Rhode Island Pensions, Where Sanity Is Not Possible

Randy Edgar had a follow-up article, last weekend, on the audit of the state’s pension management that suggested a lowering of the discount rate.

By way of refresher, the state uses a guess — called a “discount rate” — of 7.5% return on its pension fund investments (including the value of the assets, the trading price of the assets, and inflation) to figure out what it needs to have in the bank to cover its pension promises.  The auditor told the state that it has a 40% chance of achieving returns that high, and folks in relevant government offices are speaking as if, maybe, if the stars align, they’ll go out on a limb and shoot for fifty-fifty odds of achieving their goal next year, by lowering their investment guess to 7.0%.

In the private sector, anybody who wants a “riskless” investment, meaning that they’ll have a near-100% chance of having the money they expect to have at the end of the period, sets the target at 4% or less.  Having read many of the recent actuarial reports and experience studies performed at the state and local levels, in Rhode Island, I’ll opine that it’s obvious the actuaries who set the discount rates for pension funds are merely searching for rationale to do what their clients want.  In other words, government officials who can’t afford to tell the people who put them in office that the pension funds are woefully underfunded tell the actuaries what they need the percentage to be, and the actuaries (like lawyers) search the literature and the numbers for an excuse to call that percentage reasonable.

Anybody who doubts that the labor unions are in on the game need only read Edgar’s article:

Already voicing concern with the idea [of lowering the discount rate] is Ken DeLorenzo, executive director of the largest state employees’ union: Council 94, American Federation of State, County and Municipal Employees.

In his view, the discussion about possibly lowering the return assumption is “premature, especially considering that the last reduction was done just two years ago.”

“Pension funds are long-term investments, or are designed to be long-term investments,” he said.

The statement from people who are paid to represent the interests of workers ought to be: “Our primary concern is that the state has adequately prepared to provide our members with the benefits that it has promised them.”  If that means a 2% discount rate, then that’s what labor leaders should want.  As I’ve pointed out before, for every year that the fund doesn’t hit its mark, it must have an even better year that covers not only the bad year’s gap, but all of the additional profit that the fund didn’t make on money that it didn’t have.

Seen in that light, the discount rate should be adjusted every single year.  Better yet, at the end of the year, the government should have to put the shortfall into the fund from its general revenue.  Then it would never lose ground.  Of course, then the public would see what the benefit packages for its employees are really costing.

Pension funding, in general, and Rhode Island’s pension reform, in particular, are testaments to the power of misdirected attention. We had a reform that left the state with billions of dollars in unfunded liabilities and a 40% chance of achieving the necessary returns.  But we managed to avoid dramatic budget battles, and nobody’s talking about immediate tax increases or cuts in benefits, so that temporary relief becomes the touted achievement.

The dirty little secret among government officials, union leaders, and maybe even those who herald the recent pension reform as an unusual burst of fiscal conservatism in Rhode Island government is that the goal isn’t an honest accounting of what the pension fund needs.  Rather, the goal is to find a way to move the crisis down the road until an unelected escape hatch appears — whether it comes with the drop of a judge’s gavel or a ruling by a union-dominated retirement board.

At that point, officials can turn to taxpayers, and union leaders can turn to their members, and both can say, “Hey, other people didn’t adequately prepare for this, and now we have no choice but to do what’s been ordered.”

As to where the money will come from, it isn’t clear that anybody’s cared to think about that.



20 Responses to “Rhode Island Pensions, Where Sanity Is Not Possible”

  1. Tommy Cranston
    September 18, 2013 at 8:37 am #

    The only real SOLUTION is to move all (and yes this means cops and firemen) government employees into SS plus a 401 k style program and that's IT.
    Yes that means our crybababy firemen will have to live within the decidedly less corrupt disability system of SSDI.

  2. Mike
    September 18, 2013 at 9:00 am #

    Kicking the can down the road…one need only read the story of Detroit to see how that ends…

  3. Dan
    September 18, 2013 at 9:30 am #

    SSDI is less generous but hardly less corrupt. Enrollment in SSDI has doubled over the past decade and most new applications are on the basis of medically unverifiable "musculoskeletal" and "anxiety" disorders. Instead of Silvio approving his second cousin Johnny-boy for a sweetheart Providence fire disability pension that both know is bogus, SSDI is a massive bureaucracy rubber stamping applications by the thousands – by RI standards, I suppose that's an improvement.

