April 13, 2011

Paying the Pension Piper

Marc Comtois

Consultant's hired by General Treasurer Gina Raimondo will present their findings to the state retirement board today (report here - PDF). Their findings are grim if unsurprising, as reported by the ProJo. There are some basic structural problems:

The state pension system is based on three basic sources of funding: employee contributions, employer contributions and the volatile stock market. Because the employee contributions have been locked in place at 8.75 percent of pay for state employees, and 9.5 percent for teachers since 1995, taxpayers have been required to pay more and more each year....

The state adopted the 8.25-percent assumed rate of return on its investments in 1998, over the strenuous objections of then-Treasurer Nancy Mayer, who denounced the move as “amazingly irresponsible” in a volatile economy.

The actual market return averaged 2.47 percent over the 10 years that ended on June 30, 2010.

Assuming 8.5% annual return: mistake. The result:
[T]he gap between promises made and money available to pay for them is at least $1.4 billion bigger than previously believed.

• The required taxpayer contribution toward state employee pensions would shoot from 26.55 percent of payroll to 36.34 percent which, in dollars, would mean the difference between $182.5 million, with no change in assumptions, and $246 million.

• State and local contributions to teacher pensions would increase, at the same time, from 26.21 percent of payroll ($282.8 million) to 35.25 percent ($375.3 million).

At those levels, the required taxpayer contributions would be more than $100 million higher, within a year, than the $358.7 million that Governor Chafee anticipated...

Here are their recommendations (from the report):
1. Decrease the price inflation assumption from 3.00% to 2.75% per year.
2. Decrease the assumed net real return on investments from 5.25% to 4.75% per year. Combined with #1 decreases the nominal assumed investment rate of return from 8.25% to 7.50%.
3. Based on #1, change the COLA assumption from 2.50% to 2.35% for Schedule B retirees.
4. Modify the service-related components of the salary increase rates for both state employees and teachers; also change the wage inflation assumption from 4.50% to 4.00%.
5. Decrease the payroll growth rate from 4.25% to 3.75% for both state employees and teachers.
6. Improve the mortality assumption for active, and retired members, including the addition of
an assumption for ongoing future improvements in life expectancy. Also improve the
mortality assumption for disabled retirees, and lower pre-retirement mortality.
7. Make slight changes to the rates of disability for active male state employees and all teachers.
8. Make no change to the retirement rates for state employees or teachers.
9. Make no change to the termination assumption for state employees. Slightly increase the termination rates for teachers.
10. No change to the percentage of members that are assumed to be married.
11. No change to the actuarial cost method or the method for calculating the actuarial value of assets.
12. No other changes are recommended for any of the other actuarial assumptions or any of the actuarial methods.
Based on past results (which don't guarantee future returns!), even dropping to 7.5% seems too optimistic.

ADDENDUM: Ted Nesi has some thoughts from Governor Chafee on pensions.

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"The actual market return averaged 2.47 percent over the 10 years that ended on June 30, 2010."

That's correct, but it's cherrypicking.

What was the actual market return for 1990 - 2000?

"even dropping to 7.5% seems too optimistic."

I don't think so. I'm not doing any in depth googling yet, but everything that I'm reading is that over a 40 year period (ie. a career), the stock market has always returned 7.5 - 9%.

Every time we hear someone rail on about the 8%, they only look at a condensed time period that is always at least shorter than the minimum amount of time required for a fully vested pension. At least look at that amount of time, but even longer would make sense.

Sure the market has tanked over the last 10 years or so, but what happened over the last fiscal year? Wasn't it over 12%? Again, that's cherrypicking. The market is never going to give you 8% every year, there will be ups and downs, but the real problem is getting it properly funded for what's promised. There are two sides to that equation, proper funding and promise of benefits. If you can't meet those, then one or the other clearly needs to be changed. If the proper funding can't be met, then maybe the benefits out need to be updated.

Posted by: Patrick at April 13, 2011 9:15 AM

Patrick,
You're correct. Page 17 of the report:

"[F]or the last fourteen fiscal years, 1997 through 2010...the plan did exceed the
expected 8.25% return assumption in nine of the last fourteen years, [but] the average market return during this period was only 5.37%, which is significantly less than the 8.25% assumption.

The retirement system provided information showing a total return since 1984 through December 31, 2009 of 9.21%. (This return is a gross return, not reduced for the effect of expenses.) "

I won't excerpt it, but read the explanation that follows where they explain that the can't go with such a high rate of return going forward and even consulted 7-8 other investment firms. So, yes, maybe I'm too pessimistic and they will be proven correct. Basically, while what you've found may all be true, what would be more fiscally responsible: underestimating or overestimating the market return? (And I realize that could mean more taxpayer "contributions"). That's why there needs to be serious reform in retirement ages, percentages, cola's, etc.

Posted by: Marc at April 13, 2011 9:24 AM

Ok, I found what I was looking for:
www.moneychimp.com/features/market_cagr.htm

It only uses the S&P, so it's not exact, and I have no idea everything that the RI Gen Treasurer invests in, so the numbers would be different. But this just goes along with my point.

2000-2010: -0.11%
1990-2000: 7.48%
1980-1990: 10.68%
1970-1980: 2.02%

1970-2010: 7.02%
1980-2010: 9.14%
1990-2010: 7.48%

So I will concede that Marc's statement that 7.5% might be optimistic is true, given my request to look at a period of at least he minimum vesting, 20 years.

But I think these numbers also show that you can pick your numbers any way you want. Heck, look at the two years of 1/1/2009 - 12/31/2010, you get a return of 18.18%. More than double the RI fund's expectation.

Be wary of cherrypicking time periods in reports is my point.

Posted by: Patrick at April 13, 2011 9:28 AM

No problem.
The progressives will just raise the broadened sales tax a little every year to meet the increased "needs" of the unions and cronies..
Oh, that was the plan all along.

Posted by: Tommy Cranston at April 13, 2011 9:32 AM

Megadittos!

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Posted by: UrawerSesE at October 6, 2011 7:04 AM
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