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I told you so? Crockett update on Public Pensions.

The hottest seat at the Capitol last night was at the Pension Commission. The Capitol hearing room was packed with legislators, retirees, police officers and other public employees, union officials, and lobbyists. And yours truly.

In addition to passing the gavel from the House to the Senate for two years, and electing new officers (Chair, Sen. Julie Rosen, Vice Chair, Rep. Tim O’Driscoll, and Secretary, Sen. Sandy Pappas), the Commission heard from both the State Board of Investment (SBI) and the Governor’s office.

Here are the headlines:

Unfunded Liability Increases At Least $2 Billion: The unfunded liability, which will have to be paid by young employees and all taxpayers, has gone up another $2 billion just for the big three plans: MSRS, TRA (teachers) and PERA General (local government). If you add in St. Paul Teachers fund, the four funds are $15.8 billion in the hole. If you add in statewide safety funds, the number is closer to $17-18 billion (I am still crunching all the numbers).

The unfunded liability has increased dramatically despite a bull market (2016 returns were a negative 0.1%) and several of the funds are taking in tons of additional contributions and cash from employers (taxpayers) that adds up to about $117 million a year. That’s $117 million on top of the normal costs (contributions from employers and employees).

Always remember: These are the shortfalls reported by the state, a state that has gotten very good at hiding the pension problem, by using wildly optimistic assumptions. If calculated using more reasonable, market-based assumptions, the liability at least doubles.

SBI Says Discount Rate and Rate of Return Should Be Distinct (and Lower): Mansco Perry is the Executive Director of SBI, which has about $58 billion in defined benefit pension funds, and another $6 billion in defined contribution funds, under management. Mr. Perry and SBI are asked to do the impossible by the Legislature: earn a rate of return of 8.5% year after year. That assumed rate of return has been moved downward by most funds (except TRA/Teachers which is stuck at 8.5%). (Minnesota is always an outlier nationally—other funds are way ahead of Minnesota in dropping investment expectations to 7.5% or lower—still fantasy land but it is an improvement.)

Mr. Perry said two very important, and new things, out loud: first, that the assumed rate of return and the discount rate used to discount liabilities, should be determined separately. This is good advice, and one I have not heard before from SBI or any other state official, even though it should be accepted wisdom.

Private sector funds, and public sector funds outside of the United States, use the market to set rates for returns– the discount or “risk rate” is based on what the market says about the risk that the pension will not be paid. In the case of government, which is not expected to go out of business, and can raise taxes, the risk is very low that pensions will not be paid. So the risk rate is nowhere near 8.5%, or even 7.5%. Technically it is closer to zero.

Mr. Perry also said that the assumed rate of return should be 7.5% but warned that this was a big drop that would have a huge impact (on both unfunded liabilities and the calculation of how much money should be contributed from employers and employees).

Governor’s Blue Ribbon Panel Calls for 7.5% Immediately: Myron Frans, Gov. Dayton’s Commissioner at MMB, reported that the panel (made up of business executives) strongly recommended that the assumed rate of return be dropped this year to 7.5% and that “other steps” should be taken to address the unfunded liability and put the pension funds on a positive funding path.

Mr. Frans was very short on detail but the report posted on the pension website has more (the recommendations are copied below, my opinion is this is not going to do the job, it is moving chairs around the deck of a sinking ship).

Governor Dayton included $100 million in funding in his budget proposal for increased employer/taxpayer contributions.

On a positive note, some legislators sat through a presentation by Deloitte actuaries on the realities of Minnesota’s public pension funds. It was by and large like a bucket of cold water tossed in the face of legislators, to the extent the understood what the actuaries were talking about. (One member wondered out loud if the presentation was really “Alternative Facts” but then said, “Well, maybe I just did not understand it.”) Ah yes, and that is the problem. Legislators really do not understand how to run a defined pension system.

Crockett’s Recommendation: If Governor Dayton really wants to keep the promises we have made to current retirees and employees, and stop kicking the can down the road, then he has to close the defined benefit plans and stop paying COLAs to all retirees (immediately). Figure out how much we owe (honest numbers) and devise a 30/40-year plan to pay off the massive unfunded liability while the plans wind down.

Then enroll all new employees in the best, darn defined contribution plan we can offer with lots of options and mobility, so we can attract the best employees possible in this highly mobile, modern economy. Then as employees save for their future, they can control their own destiny and own their assets.

 

Blue Ribbon Report: The board of each pension plan is proposing changes specifically tailored to their needs and situation. Plans also engaged their stakeholders with a goal to come up with a proposal that could be supported by all those impacted. Generally, the proposals put forward included a combination of the following elements:

  • Increased regular employee contributions
  • Increased regular employer contributions
  • Increased supplemental employer contributions (designed to address past unfunded liabilities and address the reduced investment return and discount rate assumptions)
  • Reduced annual post-retirement benefit increases (commonly referred to as cost of living adjustments or COLAs) and elimination of automatic future COLA increases
  • Reset the amortization period (the time period over which unfunded liabilities are paid for) to 30 years
  • Requests for additional state aid to fund unfunded liabilities.

The impacts of these proposed changes will be shared among plan participants, and will vary based on the current plan structure and the specific funding needs of the plans.

In the case of TRA’s proposal, employers will bear 47% of the impact, active members 28%, and retirees 25%.

For MSRS’s General Plan proposal, employers will bear 54% of the impact of the proposed changes, active members will bear 26%, and retiree/inactive members 20%.

For the changes proposed to the Correctional and State Patrol plans, the employers will bear a larger portion of the impact – 72% and 88%, respectively – with the remaining portion being shared between active and retired/inactive employees.

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