Warwick’s Pension Numbers Serve as National Example

The local efforts by the Rhode Island Center for Freedom and Prosperity to shine a light on the pension mess have brought national attention:

A locally published interview with a member of the national pension task force, assembled by the RI Center for Freedom & Prosperity, has caused a stir in Warwick, puzzling the Mayor, confusing the local paper, and leading to an online rebuttal. Even the Providence Journal has covered the action.
On May 24, the Warwick Beacon published an article from an interview with Eileen Norcross, senior research fellow and lead researcher on the State and Local Policy Project with the Mercatus Center at George Mason University, attempting to refute her warnings that the City of Warwick is not accurately representing the true scope of the liabilities in its locally administered pension plans.

Norcross published a pie-chart, which she has now updated:

Norcross explains the logic behind her adjustments:

The chart shows Warwick, Rhode Island’s municipal budget (excluding the school budget) carved up according to current costs for funding the town’s pension benefits, Other Post Employment Benefits (OPEB), current employee healthcare costs and General Obligation bond payment. The figures come from official budget documents.
My value-added is that I estimate the additional amount needed to fully fund pensions based on the risk-free discount rate. It’s a ballpark estimate backed into based on the plans’ valuation reports. The actuaries, with access to all the plan data, can model the effect of applying the risk-free rate to plan costs more precisely.

Follow the link to read her entire explanation (and here is another national perspective supporting her analysis from National Review), but here is the root of it:

Public pensions represent a secure, government-guaranteed benefit and are not likely to be defaulted upon. Public pensions should be valued like a government bond. The rate to use is the return on Treasury bonds, currently 2.3 percent.
But what policymakers are worked up over is not the economic principles behind discount rate selection. It’s the practical effect that many politicians and plan sponsors protest, as The New York Times story of yesterday highlights. Lowering the discount rate increases the liability and the amount needed to fund the plan. That has a real impact on the budget, as the Warwick chart shows.

Even if you buy the argument that the 3% figure used by Norcross is too low, it’s still fantasy-land to use 7.5% as a basis.

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Tommy Cranston
Tommy Cranston
10 years ago

3% may be generous since the actual 13 year returns of the stock markets are ZERO. DJIA, NASDAQ and the S & P 500 are all stuck right about where they were 13 years ago.
Japan, with a catastrophic Debt-GDP ratio (and that’s right where we’re headed baby) has a 25 year stock market return of NEGATIVE numbers.
Yet progressives still drink that Bob Walsh Kool Aid.

KenW
KenW
10 years ago

Mark I really don’t know about the benchmark of 7.5% being fantasy-land as the Hawaii Employees’ Retirement System (ERS) has been showing a lot of double digit gains in the past years. Looks like Hawaii has found a winning way to invest the funds for great returns. It appears everything loss in the recession has been gained back. According to the an article in the Honolulu Star Advertiser dated May, 16, 2012 by reporter Dave Segal and posted POSTED: 01:30 a.m. HST titled: “Strong quarter lifts state pension fund by 8.3%; The ERS approaches its peak asset level as investors embrace risk once again” he wrote the following: “The ERS fund provides retirement, disability and survivor benefits to 111,648 active, retired and inactive state and county employees.” “The ERS performance beat the median 7.7 percent return of 26 public funds with assets of $1 billion or more. The ERS return also exceeded its policy benchmark —consisting of various index funds — of 7.5 percent.” “It was the second straight positive quarter and the 10th gain in the past 12 quarters for the ERS fund. The peak level for assets was $11.7 billion on Sept. 30, 2007.” (The following was a graphic chart in the Honolulu Star-Advertiser newspaper article May 16, 2012 related to the above article). “Tracking the Money The State Employees’ Retirement System Pension Fund rose in third quarter 2012. FY * 2012 3Q** Gain/loss +8.3% Total Assets (in Billions) $11.5 FY* 2012 2Q*** Gain/loss +5.5% Total Assets (in Billions) $10.7 FY* 2012 1Q****Gain/loss -11.2% Total Assets (in Billions) $10.2 FY* 2011……………Gain/loss +20.7%Total Assets (in Billions) $11.6 FY* 2010……………Gain/loss +11.7%Total Assets (in Billions) $9.8 FY* 2009……………Gain/loss -18.7%Total Assets (in Billions) $8.8 FY* 2008……………Gain/loss -3.4%Total Assets (in Billions) $10.8 FY* 2007……………Gain/loss +17.7%Total Assets (in Billions) $11.5 FY* 2006……………Gain/loss +11.1%Total Assets (in… Read more »

