The Cost of Re-Amortization

On Wednesday, on WPRO, Governor Lincoln Chafee compared re-amortization to remortgaging a house. "That's no different," he said. Actually, it's quite a bit different, which the governor might be better prepared to understand if he had more in common with the average Rhode Islander.

The cost of remortgaging comes, first, in the loss of interest that the homeowner has already paid and, second, in the added financing if the homeowner extends the period of the loan. If they know what they're doing, most folks refinance in order to lower the total cost of the loan, not just the monthly payments.

The cost of re-amortization, by contrast, comes in the amount that the state will lose in investment interest by not putting money aside. For an example, look at Exhibits S and T of the state actuaries' analysis of the pension reform law. They put the FY13 employer contribution rate for the reformed pensions at 24.38% of payroll without re-amortization and 20.35% with re-amortization. The rates for teachers are 21.18% and 18.11%. With the Retirement Board's assumption of 7.5% investment returns, this one year's change alone will cost the state $132.3 million by the time the system is fully amortized in 2035.

Exhibits S2 and T2 show the employer contribution rates and expected payroll through 2041 with re-reamortization, which allows one to calculate the expected investment return. Not surprisingly, the contribution rates without re-amortization are nowhere to be found; that would allow us to figure out the amount in interest that the state stands to lose.

However, if we take the percentage difference between contribution rates that the actuaries give us for FY13 and extend it out, we find the amount of total lost investment interest due to the six-year re-amortization to be $1.06 billion by 2029 and $1.71 billion by 2035. The loss may in fact be worth the cost, if that money stays in the RI private sector and generates a return for the economy greater than 7.5% (in turn increasing government revenue), but public officials should do a better job of explaining the cost to voters/taxpayers, and they should better understand the implications, themselves.