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.