Tommy Cranston
Tommy Cranston
10 years ago

Somebody with more time can run those numbers Ken but I think they fall short of 8% per year. Plus you don’t include (maybe you don’t have them) the years back to 1999, which would include the internet stock bubble collapse and reduce the return even more. It’s hard for me to believe Hawaii has had a healthy thirteen year rate of return when all 3 domestic markets, NASDAQ, DJIA and S & P have essentialy returned “zero”. Furthermore, there is (god-dang that pesky google!) this recent article from the Hawaii Reporter titled “Hawaii Employees Retirement System $6.2 Billion in the Hole – Will Taxpayers Have to Make Up the Difference?” Ooops. David Shimabukuro, head of the Hawaii public Employees Retirement System (ERS) for 28 years, spent his last hours on the job June 30, 2010 reminiscing on the ups and downs he’s faced for nearly three decades as the administrator for what has become a $10 billion trust. The trust has made all of the pension payments since opening in 1920, overcoming challenges through several major world events, including wars, economic downturns as devastating as black Monday in 1987, the September 11 terrorist attack and the current recent recession. While Shimabukuro emphasizes that the fund is stable for now, he and his replacement, administrator Wesley K. Machida, note there are great challenges ahead, particularly because the Hawaii Employees’ Retirement System (ERS) is facing $6.2 billion in unfunded liabilities. According to the Pew Center of the States, The Trillion Dollar Gap: Underfunded State Retirement Systems and the Road to Reform, the Hawaii ERS has one of the greatest burdens in the nation relative to the size of its payroll and population, with an unfunded liability of one and one-third times the amount of its payroll in fiscal year 2008. This… Read more »

Justin Katz
Justin Katz
10 years ago

Ken,
Here’s the problem with pension math: it’s compounding, and it’s based on an assumption that isn’t 0%. So it may look like you’re getting decent returns, but the context is (deliberately) skewed.
For some sense of what that means, consider each return that you cite by its distance from the assumed 7.7%; you get:
2003 = -4.7
2004 = -23.5
2005 = 3.6
2006 = 3.4
2007 = 10
2008 = -11.1
2009 = -26.4
2010 = 4
2011 = 13
That’s an arithmetic average return of 3.5 percentage points *less* than what you need. Assuming I’m doing the math correctly, what you end up on a compounded basis is a return of 3.3% — less than half the expected. That’s not much better than inflation over that period (if at all). (Note: the assumed returns/discount rates tend to include inflation in the percentage.)
For some sense of what this means, imagine that you begin with $100. Under the assumed return rate of 7.7%, you ought to have $187.45 at the end of 2011. What you actually have, by the numbers that you provide, is $133.65. So, if you were fully funded at the beginning, you’re now only 71.68% funded.

Justin Katz
Justin Katz
10 years ago

Rereading, I see that 7.7% was the average return of some other plans. Regardless, it’s close enough that the numbers wouldn’t be too different based on 7.5%. You’d be 72.75% funded.

Bob
Bob
10 years ago

I agree that 7.5% is unrealistic, but who is this person? She’s trying to sound like an expert and she really doesn’t understand the system.

