Task Force: Pension liabilities are “under-cooked”!

While some opponents to pension reform in the Ocean State have suggested that Treasurer Raimondo has “cooked the books” by over-stating the pension liability  … a new report by Eileen Norcross of the Mercatus Center, a member of the special pension task force assembled by our RI Center for Freedom, suggests that it is more likely that the books are “under-cooked” … and that the true pension liability may be twice as large as stated, or about $18 BILLION!

Read the full Mercatus Center Report here …

Rhode Island’s state and municipal pension systems face large and growing unfunded pension liabilities. The governor and state treasurer have identified pension reform as a key to stabilizing the state’s finances and also to ensuring a sustainable retirement fund for Rhode Island’s public employees. According to government estimates, the unfunded liability for municipal plans and state plans totals $9.3 billion. These figures are calculated under assumed discount rates based on the expected return on pension asset investments. However, according to economic theory, pension liabilities should be valued based on their relative risk and thus the return on Treasury Bonds is currently the appropriate discount rate to use when valuing liabilities. Under this valuation, the unfunded liability for municipal governments including MERS and locally administered plans (and excluding the local portion of the teachers’ plan) swells from $2.4 billion to $6 billion. The unfunded liability for the state plans increases from $6.8 billion to $12 billion.

The result of this miscalculation is that many municipal governments are in far worse shape that is currently reported, which presents serious revenue challenges for a number of Rhode Island municipalities. Unfunded municipal pension liabilities currently exceed municipal revenues by $2.6 billion in Rhode Island. The revenue index created in this paper indicates that Johnston, Providence, Cranston, Newport, and Central Falls are all in particularly bad shape relative to other municipalities in the state.

Among the eye-opening facts and figures in the report:

* Rhode Island estimates the unfunded liability for municipal and state plans is $9.3 billion, while Mercatus researchers calculate it as closer to $18 billion.

* Using the authors’ revenue index, 17 of the 39 Rhode Island municipal governments are in the danger zone-their unfunded pension liabilities exceed revenues.

* How did they reach this number? The authors argue that the huge difference in estimates is based on inaccurate accounting. In fact, financial markets and economists would calculate pension liabilities based on their relative risk, but currently Rhode Island calculates their liabilities based on the expected return on investment of the pension assets.

Click here to read the full report from the Mercatus Center website …

Clicke here to read our Center’s Media Release

MEDIA COVERAGE:

ProJo blog …

GoLocalProv blog …

WJAR TV-10 blog …

Bloomberg/BusinesWeek: http://www.businessweek.com/ap/financialnews/D9QSOVSG0.htm

Boston Globe – Online: http://articles.boston.com/2011-11-08/business/30374064_1_pension-liability-pension-problem-pension-increases

The Daily Journal: http://www.dailyjournal.net/view/story/f13c3e264ac14fb8940dae3ab1f69d50/RI–Pension-Underestimated-Costs/

Individual.com: http://www.individual.com/storyrss.php?story=146552126&hash=f715e25035269eeddf2683e5a2ee7c80

MSNBC.com: http://www.msnbc.msn.com/id/45213474/ns/local_news-providence_ri/#.TrrJxXJxB7w

WLNE-TV (ABC): http://www.abc6.com/story/15988707/researcher-says-ri-understating-pension-problem

Yahoo! Finance: http://finance.yahoo.com/news/Researcher-says-RI-apf-166933908.html?.pf=retirement&mod=pf-retirement&x=0&.v=1

Bastiat Institute: http://www.bastiatinstitute.org/2011/11/08/rhode-island-pension-problem-larger-than-reported/

Opposing Views:

Providence Phoenix blog …

Pensions Beyond Pay

Among the more detailed features of the RIOpenGov.org pension page is the comparison of pensions against final average salaries. A push of the button on the “detailed search” tab shows there to be 3,298 pensioners whose retirements are paying better than their jobs ever did.

These retirees are collecting $20,903,314 more from the state than they did in the final years of their careers. On average, they have been retired for 18 years and still have an estimated 13 years to go — having retired at 56. For all retirees, the corresponding averages are 13 years retired, with 15 to go, having retired at 58.

Interestingly, the number of pensions above pay does not match up with the number of years retired as well as one would expect. Apart from a huge burst of retirements in the early ’90s, the trend line for total retirements isn’t surprising; the farther from retirement pensioners get, the fewer of them there are:

 

Viewing pensions that exceed pay as a percentage of total pensions, however, yields a more unexpected result:

 

As a matter of simple arithmetic, it would make more sense for the percentage to continue to grow as the years go up, thanks to cost of living adjustments (COLAs).  That the result does not match expectations merits further investigation, but for the time being, suffice it to say that such peculiarities give some credence to suggestions that pension deals of the past were inordinately generous and should be pulled back.