    Federal government has its own problems (particularly gross overcompensation of mid-career HR-office-worker types), but its stupidly generous pension system was actually converted to 401k way back in 1987, so the Federal government was ahead of the curve in that one respect. Nobody has any real issues with the new system and it certainly hasn't negatively impacted retention.

  4. Warrington Faust
    September 18, 2013 at 2:26 pm #

    Assuming a rate of return of 7-7.5% requires a very high "risk preference" (some would call it betting). Considering that they are dealing with "other people's money" they should have more concern for the "widows and orphans".

    Dan, RE: disablity. When I speak to political types, the attitude seems to be "we have to support them anyway" what difference does the vehicle make. So there is no urgency to look into SSDI. I know a blue collar woman who lives in a 5 unit building where all of the other tenants are on disability. Aside from her regular job, she picks up work cleaning houses. This is seriously effecting her morale, she wonders why she goes to work. She tells me that she could qualify for disability, although I have no opinion on that.

  5. Mike
    September 18, 2013 at 2:46 pm #

    Actually, in the future 7.5% will be possible–if not probable. Too many factors are pushing us toward inflation–demand by the entitled for higher wages, the debt, higher energy costs due to a so-called "green" agenda, and so forth. Inflation is coming–and Pres O is very good at one-upping Pres Carter who had interest rates over 11%! Let the good time roll!

  6. Justin Katz
    September 18, 2013 at 3:01 pm #

    I've thought about that angle, but I'm not so sure. After all, as a variable, inflation is not independent. If you've got stock that you're expecting to grow 1% in value of the company, 3% in stock trading, and 3.5% in inflation and the stock itself becomes absolutely valueless, you don't get that 3.5% inflation as a consolation prize.

    My thinking is that the steady inflation we've seen over the past century or so has mainly been a byproduct of growing government debt, which cannot continue indefinitely. At the same time, I think we've been watching the Obama-Fed axis specifically inflate the investment markets, while working to prevent that inflation from seeping out into the broader economy. There's no reason that has to be a one-way street.

    Depending how everything washes out after the dam breaks, it may prove to be the case that REAL inflation… people being willing to pay more for things because they are more valuable relative to everything else… will not, like DEBT inflation, manifest in investment assets.

  7. Mario
    September 18, 2013 at 4:41 pm #

    The problem there is that (despite any recent "reforms") even if stock values were somehow pumped up by a rise in inflation, cost of living adjustments would cause the liabilities to grow by at least the same rate. It is far more likely that an upswing in inflation would make the unfunded liability worse.

  8. Mario
    September 18, 2013 at 5:02 pm #

    I don't see how a growing government debt could result in low inflation. The government is using that debt to buy things, after all, and so that should cause prices to increase, if anything. Think of it from the other side — if the government were to raise taxes today to pay off that debt, would inflation be more likely to go up or down?

  9. Justin Katz
    September 18, 2013 at 5:23 pm #

    Two-part response:

    1) I wasn't referring to consistently low inflation, but to consistently positive inflation.
    2) Government debt could result in consistently low and positive inflation if, over the same period, people were either unwilling to pay more for the same things or willing only to pay less for the same things.

    My larger thesis is that much of the economic growth, as measured by GDP, since the post-war period has been founded in government debt, to an increasing degree. In that scenario, absent the debt, we might have seen consistent deflation over the same period.

    The way we currently talk about economics, that sounds like government debt has been a good thing, but that's not necessarily the case (especially if we take the investment markets out of the seat of honor in the economy). Persistent inflation helps keep prices from adjusting to new priorities as society and technology change.

  10. Mike
    September 18, 2013 at 6:06 pm #

    There is a difference between cost and value. And Inflation is just a statistic…neither good nor bad in itself. But couple it with a Cola freeze and bam! Pension Problem solved…on the backs of the pensioners, of course. Fair and or ethical? Of course not. But who has excused politicians in RI of being either?

  11. Mario
    September 18, 2013 at 6:11 pm #

    The way I see it, there is no natural rate of inflation; the rate we experience in entirely at the whim of the Federal Reserve. They control the size of the money supply, and we just react to the value that level implies. And, on top of that, there is no choice about the level of the money supply that they can make that would constitute a neutral policy; it's all manipulation, so the best we can hope for is the inflation rate that would result in the least impact on people's day-to-day decisions, which happens to be a small, positive one.

