According to the, Governmental Accounting Standards Board, “The discount rate used to discount projected
benefit payments to their present value will be based on a single rate that
reflects (a) the long-term expected rate of return on plan investments, as long
as the plan net position is projected under specific conditions to be
sufficient to pay pensions of current employees and retirees and the pension
plan assets are expected to be invested using a strategy to achieve that
return; and (b) a yield or index rate on tax-exempt 20-year, AA-or-higher rated
municipal bonds to the extent that the conditions for use of the long-term
expected rate of return are not met.” Thus, the Illinois Teachers Retirement
System is contemplating the reduction of its expected investment rate of return
on August 23rd.
I
am asking these questions with limited knowledge about market valuations,
long-term growth and returns on capital:
·
Isn’t the GASB expected
investment method (risk-free all-bond investments) rather than the proven diversified
investments strategy actually used by TRS to value future liabilities inconsistent
with the overall 30-year average (of nine percent despite losses during the
Great Recession)? Of course, it would also be unrealistic to believe that any entire
investment portfolio would consist of municipal bonds. TRS has exceeded its
assumed rate-of-return (more often than not) by using a diversified portfolio.
·
Does the lowering
of the TRS investment rate-of-return have anything to do with the risks posed
by the unfunded liabilities that were caused by past Illinois General
Assemblies?
·
Are we now
considering the flawed analysis of Robert Novy-Marx and Joshua Rauh as an accurate
prediction (low investment returns), despite reputable, substantiated rebuttals
from Keith Brainard of the National Association of State Retirement
Administrators (Faulty Analysis is Unhelpful to State and Local Pension Sustainability Efforts, October 2010),
Monique Morrissey of the Economic Policy Institute (Discounting Public Pensions, April 2011), Diane Oakley of the
National Institute on Retirement (Public Pension Asset Exhaustion – Only a remote Possibility, May 2011), and Dave
Urbanek of TRS (Voice of the People,
Chicago Tribune October 25, 2010 & November 30, 2010)?
To
paraphrase Bob Lyons, TRS trustee, an expected lower investment rate-of-return will
require larger contributions from the state and increase the state’s unfunded
liability. Senator Christine Radogno recently talked about a “$130 [billion]” public
pension unfunded liability in an interview. I assume the $130 billion she
refers to will be the new unfunded liability as a result of a lower risk-free
rate.
“Conservative
critics… have gotten considerable political mileage from claims that public
pensions’ unfunded liabilities are… two to six times larger than the
conventional measures based on pension reporting… Their arguments hinge on
assumptions that current and future pension fund investments will earn
historically low rates-of-return going forward…
“Most
economists believe that the expected return on stocks is significantly higher
than the risk-free rate… Critics never address the practical implications of
using a ‘discount rate’ … below the expected return on pension fund assets.
Furthermore, simply discounting with a risk-free rate does not actually
safeguard returns or encourage prudent investment practices, it just makes all
pension funds appear underfunded.
“It
also allows critics to argue that public-sector workers are paid more than they
appear to be paid since the cost of their pension benefits (i.e., what must
theoretically be socked away) is supposedly greater than the contributions made
to the funds… [Moreover, regarding a 90 percent funding target by 2045 based on
the flawed “Pension Ramp-Up,”] there is no need for pension funds to closely
match assets and liabilities, though some boutique investment firms earn high
fees advocating this approach” (Morrissey).
Since
TRS’ recent projections are based upon “smoothing,” or
the averaging procedure that includes both gains and losses over a five-year
period to determine funding data, the return rate has been, indeed, low.
According to Lyons, the current rate-of-return for the last five years is 2.5
percent. Of course, we all know the last five years include The Great Recession.
TRS investments lost a combined 27.7 percent of its income in 2008-09.
Consider
the following excerpts from Pension Liabilities: Fear Tactics and Serious Policy by David Rosnick and Dean
Baker (January 2012) of the Center for Economic and Policy Research:
·
Participants in
the debate over pension accounting have a variety of agendas. If the purpose is
to make the situation of these pension funds appear as dire as possible, then
using a risk-free rate-of-return to assess their liabilities can be useful…
·
If the goal is to
actually manage a pension fund holding equities in a way that minimizes the
need to increase contributions above the normal level, and therefore implicitly
raise taxes, then it is desirable to use a funding rule that is based on an
economically-conditional rate of return of the assets held by the fund…
·
A pension fund
that adjusted its expected return assumptions based on the ratio of stock
prices to trend earnings would have a much smoother contribution path than a
fund that always maintained full funding using the risk-free rate-of-return as
the discount rate…
·
If the goal of
pension fund managers is to maintain a smooth flow of funding and avoid
temporary tax increases needed to meet funding targets, then the
conditional-funding rule… is unambiguously superior to a funding scheme that
maintains full funding using the risk-free rate-of-return as the discount rate.
·
Pension funds
should adopt a funding principle that is consistent with a return on holdings,
conditional on the state of the market…
·
The expected
‘conditional rate-of-return’ used in making this assessment will vary depending
on the current ratio of stock prices to trend corporate earnings…
·
An optimal
funding rule would maintain a roughly constant ratio of contributions to
payouts…
·
A pension fully
funded under the choice of a risk-free rate would… require contributions even
larger than those under the conditional rate. Of course, [public] pensions are
rarely fully funded [and don’t have to be]…
·
A proposed switch
in the discount rate affects the current funding status of the pension…
·
A decrease in the
chosen discount rate pushes a pension father below funding…
·
Under the
economically-conditional discount rate, pensions rarely must make contributions
in excess of payouts…
·
It is far more
common for a pension funded under a risk-free discount rate to pay current
benefits exclusively out of contributions…
I wrote in a previous post: before changing the expected rate of investment return,
why not wait until FY2014 to obtain a more realistic assessment of the TRS’
investment returns that are not based on asset values that include the
exceptional market lows of the Great Recession? Since actuaries use “smoothing,”
why not wait a few more years before drawing further conclusions about expected
returns? After all, the State of Illinois does not face an urgent liquidity
crisis (pension fund liabilities are long-term). Why not re-evaluate two or
three years from now to see whether the economy and Market have fully recovered?
Focus instead on the more honest and critical issue of revenue restructuring to
pay the state’s debt problem that legislators have incurred.
To answer your "why not" questions is simple. The politicians are serving the interests of their campaign contributors. They want to get re-elected and remain in power to gain even more ill-gotten swag. They have been given the job of plundering middle class public employee pensions for the benefit of the wealthy few who wish to continue the legalized corruption that benefits them at our expense.
ReplyDeleteIn all fairness to a few uncorrupted legislators who honestly believe that cutting pensions is the only possible thing to do, please remember how incompetent they are regarding as complex an issue as this.