Among retired public-sector workers whose pensions exceed their working salaries, the average pension is $45,815 per year, which is $6,338 more than the average final salary. For the pension system overall, the average is $31,388, which is $12,021 less than the average final salary.

At this point, it makes sense to look at differences in the results based on the retirees’ former employers, and clearly, not all pension-granting public entities are equal. Of the 184 public employers, 81 have retirees who have surpassed their salaries. For 43 of the employers, more than 10% of all retirees are in this group.

% of Retirees Exceeding Salaries
Overall # of Pensions
Overall Average Pension ($)
Foster School Dist.
47
19
40,962
Burrillville Police Dept.
33
9
28,660
Northern Rhode Island Collaborative (NC)
33
6
16,222
Barrington Public Schools
28
202
42,651
Warwick School Dept.
26
980
44,598
North Providence Hsg. Auth.
25
4
22,592
Cumberland School Dept.
22
334
43,614
Middletown Public Schools
22
242
42,334
Newport School Dept.
21
363
41,593
Johnston School Dept.
21
215
43,505
Coventry Public Schools
21
325
47,098
Cranston School Dept.
20
769
44,425
Lincoln School Dept.
19
193
45,148
Providence School Dept.
19
1361
41,604
North Smithfield School Dept.
19
116
41,529
Pawtucket School Dept.
19
632
43,330
Tiverton School Dept.
18
161
41,322
East Providence Schools
17
479
45,030
Scituate School Dept.
17
100
41,365
West Warwick School Dept.
16
275
45,431
Foster/Glocester Reg. School Dist.
16
104
39,093
Woonsocket School Dept.
16
469
42,289
Central Falls Collaborative
16
166
44,896
Portsmouth School Dept.
16
211
43,065
North Kingstown School Dept.
16
307
41,183
Little Compton School Dept.
15
27
38,233
North Providence School Dept.
15
251
46,787
Glocester School Dist.
15
41
38,173
South Kingstown School Dept.
14
230
40,237
Coventry Fire Dist.
14
7
33,822
Town of North Smithfield
14
14
15,970
Chariho Regional School Dist.
14
248
40,728
Bristol Warren Reg. School Dist.
14
296
41,421
EAST GREENWICH-COLA-NC
13
15
17,591
North Smithfield Police Dept.
13
15
26,427
East Greenwich School Dept.
13
175
41,045
Burrillville School Dept.
13
158
42,284
Cranston Police
13
8
41,956
Westerly School Dept. (NC)
13
8
13,585
Westerly School Dept.
12
217
43,149
State
12
10,945
27,139
City of Pawtucket
11
105
20,739
Smithfield School Dept.
11
173
41,023
City of Woonsocket
9
65
22,746
Newport School Dept. (NC)
9
171
16,049
Jamestown School Dept. (NC)
9
23
12,951
Narragansett School Dept.
8
123
40,643
Town of South Kingstown
8
25
25,559
Warren Police Dept.
8
25
24,693
Narragansett Bay Commission
8
38
19,563
EAST GREENWICH-COLA
7
14
29,504
Jamestown School Dept.
6
31
41,140
City of Cranston
6
79
17,879
Town of Scituate
6
16
14,945
Exeter/West Greenwich Reg. Schools
5
75
39,039
Town of Johnston
5
38
19,537
East Providence Schools (NC)
5
304
15,041
Central Falls School Dist. (NC)
5
42
11,350
East Greenwich Police Dept.
5
22
32,698
Middletown Public Schools (NC)
5
22
18,716
R.I. Airport Corporation
5
22
43,537
Glocester School Dist. (NC)
4
23
9,698
Town of Warren
4
46
10,211
Newport Housing Auth.
4
26
21,796
Bristol Warren Reg. School Dist. (NC)
4
79
12,882
North Providence Fire Dept.
4
55
29,392
Johnston School Dept. (NC)
3
149
11,802
North Kingstown Police Dept.
3
30
33,592
Cranston School Dept. (NC)
3
418
12,929
South Kingstown School Dept. (NC)
3
117
12,226
Scituate School Dept. (NC)
2
41
10,525
Tiverton School Dept. (NC)
2
45
8,570
Chariho Regional School Dist. (NC)
2
47
14,184
Woonsocket Police Dept.
2
52
32,490
City of East Providence
2
62
27,958
Pawtucket School Dept. (NC)
2
377
10,952
Cumberland School Dept. (NC)
2
127
8,359
Town of Bristol
1
70
12,936
North Kingstown School Dept. (NC)
1
160
10,849
Woonsocket School Dept. (NC)
1
257
9,536
Town of North Providence
1
132
8,424

Notes:
“NC” indicates school personnel who receive municipal, rather than teacher, pensions.
“Overall” data is for all pensions, whether or not they exceed final average salary.

