The Long and Short of the Interest Return Assumption

 

The Issue

When plans are made at the Minnesota Legislative Commission for Pensions and Retirement, the topic of the investment return assumption or investment rate assumption flares up. This is the assumed rate of interest returning on funds held through the State Bureau of Investments. These investments may be equity stocks, various bonds, real estate or other instruments presumed to increase in value over time.
In order to plan for the future in the pension system, agencies need to predict the number of people who will be working and thus contributing to the invested funds, what the changes in the actual cost of living will be, whether there will be inflation or deflation of the dollar and how much, the number of people retired and retiring, and how much interest will be earned on invested funds. These factors are planned out over 30 or 40 years. To put that into perspective, imagine where you were and what you were doing for Thanksgiving in 2006. How closely do you think you would have predicted the economic changes that occurred in the next ten years?
Left to experts, these exceedingly complex calculations are generally inaccurate in detail, but generally better than 50:50 in broad strokes. By comparison, index fund investments (funds automatically composed of top performing investments) perform somewhat better than the average performance of funds managed by humans. The index funds are like bookies, setting the odds, and the fund managers are like punters, playing them, at a race track.
So, why do pension commissioners care so much about this investment return assumption? Well, while the picture of the future of the funds may be drawn with invisible ink which will only become visible as it becomes history, the drawing is the best guess they have of what the future will be. It is a blueprint of where, when and how much public money – taxpayers’ and workers’ dollars – will be in the fund, and so how healthy they think the fund will be in 10, 20 or 40 years.

The Catch

The health of the Minnesota Teacher Retirement Association pension fund, and all state public employee pension funds in Minnesota, is very important to the State’s finances. The public employees’ pensions are an obligation of the State and the employers; they must be satisfied. If the money is not in the funds to make the mandated payments, the State and school districts, cities, and other employers, and the public employees’ paychecks, all of whom share responsibility, must make up the difference. That means citizens will pay either by tax increases or by loss of jobs and/or the services these jobs provide. This would be very bad.
To avoid this eventuality without contributing more into the funds before disaster strikes, some politicians and many others have an interest in changing the whole system from a defined benefit plan (the State defines what your retirement benefit will be) to a defined contribution plan (the State defines what contribution it will make to your own investments, i.e., there is no state fund.) This change would shift the pension responsibility to each individual.
So here’s the catch: assuming a lower rate of return means assuming that the fund will not grow as much over the next 20 or 40 years; the fund will look more insufficient to meet its obligation to pay our pensions. If that looks like it’s going to be the case, hadn’t the Pension Commission better shift to a plan for which the state will not be held responsible?
Many decisions are made based on the impact the investment return assumption has on the picture of the fund’s future, employer and employee contribution rates, retiree benefits, etc.

The Flaws

There are two flaws to this reasoning however: a big flaw and a huge flaw.
The big flaw is that reasoning based on an investment return assumption is equivalent to reasoning based on the odds of a 40 year long horse race. Yes, the odds may be based on past experience, but that hasn’t ever been a perfect predictor of horse races. That’s why they’re called odds. And the investment return assumption has not been a very good predictor of economic outcomes. Changing the odds doesn’t change the outcome of the race. Changing the investment return assumption will not change the future investment returns on pension funds. It only draws a gloomier or brighter future picture, which is then used by elected officials to make crucial decisions.
The huge flaw is that shifting from a defined benefit (DB) plan to a defined contribution (DC) plan, in an effort to avoid the States’ obligation, would make public sector jobs harder to fill with well qualified workers, and would thereby universally diminish teachers’ and other public sector workers’ quality of retirement. Individuals would be forced to provide their own retirement plans by managing their own investments in a market already presumable predicted to be weaker than is necessary to sustain a fund managed by the State Bureau of Investments is risky at best. Think of the difference between the value of an individual insurance plan and a large group insurance plan. Paying an investment broker or advisor further depletes the amount getting into the fund. And in 2017 the greater part of American workers are woefully under-prepared for any retirement. This bodes very ill for tens of thousands of additional workers in Minnesota should the plans be changed. Furthermore, the State and its funded employers must still find millions of dollars to meet their existing obligations as the pension funds diminish to zero.
Yes, the investment return assumption really matters, even if though it’s just a guess.
This has been the short explanation. I know. It’s not short, but it’s shorter than the long explanation that is attached.

The Long of It

NASRA Issue Brief: Public Pension Plan Investment Return Assumptions, Updated February 2017
(http://www.nasra.org/returnassumptionsbrief)

 

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LCPR hears financial update – 9/20/2017

The Legislative Commission on Pensions and Retirement (LCPR) on Wed., Sept. 20, heard reports from the pension fund executive directors on the financial impact of the recent 15.1 percent investment return and the failure to enact a pension bill during the 2017 session. The commission also heard from the State Economist Laura Kalambokidis and State Board of Investment (SBI) Director Mansco Perry regarding national economic forecasts and the investment return assumption.

MSRS Executive Director Erin Leonard reported that the MSRS General Plan’s estimated funded ratio for FY17 is 81.5 percent (assuming a 7.5 percent investment return) and its estimated deficiency is 4.3 percent of pay. That plan’s funded ratio is projected to decline to 62.6 percent in 30 years if no action is taken to address its deficiency. Had the 2017 pension bill been enacted, the MSRS plan would have a slight sufficiency of 0.35 percent of pay and would have been projected to exceed 100 percent funded by 2047.

