Treasurer Caprio on Pension Reform

During Anchor Rising's interview of Rhode Island General Treasurer Frank Caprio, Treasurer Caprio presented the results of several case studies illustrating how the pension reforms implemented in 2005 have helped bring the cost of Rhode Island's pension system in line relative to the other New England states. One set of analyses compared benefits owed to a state retiree with 30 years of service and a final salary of $57,000 who retired at age 55 -- as was allowed in the pre-2005 system -- to what is owed to a state retiree with the same service time and salary who retired at age 60, under the post-2005 schedules…

• The ERSRI benefit under [the pre-2005 schedule] is 48% larger than the average in the other five states, and the APV is 60% larger than the average.
• The benefit under [the post-2005 schedule] is 7% larger than average, and the APV is 15% larger.

General Treasurer Frank Caprio: Here's how I like to conceptualize the unfunded liability. Assume that we're buying a house, and the house costs $700,000. We're going to have to put in place a mortgage to buy the house…over 30 years it gets paid off. Change those numbers; the unfunded liability in Rhode Island is about $7 billion for our pension. We have $6 billion that we have to pay it, but then we need another $7 billion to be fully funded.

Anchor Rising: And that's to pay out if everybody works a normal working career, retires, and lives an actuarily determined lifespan?

FC: Correct. The actuaries will make a bunch of assumptions. Usually, they're pretty close to being accurate. Large numbers are in play here. You look at the past practice and experience, and you overlay that onto the future.

Think of the house example. We have this liability and we're paying a yearly payment in the form of a mortgage. After 30 years, we'll have no debt on this asset. Now, think of the same concept with the unfunded liability. We have a $7 billion unfunded liability. We are currently paying between the state and the municipal payments into the system...about half-a-billion dollars a year in employer contributions. The reason we're doing that is we're 10 years in on a 30-year plan. 20 years from now, we'll have a fully funded pension system. The system gets high marks – when I say system, I mean the state of Rhode Island -- because we've anted up the payments on that mortgage, so to speak.

What the changes that are being proposed to the system do is take that $7 billion that we currently owe and shrink it, because by not guaranteeing that 3% a year cost-of-living adjustment, our future liability becomes much smaller. It will shrink by about 25% and therefore our "mortgage" payment can shrink. That's what's being attacked, by changing the benefit formula and not being able to retire at any age.

AR: What changes would you like to see?

We have to save somewhere between $100 million to $150 million on our pension costs. With the budget strain we have, about 25%-30% of the strain is caused by the employer, taxpayer contribution. One end would say let's go to a 401(k) style self-directed plan, the government should not be in the business of putting extra money in to the level that we do. The issue with doing that currently is that it would cost us about $500 million over the next 5 years. We wouldn't save the $500 million we're trying to save, and it would cost us $500 million, so it's about a billion dollar swing. I'm answering your question with a specific answer, not theoretically as if in a perfect world, what would you do. We have to play the hand we're dealt…

AR: That cost is related to accounting rules, right?

FC: Yes. The reason why that would happen is if you close a defined benefit system like the state currently has, it accelerates certain schedules of payments that you as the employer have to make. The government has put in place a little bit of a soft-landing, so people can't whipsaw from one decision to another and there's some financial ramifications for doing it. If we're going to do it we have to come up with more money, not save money, so again it puts us in the wrong $500 million, not in the right $500 million.

AR: And I know you don't have any control over those accounting rules, but as someone who's on top of their financial ramifications, do those rules make sense? Is it a good thing that that rule is in place, or is it something that's getting in the way of doing the right thing?

FC: It's good financial management practice, because the state taxpayers are going to be responsible for those payments, one way or another. For the state, it's better to have a fund set up with the requisite assets in it to pay those future liabilities and not continually go back to the taxpayers. The worst case scenario is you end up with a pay-as-you-go system, which we've seen examples of in cities and towns, where they don't have put enough money aside and there's a line item in their budget every year to pay pension benefits.

A second potential would be what's called a hybrid system. In a hybrid system, you have a portion 401(k) self-directed benefit, you have portion like the state current has, defined benefit, but nowhere near 60-80% of your highest three years; instead maybe 20-40% of your highest three years, and then you have social security. All state employees and most school teachers, not all, but most participate in social security. Retirement then becomes a three-legged stool.