Mike Cappelli
Mike Cappelli
10 years ago

I see the amounts listed in the funds in each year, but how much of the additional funds are from contributions and not necessarily “returns”?
And remember this, numbers and percentages can be misleading. If you have $100 and you lose 50% you now have $50. To get back to even, you need a 100% return.

Justin Katz
Justin Katz
10 years ago

Bob,
Actually, Norcross is an expert by any fair definition. What’s screwy is the way accountants think of pensions. In theory, the discount rate and the projected return are different things. The point is that risk has to be factored in, and with a pension fund, there’s essentially no risk to the beneficiary, so a zero-risk rate would be appropriate for budgeting purposes.
—-
Mike,
Ken’s numbers, I think, are the actual gains and losses from investments. I think I strayed a bit in my explanation, above (essentially assuming 0 contributions when talking about funding levels), and my oversimplifying may have been misleading of the actual state of such a plan. (Obviously, one would have to know, as well, what the starting amount of the fund was and what the contributions and payouts were.)

KenW
KenW
10 years ago

Tommy Cranston excellent reporting and also to everyone else who commented!!!!! But you didn’t “fully” address why there is a Hawaii ERS unfunded liability which was caused by the state GA (D) not paying into the fund the full state % share (just like RI) which the, I believe and remember correctly, it was the Honolulu police union, that went to court to force the issue all the way up to the Hawaii Supreme Court and won all court battle over many years forcing the State of Hawaii under court order to start paying in the underfunded liability difference that was being diverted for pet projects. Gov. Linda Lingle (R) with GA (D) in a cover a my A_s move did pass another law that says the ERS fund can no longer be raided to balance the state budget (during the last 2007-2008 recession) but she and GA (D) were forced by the Hawaii Supreme Court by court order after all the state appeals up the court ladder to the highest state court. It was not her good will gesture! I started coming to HI in 1968 with the military and in 1970s started vacationing regularly almost every year till I retired and moved my wife and I here in 2006. All that time we’ve been keeping our finger on the pulse of what was happening in HI including my father per a Presidential mission to China and my wife via the invitation of the U.S. Congressional supported East West Center in Honolulu (I already had been in both places). Things in HI are completely different than back in RI as RI has 39 cities and towns and 37 school districts for the smallest state in the union and HI over 1,500 miles long is comprised of 120 islands and… Read more »

KenW
KenW
10 years ago

FY 2003 to FY 2011 the average return on HI ERS investments is 4.177777777% with one of the most damaging 2 year recessions. However as I first stated above, it appears HI ERS has recovered losses from recession max Sept. 2007 was $11.7 Billion and 2012 3rd Q is $11.5 Billion. The unfunded libility is still there but I think HI ERS investments have brought HI ERS back to level playing field baseline.

Justin Katz
Justin Katz
10 years ago

Being even with where you were five years ago is actually being very far behind, because the plan relies on compounding growth every year. Roughly speaking, over five years, at 7.5% compounding growth, the fund should have grown by 50%. That missing money blows a huge gap in the whole thing going forward, because it is not in the account earning returns at this moment.

Bob Cushman
Bob Cushman
10 years ago

On Thursday May 31, 2012 at the City of Warwick fiscal year 2013 budget hearing when the issue of pensions was discussed before a packed City Council chambers containing police, firefighters and public works employees I testified on the specific problems facing the city.
As a former Warwick City Councilman I have been warning city leaders of these problems for years.
At one point the administration officials, which included the mayor, his chief of staff, finance director and personnel director, announced that the pension funds had achieved a rate of return over 8% for the previous quarter and assets had appreciated by $25 million. The crowd errupterd into a standing ovation.
This exemplifies the problems we have in RI.
I wonder what the rate of return is after the market tanked in May?
Here is the link to the audio
http://www.warwickri.gov/index.php?option=com_content&view=article&id=1213:audio
Start at position 2577 of the May 31, part III audio.
It takes about 25 minutes. The audio before and after is also worth listening
to.

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