January 30, 2011

How Big is the Real Unfunded Pension Liability, Madam G.T.? We Had an Answer in October

Monique Chartier

... though even it may have been too optimistic.

In her interview yesterday with Kathy Gregg, General Treasurer Raimondo points out that the assumed rate of return on the state's pension fund is almost certainly not realistic. She goes on to ask the logical question.

Over 10 years, she said the state has averaged 4.4 percent, which is significantly less than the 8.25 percent assumed rate of return on investments the state’s pension consultants have used to determine the magnitude of the state of Rhode Island’s unfunded obligation to its retirees, “which means the unfunded liability is probably higher than what we hear about.

“That’s one of the things I am trying to figure out straight away,” she said. “How big is the liability?

And here's one answer, thanks to 1) WPRI's Ted Nesi who spotted a reference to a report commissioned by 2) former G.T. Frank Caprio and made a point of requesting and then posting it October 6.

An indication of just how much money we’d owe was buried in a June 1 memo to the treasury by Gary Bayer, an actuary at the big broker Aon, that Caprio’s office released this week. Aon was asked to estimate how much larger the unfunded liability would be if we assumed a 6% return instead of an 8.25% one, and here’s what Bayer came up with:

If liabilities were valued based on a 6% rate instead of the current 8.25% rate, we estimate that the unfunded liability would increase from $1.7 billion to $2.7 billion for the state employees and from $2.7 billion to $4.6 billion for the Teachers.

For the mathematically challenged, that’s an increase in the unfunded liability from $4.4 billion to $6.5 billion, or nearly 48%.

At a 6% return, which is still inflated over the actual rate of return for the last ten years of 4.4%, the liability grows by 48%. What does it look like at the realistic rate of 4.4%???

So bad, I, for one, don't want to see it. It's clear that even at the inflated rate of 6%, we're in enormous trouble. I'd like to suggest that we cut our "losses" here, at 6%, stop calculating and turn to fixing the problem.

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But 6% or even 8% might not be inflated going forward. Didn't she also say that in the last year, the fund grew by 12%? So that means next year it can grow by only 4% and keep up an 8% average. And what are the odds that it'll only grow by 4% next year? Possibly, though pretty slim.

Though this doesn't mean that the pension fund isn't in trouble. Just cut the losses, don't let anyone else into the pension fund and turn all new employees to a 401k. Then figure out how to pay off the current employees and retirees.

Posted by: Patrick at January 30, 2011 9:02 PM

"But 6% or even 8% might not be inflated going forward."

Patrick, the problem is that the fund averaged 4.4% per year for the ten years prior to 2010. Further, the fund hasn't even fully recovered from the economic crash of a couple of years ago.

"Just cut the losses, don't let anyone else into the pension fund and turn all new employees to a 401k."

Sorry, that's not enough. Yes, all of that should be done as a first step. But, alone, it won't stop the checks from bouncing.

Posted by: Monique at January 30, 2011 9:31 PM

"Patrick, the problem is that the fund averaged 4.4% per year for the ten years prior to 2010."

That is a current problem, but irrelevant going forward. If the fund can maintain a 12% average, which I know is highly unreasonable and irresponsible to assume, then the situation isn't as dire as your post suggests. It was 12% last year, so I don't see why you'd even mention looking at liability for 4%. They're trying to figure out the liability going forward, so the future numbers and assumptions are what matter. We have no way of knowing what the investment market will do over the next 10 years, but the previous 10 have been historic in how bad they've been. Can that continue for another 10? I wouldn't bet my house on it (no pun intended) but I would bet it'll be better than 4 or even 6%.

Posted by: Patrick at January 31, 2011 8:09 AM

My sources tell me that the "leadership" feels that (and sadly, this is NOT a joke) "the employees have already given enough on pensions for the next couple of years".

Posted by: Mike at January 31, 2011 9:21 AM

What was the rate of return over a longer time period, say 20 or 30 years? Why concentrate so much on the 10 year rate when historically it is an abnormality? The market has up and downswings and no one felt the need to increase the assumed rate back in the 90's.
Shouldn't you match the growth period with the liability, which I believe is amortized at 22 years?

Posted by: Ron J at January 31, 2011 11:30 AM

Ted Nesi's quote seems mathematically challenged. Using the numbers in the previous sentence, the state employee increase is $1.0 billion and the teachers increase is $1.9 billion. The total grows from $4.4 billion to $7.3 billion, a 66% increase.

Posted by: BobN at January 31, 2011 6:45 PM
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