 

With some notable exceptions, schools in general and teaching staffs in particular dominate the list for retirees who make more in retirement than while working. And teacher pensions tend toward the higher end of the dollar scale.  However, there is no apparent correlation between the percentage of retirees over-earning their working salaries and the average number of years that each entity’s pensioners have been retired:

 

Removing Pension Dollars from the RI Economy

Rhode Island’s pension system sent $142,159,475 directly out of state, in 2010, to the 4,575 public-sector retirees who live elsewhere. That’s according to the RI Center for Freedom & Prosperity’s new RIOpenGov.org section on pensions. Overall, government pension payouts amount to approximately 1.7% of Rhode Island’s gross state product (GSP), and 17.2% of them support the economies of other states, with the following top 10:

 

The pension dollars lost to Rhode Island’s economy are of particular concern during this era of high unemployment and sluggish economic activity, when it seems as if political actors feel they must couch every argument about public policy in terms of economic stimulus. In the debate over pension reform in Rhode Island, National Education Association Government Relations Director Pat Crowley got ahead of the pack by telling GoLocalProv on October 21 that freezing cost of living adjustments (COLAs) would “be a major drain on the Rhode Island economy.” The following week, the Brown Daily Herald noted the point being made in the wave of Finance Committee testimony. The assertion, in brief, is that if retirees’ pensions do not match or exceed inflation, they will have less cash to spend, which means that less money will cycle through the local economy.

The broadest response to such claims is that every dollar paid into the public sector pension system has to come out of the economy in the first place, most of it reducing local buying power in order to fund national and international investments. In that light, General Treasurer Gina Raimondo’s proposed reform — any reform — would count as stimulus. The state’s pension actuaries, Gabriel Roeder Smith & Company, estimate that the retirement system will require state and local governments to contribute $659 million in fiscal year 2013 without reforms, but only $383 million with the proposed reforms. That’s a difference of $276 million that taxpayers could use to pay bills, purchase goods and services, and make investments.

Meanwhile, additional data from RIOpenGov.org shows that the pensions paid out in 2010 were augmented by $176.0 million for total COLAs already applied to base pensions. In other words, while special interests are arguing that freezing COLAs at their current level would harm Rhode Island’s economy, the state could erase COLAs from the pension system entirely and the economic harm still wouldn’t amount to two-thirds of the economic benefit that the current (arguably too restrained) reform would represent for local economic activity.  (All of this leaves aside, of course, the additional benefit of proving that the state is interested in securing its future.)

And as the total pension dollars sent out of state show, that’s not the whole picture. If COLAs are distributed equally among retirees in state and out of state, $149.6 million of the money paid to retirees who live in Rhode Island is attributable to the adjustments. That means that completely eliminating every penny of current COLA payments would have about the same economic impact, in Rhode Island, as paying for the retirements of people who don’t live here.

Whether these amounts are significant in a $47.6 billion state economy is a matter of opinion. So, too, is the legitimacy of various changes and restrictions that the state could consider imposing on pensions. When assessing the impact of reform, however, it is critical to consider the many ways in which Rhode Island’s public-sector pension system interacts with the economy.

Later Retirement Doesn’t Harm School Districts’ Payroll Costs

National Education Association of Rhode Island President Larry Purtill is gaining some traction with his claim that having teachers retire later will hit local communities in the payroll. As described in an October 25 Providence Journal story by Kathrine Gregg (not online):

Sen. Walter Felag, D-Warren, asked the question that Larry Purtill, president of the National Education Association of Rhode Island, has asked on YouTube and elsewhere: how will city and town taxpayers be able to afford all of the top-scale teachers who would now be forced to work until they are 67 years old?

A top-step teacher averages $70,764 a year in Rhode Island; a first-year teacher averages $39,087, according to Purtill.

Purtill has not yet had his turn to testify before the legislators, but in other venues he argues: “If a teacher is forced to go from 62 to 67 to retire and would have been replaced by someone on Step 1, that is an additional $130,479 for one teacher over that five-year period. Has anyone thought about this, and figured it into the actuarial studies? I am assuming that unless state aid increases by a drastic amount, this cost will go directly to the cities and towns.”

