the necessary rate to meet demand.

Also contributing to the System’s financial woes are politicians seeking votes. For years, politicians showered government employees with more pension benefits in order to win votes. But the deal consisting of more benefits created a financial crisis.

For instance, a merit pension developed for public employees hired before April 1, 1990 allowed them to receive 75% of their final three years’ average salary after 30 years of service, beginning as early as age 55. If they left government employ before age 55, they would receive 65% of their average salary.

Even though pension benefits were cut in 1990, employees are guaranteed 45% of their salary and a 3% adjustment for inflation every three years.

The retirement system’s shabby finances were somewhat temporarily patched when proceeds from the government’s sale of the Puerto Rico Telephone Co. to GTE in 1999–as part of a policy to privatize certain government-owned assets–paid off a $172 million line of credit into which the pension fund had entered with Banco Santander when the pension payments surpassed the System’s contributions.

Changing the rules of the game

Today, a new pension system created three years ago by the former administration, known as Reforma 2000, requires government workers hired since Jan. 1, 2000, currently numbering 21,000, to take sole responsibility for their retirement. Without the reform the System would have gone belly up by 2008.

What’s more, the 21,000 government employees under the new pension system may have to work beyond age 65 before they can retire.

Retirement benefits under Reforma 2000 are worth less than under the old pension system. That is because central government agencies, municipalities, and public corporations under the System don’t contribute to their employees’ retirement plans.

Instead, an employer’s contribution is paying down the deficit of the system in place before 2000. The 9.275% government contribution that would have gone to each of the 21,000 employees’ (hired after 2000) retirement savings accounts is going only to bailing out the System’s debt. The new system was established to prevent the old System’s collapse.

Under the defined-benefit plan for retirees hired before 2000, the amount of the pension is linked to salary and years of service. Reforma 2000 established a parallel retirement system based on a defined contribution, or contributions made by an employee to his or her retirement savings account. At the end of 30 years, the employee’s cash balance is used to purchase a lifetime annuity.

The question now is how long can it all continue to limp along before real reform occurs.

Reforma 2000 provided some relief. But to make the pension fund whole, the combined contribution by an employee and the government would have to increase dramatically. It would have to equal 40% of an employee’s paycheck, half of which would come from the government.

Given such a shortfall, Marchand has recommended that the government step in and bail out the sinking pension fund, because no matter how much the economy improves, the System won’t be able to gather sufficient funds to meet its pension obligations in 15 years. And that’s where taxpayers would come in.

. Defined-Contribution Pension Plans Encourage Employees To Work Longer

The fastest growing type of pension plan, defined contribution, seems to encourage people to work nearly two years longer before retirement than people covered by traditional defined-benefit pension arrangements.

That’s one of the key findings of economists Leora Friedberg of the University of Virginia and Anthony Webb of the International Longevity Center in New York, who presented their research at the Southern Economic Association convention earlier this year in Florida.

Defined-contribution plans make pension payments according to the performance of an individual’s investments. Defined-benefit plans, on the other hand, pay a predetermined amount that is based on a person’s salary and years of service.

Friedberg and Webb arrived at their conclusions by analyzing pension information collected between 1992 and 1998 from more than 7,600 households with people aged 51 to 61.

The workers who stayed on the job longer seemed to do so because of economic incentives. The participants in the study were generally middle-class homeowners with at least a high school education. They develop a "good sense of what’s going on economically, even without precise calculations," Friedberg said.

These people come to realize what the researchers’ analysis of the Health & Retirement Study figures have borne out: The total lifetime value of their private and social security pensions peaks somewhere between the age when pension rules let them retire early, typically between 55 and 60, and when they turn 65.

After that, the value added to their pension benefits by continuing to work is offset by the shortened timeframe for reaping those benefits.

"In a defined-benefit scheme, at younger ages there is a big incentive to keep working," Webb said. "At older ages, there’s often a big incentive to quit. Defined-contribution pensions, in contrast, lack these age-related incentives, and older workers get a pension reward for additional years of work."


This Caribbean Business article appears courtesy of Casiano Communications.
For further information please contact

Self-Determination Legislation | Puerto Rico Herald Home
Newsstand | Puerto Rico | U.S. Government | Archives
Search | Mailing List | Contact Us | Feedback