Riley: Why Doesn’t All of Rhode Island Use One Discount Rate?
Tuesday, November 21, 2017
There are two important points to be made here. First, unless two investors have exactly the same portfolios, it is very unlikely that they will have the same returns. Typically, the more risk that is taken by that investor, the higher the expected return. A fiduciarily sound portfolio is never 100% in stocks or 0% invested but rather the standard for the last several decades has been 60% stocks and 40% fixed income.
Performance then varies based on specific instruments used and their costs. For some as yet unexplained reason current government accounting standards (GASB) instruct states to discount their liabilities at the expected return on their assets. In the opinion of most economists, doing so creates a false equivalence between future pension payments, which almost certainly will be incurred, and the outcome generated by a risky investment portfolio, which by definition is highly uncertain.
Economists believe since the liabilities are certain and the returns are not, that the liabilities should be discounted at the “risk-free” rate of interest. Currently, risk-free rates in the U.S. are under 3% for 30 years. For those in Rhode Island, who believe 3% is ridiculously low, consider the last 10-year performance in Rhode Island of 4.4% under Caprio, Raimondo, and Magaziner.
This is the main reason that, despite pension reform that included dramatic re-amortization under Raimondo, the funded ratio has actually declined from the reforms of 2012 at 60% to 55% as of June 30, 2016. This trend is very unhealthy, especially considering the exceptionally long bull market in equities.
Who selects the discount rate?
Every Pension fund has trustees charged as fiduciaries. In Providence, for example, Mayor Elorza heads the Investment Commission as did Cicilline and Taveras before them. The commission discusses with the hired actuary the current valuation of the pension assets, the contents of the portfolio and past performance of the adviser. Providence has been above 8% for many decades now in its expected returns despite little evidence of that kind of performance. Some towns or Mayors believe their adviser is super good and better than anyone else in Rhode Island or America for that matter. They choose 8% or more for their expected return.
Coincidently, choosing a very high expected return reduces the amount of money to be set aside today in budgeting. If you expected 10% for some reason as Mayor you could set aside even less money for pensions and spend that money on something else. Maybe on something more popular? The mayor of an economically struggling town could even mask cash flow problems by purposely overestimating returns in the pension fund.
The most important factor in choosing expected investment returns is not your adviser or actuary or portfolio but rather the general interest rate environment. Today there are trillions of dollars earning little or no return. Twenty years ago rates of 6% or 7% were commonplace and investment commissions could easily fund the pension plan expecting 8% with a big slug of low risk fixed income investments. That is emphatically no longer true and politicians across the country are aware of the problem.
Fiduciaries like Mayor Jorge Elorza are currently deliberately overstating investment returns in order to contribute even less to pensions. Providence is currently funded at just 25% using an 8% discount rate. This is the worst funding ratio in the nation yet Elorza is misleading taxpayers and municipal bond markets by overstating investment returns. The SEC should investigate and an outside forensic Audit should check into the accounting in Providence where claims of employee paycheck pension contributions not being invested for months or even years are well known. It’s time for Elorza to come clean on his pension mismanagement and deception.
Related Slideshow: Timeline - Rhode Island Pension Reform
GoLocalProv breaks down the sequence of events that have played out during Rhode Island's State Employee Pension Fund reform.
Governor Don Carcieri makes pension reform a top priority in his emergency budget plan. His three-point plan included:
1. An established minimum retirment age of 59 for all state and municipal employees.
2. Elimination of cost-of-living increases.
3. Conversion of new hires into a 401(k) style plan.
See WPRI's coverage of Carcieri's proposal here.
Rhode Island's state administered public employee pension system only held 48% of the assets to cover future payments to its emplyees.
"This system as designed today is fundamentally unsustainable, and it is in your best interest to fix it" - Gina Raimondo
Check out Wall Street Journal's coverage here.
Gina Raimondo defeats opponent Kernan King in the election for General Treasurer of Rhode Island using her platform to reform the structure of Rhode Island's public employee pension system. She received 201,625 votes, more than any other politician on the 2010 Rhode Island ballot.