There’s a reason Purtill stops his cost clock at five years: because after that point, the older teacher retires and a replacement is hired at step one. Obviously, that teacher will be making less, to start with, than a teacher hired five years earlier, so the scenario of a later retirement actually begins to save the district money. And the district continues to save money for the ten years it takes the new teacher to reach step ten, herself.

To put a number on this dynamic, I averaged all of the salary steps compiled by the Rhode Island Association of School Committees for the 2011/2012 school year. For easier comparison, I then removed the few districts that spread their steps over more than ten years, leaving me with 14 cities and towns. (To check for any distortion, I compared these districts to the broader average available for 2010/2011 and found them to be about 0.1% higher, overall.) Using these averages, I figured out the year-to-year step raises and factored in the 4% increase that the pension actuaries estimate that the overall step system receives each year, on average (inflation plus general increase). By this method, I found step one to be $39,175 and step ten to be $72,393.

It is true that a local district will therefore pay an extra $141,475 for five more years of the older teacher’s salary, compared with a replacement starting at step one. However, seven years after the delayed retirement, the savings in waiting to hire her replacement have erased the extra costs. By the time the later replacement reaches step ten, the district turns out to have saved $44,990, and that number holds for decades, until the year that the earlier replacement would have retired.

Remember that this is savings to the district on salary alone. Most districts offer retirees some sort of health benefit, which will erode the initial salary savings of earlier retirement. What’s more, a good number of districts only pay retiree healthcare until Medicare age, so pushing retirement beyond that point would eliminate the healthcare portion of districts’ other post-employment benefits (OPEB) liability completely.

An important note arises if we expand the inquiry to figure out the cost/savings of later retirement in terms of the older teacher’s pension. Such an analysis is difficult to perform, because changes to the retirement system over time have left a number of categories into which employees can fall; moreover, teachers can retire at various ages, with varying years of service, so an accurate comparison would require teacher-by-teacher analysis.

For illustration purposes, however, I assumed normal retirement at age 62 with 29 years of service on a non-grandfathered Schedule A. (That means the teacher receives the more generous percentage of pay that Schedule A provides but has the retirement benefit calculated as an average of his or her highest five years, not three years, as would be the case for a grandfathered Schedule A pension.) For the second scenario, I added five years to this teacher’s career, but followed the proposed pension reform such that the teacher only accrues an additional 1% of salary for each additional year of work. I did factor in cost of living increases for both scenarios, but I used the reformed rate, which ties increases to pension fund performance.

The upshot is that the later retirement saves the retirement system about $54,000 over the life of an individual teacher. But those savings only materialize under the terms of the proposed reform. Applying a later retirement to the current system, without other reforms, winds up costing money in the scenario I’ve described, because the starting pension rate and higher cost of living adjustments (COLAs) increase the total benefit by so much.

Whatever the case, under the current system, the teacher is working for 29 years and retiring for 25. Under the reform, he or she is working for 34 and retiring for 20. Put differently, under the current system (with all of my assumptions), the older teacher will be collecting retirement for almost the entire career of his or her replacement. Essentially, for just four years will the system be paying for only one teacher for one teaching job. Under the reform plan, that differential increases almost fourfold, leaving fifteen years of the replacement’s career unburdened by pension costs for the older teacher.

One needn’t run the numbers to get a sense of just how quickly Rhode Island and its cities and towns — collectively and individually — will save money.

Task Force Commentary: R.I.’s pension debt worse than admitted (by Jagadeesh Gokhale)

As part of the national task force that our Center has assembled, Jagadeesh Gokhale, from the Cato Institute, published the OpEd below that appeared in the Providence Sunday Journal, Oct. 23, 2011.

R.I.’s pension debt worse than admitted

JAGADEESH GOKHALE

WASHINGTON, DC -Rhode Island’s pension crisis reminds one of Greece, now slaving under externally imposed austerity — the fruits of engaging in systemic deceit.

Lavish retirement benefits, including automatic inflation adjustments, awarded to state employees have resulted in future pension obligations of $11.5 billion in today’s (2010) dollars. But the state has assets worth only $6.8 billion on hand to cover these obligations, implying a funding ratio of less than 60 percent.

In addition, the state provides other post-employment benefits (OPEB) to its employees (general employees, teachers, police, judges, legislators, and so on) — whose present valued obligation amounts to $8 billion. This obligation is completely unfunded — that is, benefits are paid out of current revenues each year.

Adding it all up, the official measure of total pension and OPEB liabilities as of 2010 is $12.3 billion and the unfunded component is $5.5 billion.