    So my point about the government debt is that you would expect to see a rising debt result in higher inflation but, for the most part, the Fed has successfully maintained inflation in its preferred range despite tax cuts, tax increases, spending binges, the sequester, etc. The best explanation is that fiscal policy simply doesn't matter; the Fed is more than capable of choosing and hitting whatever inflation rate it wants, when it wants to — the amount of government spending is a non-factor. Occam's razor. In other words, I think it is highly likely that we would have had the same level of inflation had we been running surpluses all these years instead of deficits.

  12. Justin Katz
    September 18, 2013 at 6:32 pm #

    Mario,.

    That's entirely within the bounds of my argument. For one thing, in the balance of things, one could argue that Fed policy is most effective at slowing inflation down, which stands as a direct counter to your suggest that government debt would accelerate inflation.

    For another thing, monetary policy affects inflation in a particular way. As I've argued before, inflation doesn't fall on the economy like dew. It enters at particular points and affects different parts of the economy differently, depending where prices adjust. Using monetary policy to affect inflation relies on monetary policy's ability to change behavior. But human behavior doesn't depend on monetary policy and can change independently.

    If it's possible to inflate the finance world without inflating or increasing GDP, it's possible to do the opposite. The costs of living in the modern world could go up (inflation) without financial investments' adjusting in the same degree.

  13. _Andrew_
    September 18, 2013 at 6:38 pm #

    So is Milton Friedman right here? http://www.youtube.com/watch?v=YgxPyabmOrU

  14. Tommy Cranston
    September 18, 2013 at 9:20 pm #

    Who makes $100,000 plus on SSDI? Who gets to work side jobs that are "not EXACTLY the same" and keep their disability checks on SSDI? Who gets free college tuition for their kids on SSDI?
    Nobody.

  15. Tommy Cranston
    September 18, 2013 at 9:22 pm #

    By the way if you insist on making cheap ethnic attacks it is FAR more likely that in Providence Fire it would be Sean approving his second cousin Paddy for the disability.

  16. Dan
    September 19, 2013 at 8:47 am #

    Warrington: "When I speak to political types, the attitude seems to be "we have to support them anyway" what difference does the vehicle make. So there is no urgency to look into SSDI."

    That is the mentality, but the vehicle in fact makes a huge difference. Disability encourages mental and physical breakdown (more dependence on the state) of the recipient while discouraging return to work. More traditional welfare mechanisms, such as military service, tend to be only a few years in nature and promote physical fitness and development of semi-job-related skills, preparing the temporarily unemployable individuals for eventual return to the workforce. Also, a huge percentage of the public realizes disability is little more than a huge scam, so it does irreparable damage to our public trust in our institutions and fellow man. When the public starts viewing the system, as a whole, as corrupt, they then rationalize all sorts of destructive and deceitful behavior. Hey, everyone else is doing it.

  17. Fred Floon
    September 19, 2013 at 10:46 am #

    Justin-
    We gotta raise taxes…there’s lots of starving teachers, police and firemen in the state, and we must not fail them.

  18. Warrington Faust
    September 19, 2013 at 11:26 am #

    Dan, your position is supported by the woman I mentioned who iives in a building where everyonne else is on disability. Her morale is shot, but she still wants to "do the right thing". I wonder how long that will last.

  19. Warrington Faust
    September 19, 2013 at 11:38 am #

    I think the discussion about inflation has become overly "technological" and indicates a faith in central planning which is unseemly here. We have a currency based on fiat, all that is necessary is that the populace lose faith and begin to prefer "things" to cash. I don't expect us all to become "gold bugs", but we have seen it in the last decade. People rushed to buy houses that they couldn't afford as a defense against "inflation", or more properly rising prices. People recognize "printing money" as bad, if it continues it may result in irrational behavior.

    Sometime the "great recession" will end, "stimulus" and "QE" will receive the credit. After that they will be respected "standard procedure." We are still referring to it as "priming the pump". Anyone who has actually primed a farm pump knows the power of urine. (does that make sense?).

  20. Tommy Cranston
    September 21, 2013 at 8:23 pm #

    I feel pretty safe predicting that the Party of Jackson, Sharpton and Pelosi will keep up the money flood till double digit inflation returns and like 1980 the people hold their noses and vote out Santa Claus in a landslide.

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