How to defuse North Carolina’s fiscal time bomb

NC treasurer Dale Folwell says the state’s employee health care liabilities are alarming.
NC treasurer Dale Folwell says the state’s employee health care liabilities are alarming. Observer file photo

For many decades North Carolinians of all political stripes have taken solace in the fiscal responsibility of our state. One of only a handful of states with a coveted AAA bond rating, North Carolina benefited from sound fiscal management for almost 50 years under Treasurers Edwin Gill (1953-1977) and his successor, Harlan Boyles (1977-2001). This fiscal heritage is now in danger.

Current Treasurer Dale Folwell recently warned, “North Carolina is just behind Illinois in unfunded healthcare liabilities.” To assign North Carolina to the same heap with Illinois, the nation’s most profligate state, likely is a big surprise to most North Carolinians. Our state retirement system is the ninth largest in the nation, with over 900,000 participants and $98 billion in assets. The state healthcare plan is one of the 10 largest in the nation. While these employee plans cost taxpayers billions, there is little comprehension of the scale and scope of benefits. System-wide, non-salary fringe benefits average over 30 percent of total compensation, according to Folwell.

North Carolina’s employee plans currently represent an estimated unfunded future liability of over $50 billion. The retirement plan has an unfunded liability of approximately $15 billion. It is 88 percent funded, the fifth highest in the country, but as recently as 2007 was 104 percent funded. If the funding ratio is not restored to 100 percent, the employee plan commitment will ultimately squeeze out other needs, such as transportation and education.

A significant part of the funding shortfall involves the “assumed rate of return.” The plan’s assumed rate of return for many years was 7.25 percent, but results have fallen far short in recent years. In April, 2018, Folwell announced a reduction in the rate to 7 percent, which “’will provide the best opportunity to meet the state’s long-term obligations as well as maintain its AAA bond rating.”

While this reduction places additional strain on the current state budget, it is a step in the right direction. But it may be only a small step. A recent Bloomberg article recently sent shock waves through the financial community when it quoted Howard Marks of Oaktree Capital advocating an assumed rate of return as low as 5 percent.

The state health care plan is, according to Folwell, “insolvent, with a $35 billion unfunded liability.” State employees contribute very nominal amounts ($25 to $50/month) for health coverage. Employees who retire after 20 years of service receive full health coverage for life. More is clearly needed, including bringing health care benefits more into line with those offered in the private sector.

A major reform, requiring legislative action, would be for the state to follow the private market by converting to a fixed contribution model. Today there are very few defined benefit retirement plans provided by private companies. Most have migrated to fixed contribution 401k plans (often as a match to employee contributions), and the retirement value is determined by the investment performance of the employee’s 401k account. North Carolina has retained the old defined benefit model, which requires adequate funding from the state to meet set benefit commitments. An attempt to convert to a fixed contribution model failed in the legislature last year. Hopefully Folwell will endorse this reform and get it through the legislature.

Warren Buffett has warned that government employee plans “are huge and woefully underfunded. Because the fuse on this time bomb is long, politicians flinch from inflicting pain, given that problems will only become apparent long after these officials have departed.” North Carolina should follow Folwell back to the wisdom of Edwin Gill and Harlan Boyles.

Tucker is a Senior Fellow at the John Locke Foundation