Taking the numbers at face value, the state must make up this $5.5 billion shortfall in retiree pension and OPEB programs by increasing the share of general fund budget devoted to covering accruing pension obligations and amortization costs.

State general fund revenues amounted to $5.5 billion in 2010, of which 4.2 percent is contributed to meeting current benefit accruals and amortization costs. The state’s pension obligation amortization schedule extends to about 20 years, but OPEB obligations will remain unfunded.

Unfortunately, the reality that is most likely to unfold in the future is much worse. The accounting methods used by the actuaries amount to sugarcoating the situation. The true magnitude of the Rhode Island’s pension and retiree health underfunding problem is larger by billions of dollars.

As economists have repeatedly asserted, because pension benefits are guaranteed, they should be evaluated by discounting future benefit flows using a relatively safe rate of return — on the order of 3 percent per year in inflation-adjusted terms. Pension actuaries, instead, use the much higher rate of return they expect on the pension fund’s assets — which are usually invested in risky private equities and bonds.

This accounting treatment undervalues (ignores) the risk that the relatively fixed and certain benefit obligations would have to be paid out of additional taxpayer funds because the pension fund’s asset portfolio suffers losses from a market downturn precisely when it must be drawn upon (sold) to fund benefit obligations coming due.

Discounting future benefit flows at a risk-adjusted rate of interest, however, is politically unpalatable because it results in a much higher measure of pension liabilities and increases the current funding burden on the state’s budget.

In the case of Rhode Island, the state’s Comprehensive Annual Financial Report for 2010 (the most recent available) specifies an expected return on pension assets of 8.25 percent. The present valued pension and retiree health liability reported earlier are calculated using that discount rate.

However, using a risk-adjusted rate of return in evaluating the pension liability, and incorporating a 2 percent annual growth rate of the retiree population, shows that the total accrued pension and health liability would be 56 percent larger — or $18.7 billion instead of the official total of $12.3 billion. And the unfunded liability component would be $11.9 billion instead of the officially reported $5.5 billion.

There are other concerns, as well, regarding the level of contributions being made by Rhode Island to amortize this liability and the management of the pension fund’s investment portfolio. Ongoing reform efforts are likely to affect current and future state employees, but the understatement of pension liabilities hides the size of taxpayer exposure to future pension funding shortfalls.

A thorough exploration of feasible pension reform alternatives in Rhode Island is urgently needed. Unfortunately, the underlying data on historical earnings, job tenure and other information on state pension plan participants has been kept under wraps by the authorities.

This impedes transparency and the ability of state lawmakers to analyze and draw upon new ideas on how to resolve the state’s pension funding dilemma and improve the programs’ financial condition over time. That has to change soon if there is to be any hope of dealing with this crisis.

Jagadeesh Gokhale is a senior fellow at the Cato Institute in Washington D.C.

Hybrid Savings Mean System Failure

The only argument that I’ve heard against my suggestion that the proposed hybrid pension system will be more expensive than the current system is that the hybrid offloads market risk onto the employee, alleviating the risk to the employer (i.e., us, the taxpayers). Moderate Party founder and gubernatorial candidate Ken Block made the point on Anchor Rising, and Gary Morse, pension adviser to the Republican who was almost governor, John Robitaille, called in when I was on Friday’s Dan Yorke Show to make a similar point.

My response has been to suggest that, while the objection may be true, the entire pension reform relies on the 7.5% rate of return that the state’s actuaries have assumed. As a reminder, the current system is a defined benefit plan, which promises employees a certain retirement package; the hybrid system would decrease that benefit but put money into a 401(k)-style plan for each employee to fill in the gap. Right now, the major problem is the liability for defined benefit promises already made, and the hybrid doesn’t make those go away.

Unfortunately, I haven’t come across “what if” data from the actuaries that allows a real comparison of the system’s health with different rates of investment return. One can, however, infer the effect of the Retirement Board’s recent lowering of the return rate assumption from 8.25% to 7.5% from the latest actuarial report. Specifically, the Board dropped the rate of return by 9%, and the normal cost of an active employee’s pension (that is, the percentage of payroll that must be put aside to fund an individual employee’s retirement) went up by 22% for state workers and 18% for teachers.

