Pension Follow-Up and Cost of Settlement

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After putting up my post about Rhode Island’s pension fund performance, yesterday, I managed to get my hands on the valuation report for 2015, which isn’t on the general treasurer’s Web site, yet.  My confusion about the fund’s performance derived from the fact that, although the pension settlement wasn’t signed into law until the last day of the fiscal year (June 30, 2015), the actuaries applied its changes to a revised valuation of the 2014 fiscal year.

That change pushed the state employees funded percentage from 57.4% to 56.1%, and for FY15, it rose slightly to 56.6%.  For teachers, the FY14 drop was from 59.6% to 58.2%, rising to 58.8% in FY15.  The total unfunded amount went from $4.4 billion to $4.6 billion, with the FY14 revision and then to $4.55 billion for FY15.

For most folks, those numbers are probably just a bunch of abstractions.  Here’s a number that might seem a bit more real:  The actuarial accrued liability — the cost of the promised pension benefits beyond what the state and employees will put into the fund — increased a quarter-of-a-billion dollars with the settlement, or $250.7 million, and another $17 million in FY15.

But we can’t stop there, because that number assumes the state’s 7.5% return on investment in order to reduce (“discount”) the total cost.  As of the end of FY14, the state employees’ pension was scheduled to be amortized (i.e., fully funded) over 21 years, and to disguise the increase, the teachers’ pension amortization was increased a little, to 23.3 years.  Removing the “discount,” the pension settlement actually added $1.3 billion over the amortization period.  That’s  $469 million for state employees over 21 years and $798 million for teachers over 23.3 years.

This number is important to know because of the effect of actual returns.  According to the valuation report, the average annual return over the past 10 years was 6%.  Readers can decide for themselves whether even that number is likely to be hit in the two decades to come, but even if it is, the actual cost (using the accrued liability) of the settlement would have been more like $343 million.  That’s nearly a $100 million hit to our pension liability simply by adjusting predicted investment returns to match the experience of the last decade.

These numbers can be staggering, and it only gets worse.  As stated above, the actuarial accrued liability is the cost above and beyond the contributions that the state and employees will make.  As of the end of FY15, the present value of all promised benefits was $12 billion.  For FY14, the settlement increased this present value of all future benefits by $412 million.

That’s the actual estimated benefits for all individual employees, individually discounted back to that year.  I’ve never seen the undiscounted total promised benefits published anywhere, but for illustration, if we calculate the FY15 present value to the end of the amortization period (around 20 years), the total pension benefit for teachers and state employees is currently worth $57 billion.

Given the reliance on investment returns and the sheer numbers involved, one can see how this simple employee benefit can become a threat to our entire economy and why, ahem, it’s in officials’ interest to keep the issue quiet for as long as they’re able to do so.



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