STUMP » Articles » A Week of Bad Pension Ideas: Splitting the Pension Plan to Save It? » 10 November 2015, 05:44

With one of the pieces being completely unfunded:

Malloy Proposal To Split CT Pensions Could Save System

Gov. Dannel P. Malloy’s plan for avoiding fiscal catastrophe in 17 years by rejiggering the state employee pension system may be the only realistic option. But it’s hard to know without more details.

It’s concerning, however, that the state is conceding it won’t be able to make contributions to the pension fund that it had pledged to make.

State budget chief Ben Barnes says annual pension fund payments will balloon by 2032 to $6.6 billion — more than four times this year’s $1.5 billion payment. “Anybody think we’re going to make this [2032] payment?” he asked a roomful of state commissioners and media last week. “It’s not going to happen.”

Refinancing The Pension System

The Malloy administration is proposing major changes to the state employee retirement system to avoid what The Connecticut Mirror’s Keith M. Phaneuf describes as a fiscal iceberg.

It would split the system so that the state pension fund would cover only the benefits of those workers hired after 1984, which are less expensive than the benefits of pre-1984 hires.

The pre-1984 hires, also known as “Tier I,” would have their benefits paid out of the state budget annually, in a pay-as-you-go system.

With the expensive Tier I’s gone, the state employee pension fund goes from having less than half the assets needed to pay its retirement obligations to having enough to cover the smaller pool of workers.

…..
Pay-As-You-Go Is Tricky

The Malloy administration argues that under its new plan, pension payments wouldn’t spike unaffordably by 2032. The new plan would put the state on a more even and predictable, although still hefty ($2 billion yearly) pension-payment schedule — rather than the wild, break-the-bank trajectory it’s now on.

It may be that’s the only way the state can afford public employee pensions going forward. But pay-as-you-go pensions are what got Connecticut into the financial morass it’s in.

Before 1984, the state wasn’t putting any money aside to pay for the unaffordable retirement promises it was making to employees. Even after the state started a pension fund, governors — with the collusion of legislators and labor unions — often skipped contributions to it.

Uh…..

I love these plans where the already accrued pension promises aren’t affordable right now will somehow magically become affordable in the future.

Given the timing, most of the people on the pre-1984 pension plan are already retired (even the younger people who got on the old plan are pushing governmental retirement age). Theoretically, ideally, the money should all be there given their service was in the past.

But fine, we realize that’s not the case. Not only was the pre-1984 plans not funded before 1984, they’ve been underfunding the pensions since then.

Or have they?

PUBLIC PLANS DATABASE RESULTS

The Public Plans Database has 3 CT plans in it.

Here’s the regular state employees fund — in recent years, they underpaid a little but generally paid 100% of the ARC:

Note that increasing percentage of payroll for the ARC, and how high that percentage is.

The teachers plan:

Oh lord, they did a pension obligation bond around 2008, didn’t they. Yup, sure did.

Connecticut’s pension fund for public school teachers also had suffered from decades’ worth of inadequate contributions. It had just 63 percent of its obligations funded in 2007 when the legislature and then-Gov. M. Jodi Rell approved Treasurer Denise L. Nappier’s plan to borrow $2 billion through bonding and deposit it into the pension fund.

The assumption was that the investment return on those borrowed dollars would average more than 8 percent annually over the next two decades, while the interest on the bonds would be just over 5 percent.

As part of its contract with the investors that bought Connecticut’s bonds, the state promised to make the full contribution recommended by teachers’ pension fund analysts for the life of the bonds.

“We were the only known pension fund with that policy at the time, ensuring full funding,” Nappier said, adding this bond covenant guarantee was crucial “to rid ourselves of the undisciplined actions of the past.”

Hmmm, wonder if that includes the pre-1984 teachers. I may be seeing a source for wanting to split off the pre-1984 plan if it includes the teachers. Of course, they may be only talking about the SERS plan for the split idea.

And the final of the three, the municipal plan, which has less data:

Given those great contribution histories, let’s take a look at the funded ratio results:

Observation: they are supposedly regularly making full or more-than-full contributions (with the POB), with only a few contribution shortfalls for this period.

And yet the funded ratio doesn’t noticeably improve. And the ARC as a percentage of payroll is climbing.

What could be driving that?

THE KEY: TOO-HIGH RETURN ASSUMPTION

Checking the three CT plans in the Public Plans Database, I see some incredibly high return assumptions. I’m not sure why the return isn’t in there for each year, but it’s pretty clear that the most recent valuation assumptions:

• CT Municipal: 8% (2013)
• CT SERS: 8% (2014)
• CT Teachers: 8.5% (2014)

Holy crap, that’s high.

But that does explain why, even with years of paying officially 100% contributions, they keep losing ground in funded status. For all I know there are other assumption problems, such as salary scale assumptions or mortality, but the higher the discount rate, the less any of the other assumptions have an effect.

A report is recommending that CT drop its return assumption:

A report expected next week on reforming Connecticut’s state employee public pension system will recommend cutting the annual expected rate of return by 1 percentage point to 7 percent, a lead researcher told Reuters on Friday.

The lower return forecast means the state may have to contribute more money to the pension system. The report was commissioned by Connecticut’s Office of Policy and Management (OPM) and prepared by analysts at the Center for Retirement Research (CRR) at Boston College.

“Poor returns over this past decade just really put a lot of pressure and strain on the system,” said Jean-Pierre Aubry, associate director for state and local research at CRR, who worked on the report, which could be released as soon as Tuesday.

The CRR are the some of the people who run the Public Pensions Database, btw. And their data sure do show that 8% is too high.

8.5% is idiotically high.

BACK TO THE BAD IDEA

So I’m still trying to figure this out.

The liability value is just trying to make a present value of future cash flows. And this is assuming a return of 8% on assets (or 8.5% in the case of the teachers plan) for the lifetime of those cashflows.

If you can’t finance it even pretending that you get 8% indefinitely, how the hell are you going to afford the cash flows when you actually have to pay them?

Even the reporters, not known for being a particularly numerate class of people, were having trouble with this supposed plan. It is not at all clear to anybody how splitting the liability into one part that is funded and one part that is completely pay-as-you-go as opposed to one big underfunded pool is going to make the promises more secure.

Let’s think this through. The post-1984 plan participants will be in a plan that will be at what funded ratio? There is definitely not enough information in this 2013 report to tell us what portion of the liability is “Tier I”, the pre-1984 participants. The report does show that most of the ARC is coming from the unfunded liability, and not new benefits accrued… but that’s hardly surprising given the abysmally low funded ratio.

By the way, the number of retirees is uncomfortably close to the number of active workers. Also, if you look at page 5, you’ll see that the contributions are less than the retirement disbursements. This is a cash flow negative situation, which many public plans are in right now. Some NYT reading on the cash flow negative situation., though as exactuary notes, being cash flow negative is not necessarily a problem.

But it is a really bad problem for grossly underfunded pensions. Because you can’t grow your way out of the hole when you’re cash flow negative, and many pensions have gotten into trouble (specifically, Detroit) by assuming there would be a growing base of public employees (which just naturally comes with the expected growing tax base) to pay for any shortfalls in prior accrued benefits.

They won’t be, by the way.

In any case, for accounting purposes, I think splitting up all the Tier valuations may clarify a bunch of things. It can show exactly which part of the liability is causing trouble. But yanking away any backing assets?

That’s supposed to make Tier I retirement benefits safer?

Well, I will see if better explanations come along. My brain could use with less breaking.

Compilation of Connecticut posts