For an accurate “what if” scenario, the actuaries would have to apply the different assumptions to their models, but purely for the sake of illustrating my point about the cost of the hybrid plan, I’ve assumed that same return-rate-to-normal-cost ratio applies consistently to the equation. If that’s accurate, then the hybrid plan doesn’t cost the taxpayer less than the current system unless the market returns less than 5% on investment:

The solid lines show the effects of an under-performing market on the current defined-benefit plan; the dotted lines show its effects on the hybrid plan. And, yes, the lines do cross eventually. However, under those circumstances, the total cost for the pension system to the employer, even under the reform, will be well above the annual cost that currently has everybody in a panic — over 60% of payroll for teachers and nearing 80% of payroll for state workers:

Of course, the solid lines, which track the current system, show just how scary the situation will be if the General Assembly does nothing, and a defined contribution component ought to be part of the solution (if not all of it). That doesn’t mean, though, that reformers should take the system on the table just because it incorporates some worthwhile concepts. If this reform passes, it’ll be years before the panic level rises sufficiently for further action by elected officials, and by that point hundreds of millions of dollars will have been siphoned into untouchable defined-contribution accounts.

As with Cars, a Hybrid Pension System Will Cost More

The complexity of the pension problem comes in the multiplicity of angles from which the numbers can be presented. When it comes to the cost of current employees’ pensions, General Treasurer Gina Raimondo’s hybrid pension system will cost more than the system that’s already strangling Rhode Island.

The headline grabber — because it’s such a large figure — has been the unfunded liability. Essentially, that’s the difference between the benefits promised over the amortization period and the accumulated resources expected to be available to pay them.

It’s critical to realize that both sides of that equation are predictions. General Treasurer Gina Raimondo induced her recent shock to the pension system by leading the Pension Board in a reduction of the predicted annual market return on the system’s investments of just 0.75%, from an 8.25% expected return to a 7.5% expected return. In tweaking its assumptions, the board effectively increased the unfunded liability of state worker and teacher pensions from $5.40 billion to $6.83 billion, according to the most recent actuarial report. The overall problem, however, requires predictions about everything from a female desk clerk’s life expectancy upon retirement in twenty years to the average raise that RI school committees will give to their teachers over the next several decades.

Although interested parties like to pick and choose from among them, various factors have contributed to the existence of the liability. Given the lag time between a particular year’s pension payments and its full effects on the system, elected officials have had plenty of incentive to promise future benefits that outstripped the budget dollars that they were actually willing to put aside in the present, and union leaders have been happy to play along, expecting those promises to be fulfilled somehow, someway.

Another factor has been the market. Even responsible officials, who put aside every penny that the actuaries called for would have wound up underfunded, because the actuaries were basing their predictions on an 8.25% return, when the system has only realized 2.51% per year, considered over the past five years, 2.28% over the past 10 years, and 6.57% annually since 1995.

And then there are all those predictions. The actuaries currently expect a female teacher who retired last year to live for 24.2 more years. They predict that the same teacher retiring in 2030 will only expect an additional 1.1 years of life,  or 25.3 years of retirement. With the rate of advancement in medical technology, does that really seem plausible?

The incentives and unpredictability of pension planning are what make defined-contribution option so attractive. With a defined benefit, the employer promises employees a certain amount of future income, and it is up to the employer (or, in the public sector, the taxpayer) to make sure that the money is there; with a defined contribution, the employer promises to put a certain amount of money aside, and future income will depend on the plans and investment returns of the specific employee. The dollar amounts may turn out to be exactly the same, but it isn’t a “liability” in that the employer hasn’t pledged to make up the difference for unmet expectations.

Leading up to the release of Treasurer Raimondo’s pension reform proposal, advocates for public workers and retirees have been downplaying the importance of reducing this liability by separating the theoretical cost of pensions for current employees from the amount that municipalities and the state have to put aside to catch up on the current debt. The mechanism for this argument is the “normal cost” of a current employee’s pension — that is, the percentage of payroll that must be invested in order to fully fund pensions as if the past liability did not exist.

For teachers, the “normal cost” is now pegged at 11.82% of payroll, and since the teachers contribute 9.5% from their own paychecks, the city and state combined only have to put in another 2.32%. That’s what NEA-RI Executive Director Robert Walsh meant when he wrote in the Providence Journal that “for the vast majority of existing employees, the facts support no further changes” to the pension system. Get over the liability hump, in other words, and it’ll be clear sailing for public-sector retirees.

The question that hasn’t been asked, yet, is what Raimondo’s hybrid defined-contribution/defined-benefit plan will do to public costs when calculated in these terms. The answer is that it will actually increase them, as the following table shows.