Raimondo leads effort to reduce the state’s assumed rate of return on pension investments from 8.25 to 7.5%.
Her proposal includes plans to suspend the Cost of Living Adjustment (which allows for raises corresponding with rates of inflation for retirees), changing the retirement age to match Social Security ages, and adding a defined contribution plan.
Raimondo releases “Truth in Numbers”, a report detailing the pension crisis and offering possible solutions. She continues to work to raise public support for her proposal.
"Decades of ignoring actuarial assumptions led to lower taxpayer & employee contributions being made into the system." - Gina Raimondo (Truth in Numbers)
Read GoLocalProv's analysis of the report here.
Read the Truth in Numbers report here.
Governor Lincoln Chafee and General Treasurer Gina Raimondo present their pension reform legislation proposal before a joint session of the General Assembly.
“Our fundamental goal throughout this process has been to provide retirement security through reforms that are fair to the three main interested parties: retirees, current employees and the taxpayer…I join the General Treasurer in urging the General Assembly to take decisive action and adopt these reforms.”- Gov. Lincoln Chafee
Head of Rhode Island firefighters’ union accuses Raimondo of “cooking the books” to create a pension problem where one did not exist. Paul Valletta Jr. states that Raimondo raised Rhode Islanders’ assumed mortality rate to increase liability to the state, using data from 1994 instead of updated information from 2008, and lowered the anticipated rate of return on state investments.
“You’re going after the retirees! In this economic time, how could you possibly take a pension away?” Paul Valletta Jr (Head of RI Firefighters' Union)
Read more from the firefighters' battle with Raimondo here.
Check out the New York Times' take on RI's pension crisis here.
November 17, 2011
The Rhode Island Retirement Security Act (RIRSA) is enacted by the General Assembly with bipartisan support in both chambers. RIRSA’s passing is slated to reduce the unfunded liability of RI’s pension system and increase its funding status by $3 billion and 60% respectively, level contributions to the pension system by taxpayers, save municipalities $100 million through lessened contributions to teacher and MERS pension systems, and lower the cost of borrowing.
Read more from GoLocalProv here.
November 18, 2011
Governor Lincoln Chafee signs RIRSA into law. According to a December 2011 Brown University poll, 60% of Rhode Island residents support the reform. Following its enactment, Raimondo holds regional sessions to educate public employees on the effects of the legislation on their retirement benefits.
Read about how Rhode Islanders react to RIRSA here.
Raimondo hosts local workshops to explain the pension reforms across Rhode Island. She also receives national attention for her contributions to the state’s pension reforms. The reforms are given praise and many believe Rhode Island will serve as a template for other States’ future pension reforms.
Read about the pension workshop here.
Read Raimondo's feature in Institutional Investor here.
March - April 2012
Raimondo opposes Governor Chafee’s proposal to cut pension-funded deposits. She continued to provide workshops on the pension reforms.
December 5, 2012
Raimondo publicly opposes Governor Chafee’s meetings with union leaders in an effort to avoid judicial rulings on the pension reform package. In response, Chafee issues a statement supporting the negotiations.
Read more about Raimondo's opposition here.
Read about Chafee's statement http://www.golocalprov.com/news/new-chafee-issues-statement-supporting-pension-negotiations/">here.
Led by the Rhode Island State Association of Fire Fighters, unions protest the 2011 pension reform outside of the Omni Providence where Governor Lincoln Chafee and General Treasurer Gina Raimondo conduct a national conference of bond investors.
Read about Raimondo's discussion of distressed municipalities here.
The pension plan comes under increased scrutiny as a result of the involvement of hedge funds and private equity firms. Reports show that $200 million of the state pension fund was lost in 2012.
"In short, impressive educational credentials and limited knowledge of investment industry realities made Raimondo ideally suited to champion private equity’s public pension money grab." - Ted Seidle (Forbes)
Read GoLocalProv's coverage of the State Pension Fund's losses here.
Read Ted Seidle's criticism of Raimondo in Forbes.
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