RI State Pension Employee and
Employer Contribution Rates (% of Payroll)
Current Employees Defined Benefit
Current Employees Defined Contribution
Liability Amortization
Subtotal
Total
Employee
Employer
Normal Cost
Employee
Employer
Employee
Employer
Employee
Employer
State workers – current system
Prior assumptions
8.75
0.60
9.35
0
0
0
25.95
8.75
26.55
35.30
Assumptions in effect July 2012
8.75
2.64
11.39
0
0
0
33.70
8.75
36.34
45.09
After 2029 amortization
8.75
2.64
11.39
0
0
0
0
8.75
2.64
11.39
State workers – proposed system
2029 amortization
3.75
5.44
9.19
5
1
0
18.94
8.75
25.38
34.13
2035 amortization
3.75
5.44
9.19
5
1
0
14.91
8.75
21.35
30.10
After 2029 amortization
3.75
2.49
6.24
5
1
0
0
8.75
3.49
12.24
After 2035 amortization
3.75
2.49
6.24
5
1
0
0
8.75
3.49
12.24
Teachers – current system
Prior assumptions
9.50
0.50
10
0
0
0
25.71
9.50
26.21
35.71
Assumptions in effect July 2012
9.50
2.32
11.82
0
0
0
32.93
9.50
35.25
44.75
After amortization
9.50
2.32
11.82
0
0
0
0
9.50
2.32
11.82
Teachers – proposed system
2029 amortization
3.75
4.84
8.59
5
1
0
16.34
8.75
22.18
30.93
2035 amortization
3.75
4.84
8.59
5
1
0
13.27
8.75
19.11
27.86
After 2029 amortization
3.75
2.42
6.17
5
1
0
0
8.75
3.42
12.17
After 2035 amortization
3.75
2.42
6.17
5
1
0
0
8.75
3.42
12.17
Notes
1) Prior and current data from Employees’ Retirement System of Rhode
Island Actuarial Valuation Report as of June 30, 2010

2) Proposal data from “Actuarial Analysis of the Rhode Island Retirement
Security Act of 2011”
3) Amortization is currently scheduled for 2029; 2035 represents reamortization.
4) The proposed system continues the assumptions that will be in effect
as of July 2012.
5) Liability amortization includes current retirees’ pensions and the portion of current employees’ pensions not covered under normal costs.

Reformers should be wary of two facts that emerge from these eye-glazing numbers:

  1. Five percent of current retirees’ contributions will be entirely insulated from any problems that might arise with the defined-benefit component of the system — whether they be low investment returns, proof of unrealistic predictions, or a failure to meet recommended funding.
  2. Combining the defined-benefit and defined-contribution payments, the amount of money that state and local governments will spend on the retirements of current employees every year will increase — more than doubling until such time as grandfathered employees leave the system and continuing on at a higher rate even then.

This means that the savings of the overall pension reform rely entirely on changes to the existing system (e.g., COLAs and retirement age), because the hybrid will cost tens of millions of dollars more every year… even when the “pension crisis” is completely resolved and even if the assumptions prove accurate. And changes to the existing system are precisely the controversial elements that have battle lines being drawn.

With all the lines on the field and the questionable allegiances, taxpayers should be sure that somebody is defending their interests.

Hybrid Pies

As much as I love text and tables, they do require quite a bit of background consideration before their more interesting revelations are truly visible. So, herewith, some pie charts to illustrate my core point on the matter of General Treasurer Gina Raimondo’s hybrid pension proposal.

The first chart shows state workers’ arrangement currently in place for fiscal year 2012.  Of total state worker payroll, each employee will contribute 8.75% of his or her salary to the defined benefit plan (the light-blue wedge), and the state will add in another 2.64% of payroll (the dark blue wedge).  The larger part of the state’s pension expenditure, accounting for 33.7% of payroll, is the brown wedge, which will go toward amortization of the unfunded liability.  In total, 45.09% of state worker payroll goes toward pensions.


Under the new pension system that General Treasurer Gina Raimondo and Governor Lincoln Chafee have proposed, state workers will put 3.75% of their salaries into the defined benefit plan (light blue) and 5% toward a defined contribution plan (leaving their total contribution the same). These amounts will be supplemented with 5.44% of payroll from the state toward the defined benefit program (dark blue) and 1% toward the defined contribution program (dark green).  The amount to be put toward the unfunded liability (brown) is 14.91%, bringing the overall cost of pensions to 30.1% of payroll.

The current arrangement in place for fiscal year 2012 for teachers calls for each employee will contribute 9.5% of his or her salary to the defined benefit plan (the light-blue wedge), to which the state and local governments combined add another 2.32% of payroll (the dark blue wedge).  Again, the larger part of the state’s pension expenditure, accounting for 32.93% of payroll, is the brown wedge, which will go toward amortization of the unfunded liability. In total, 44.75% of teacher payroll goes toward pensions.

Under the proposed pension system, teachers, will put 3.75% of their salaries into the defined benefit plan (light blue) and 5% toward a defined contribution plan (reducing their total contribution by 0.75% of salary). These amounts will be supplemented with 4.84% of payroll from the state toward the defined benefit program (dark blue) and 1% toward the defined contribution program (dark green).  The amount to be put toward the unfunded liability (brown) is 13.27%, bringing the overall cost of pensions to 27.86% of payroll.

Negotiating Points in the Pension Proposal

Underlying the policy complexities of the pension issue is the background give and take of financial interests and political careers. General Treasurer Gina Raimondo, for example, is free to propose pretty much anything and let the General Assembly take the heat for actual changes. As long as she stays off the unions’ “not with a 10-foot pole” list, she can run for higher office as the stern-chinned pragmatist.

Similarly, Governor Lincoln Chafee can seek to burnish his “fiscal conservative” bona fides by publicly endorsing a plan more generally seen as Raimondo’s handiwork. For their part, legislative leaders can play off the treasurer’s supposedly objective calculations and the governor’s veto power. What the public is seeing and what elected officials are planning can be two very different policies.

An October 10 Providence Journal op-ed by National Education Association Rhode Island Executive Director Robert Walsh fits neatly into that interpretation:

The only equitable option presented to the pension advisory group was to make current retirees subject to the “Plan B Cost-of-Living Adjustment.” The Plan B COLA, already in place for current teachers and state employees, bases the COLA on the lesser of the rise in the Consumer Price Index or 3 percent, and it is further capped at the first $35,000 in pension earnings, which is also indexed to inflation. (The CPI is also used to calculate Social Security increases.) When combined with a more modest 25-year reamortization of the pension fund, the Plan B COLA option for retirees solves a significant part of the pension dilemma, unless the courts rule otherwise.

General Treasurer Gina Raimondo, to her credit, has allayed some fears already by strongly stating that no earned benefits would be cut, and that the debate regarding retirees would focus on the COLA. She has also wisely shown more openness to reamortization as part of a comprehensive solution to the pension issue.

Obviously, Treasurer Raimondo’s proposal (onto which the union-backed Governor Lincoln Chafee has signed) goes a bit farther than that, mainly in that it completely suspends COLAs pending the pension system’s healthy recovery, it introduces a hybrid defined-benefit/defined-contribution plan, and it adjusts the retirement age upwards to Social Security standards.  (Keep in mind, by the way, that various categories of employees — teachers, public safety, and so on — receive differing treatment.)

Several components of the proposal are subject to basic mathematical negotiation, meaning that the sides will trade dollar amounts in order to secure principles that they want to protect. It’s useful, therefore, to consider COLAs, retirement age, and amortization in this context.

The “Plan B” COLA calculation to which Walsh refers follows the Consumer Price Index and is capped at 3%; it also applies only to $35,000 of the pension benefit (although that number adjusts upwards every year by CPI-to-3%, as well).  Raimondo’s proposal replaces the CPI with the pension’s annual net return (over a five-year average), with the cap at a 4% increase.  In terms of the actuarial calculations, the upshot is that this move reduces the predicted annual COLA from 2.35% to 2%.  The sticking point is that the new proposal would withhold COLAs in any year that the system is less than 80% funded, which could mean a decade or more of no increases.

That aspect of the proposal, along with the increase in retirement age, are likely to be hotly contested.  And since Raimondo has crossed the Rubicon of reamortization (thus extending the number of annual state budgets until the plan is fully funded, reducing the hit each year, but also reducing investment returns), it will appear more reasonable to extend the amortization period even farther in order to “buy back” reduced benefits.  So, for example, advocates for retirees might accept the later retirement age but insist that the COLA pinch be eased, with the difference in costs made up with a few more years of amortization.

But this is all a numbers game.  The interesting wild card is the hybrid plan, which reformers rightfully like as a means of shifting market risk away from taxpayers and toward retirees, but which contains details that ought to make them wary.  Given the complexity of that topic, I’ll take it up in a separate post.

Gio Cicione on Newsmakers (Ch-12 & Ch-11) this past Sunday

Our senior policy advisor, Gio Cicione, appeared this past Sunday, 9/25, on Channel-12. Tim White and co. reviewed our Center’r recent Policy Brief on the legal authority to adjust state pensions as well as our recommendation that the General Assembly clarify the law with legislation that states this intent due to a critical “public purpose”. Check back soon for a link to the video.