PERA Executive Director Doug Anderson reported that the PERA General Plan’s estimated funded ratio for FY17 is 76 percent (assuming a 7.5 percent investment return) and the plan has a slight sufficiency of 0.2 percent of pay if measured using a 30-year amortization period. That plan’s funded ratio is projected to steadily increase to 95 percent in 30 years. Had the 2017 pension bill been enacted, the PERA plan would have a sufficiency of 1.3 percent of pay and would have been projected to attain 117 percent funded by 2047. Anderson fielded questions regarding the recent Bloomberg article which focused the Governmental Accounting Standards Board (GASB) accounting numbers. Anderson cautioned the LCPR that the GASB numbers are likely to be very volatile year to year and that they reflect only a snapshot in time rather than the long-term financial status of the plan.

TRA Executive Director Jay Stoffel reported that TRA’s estimated funded ratio for FY17 is 69.1 percent (assuming a 7.5 percent investment return) and its estimated deficiency is 8.53 percent of pay. TRA’s funded ratio is projected to decline to 50 percent in 30 years if no action is taken to address its deficiency. Had the 2017 pension bill been enacted, the plan would have a deficiency of 0.74 percent of pay and would have been projected to attain 95 percent funded by 2047. During discussion of TRA, Rep. Tim O’Driscoll commented that TRA did not come to the table, as other plans did, with sufficient benefit reductions and that TRA was asking for more funding than the other plans. Sen. Julie Rosen, commission chair, added that she appreciated Sen. Dan Schoen’s amendment to put TRA’s provisions back into the bill after they had been removed in committee. Rosen characterized the Schoen amendment as a good faith effort, but commented that it was unfortunately designed to pay for school district costs at a later time. Rosen also said that TRA had been resistant to accepting the 7.5 percent return assumption and stressed that she wanted to achieve that change. Stoffel explained that TRA is asking its actuary to perform a mini-experience study focused on economic assumption to update the actuary’s recommendations. The study is due in November.

SPTRFA Executive Director Jill Schurtz reported that the St. Paul teacher plan’s estimated funded ratio for FY17 as 60 percent (assuming a 7.5 percent investment return and taking into account mortality improvements) and its estimated deficiency is 4.2 percent of pay. That plan’s funded ratio is projected to decline to 52 percent in 30 years if no action is taken. Had the 2017 pension bill been enacted, SPTRFA would have a sufficiency of 0.9 percent of pay and would have been projected to attain 99 percent funded by 2047.

State Economist Laura Kalambokidis warned that due to an aging population, slow labor force growth and ongoing federal fiscal risks, the U.S. economy is expected to have slower than expected economic growth and lower than expected investment returns. She indicated that past performance of the financial markets does not guarantee the same future results. Kalambokidis advised LCPR to recognize that future investment returns may be lower and more uncertain than past returns. She said that getting the discount rate wrong has consequences: setting it too low can result in overstating liabilities and incurring unnecessary costs today while setting it too high will understand liabilities and push costs to future generations.

SBI Executive Director Mansco Perry provided an overview of how SBI’s assets are managed and what SBI returns have been over short- and long-term periods. He showed that SBI return performance ranks in the upper 20 percent of funds. With respect to the investment return assumption, he stated that once the LCPR changes the assumption, he recommends that it stay with that assumption for a minimum of five years because investment forecasts are highly uncertain and do not lend themselves to such precision.

The commission plans to meet again on Oct. 10 or 11.

Pensions Are Important to People

Let’s be clear: Pensions are important to people. 51% of American workers say it influences taking and keeping a job. Like Social Security, it is somewhat sheltered from predatory advisers and brokers. While not flashy, a pension is also not volatile as the equities market is.
The average couple in the U.S. will spend roughly $250,000 in medical expenses including Part B and supplementary health and prescription drug insurance but not including long term care, and those dollar figures will inflate. How will you cope? A secure pension looks much more attractive than working until you are forced out to live on an extreme poverty Social Security check and whatever investments the financial industry has left you, if the Market hasn’t scuttled them.
The billions of dollars in nation-wide retirement investments are surely attractive to advisers, brokers and financial firms, all of whom want a slice of your pie. And they may bend, twist or disguise the facts to convince you to depend on them. They work on the businesses and politicians to persuade them that they will take care of you while sparing the big money interests from having their profits converted into taxes. Yet those taxes support the very people who—toiling away in their offices and classrooms and in their snowplows and firehouses—work to make the country educated, safe and pleasantly livable.
Since others want to take some of our money, we must all be vigilant, informed and ready to speak up in defense of the Minnesota public employee pension plans. The health of all of them is vital to the health of each of them. Connect with and support those organizations that are working on your behalf. While the Minneapolis Committee of Thirteen will work tirelessly to secure the retirement future of Minneapolis Public School educators, they need you to do two things.
Your contributions over the next 12 months will make it possible to adequately support pension friendly candidates who will in turn support you if elected. You must also tell friends and co-workers to speak up and step up for legislative support for the Minnesota Teacher Retirement Association and all Minnesota public employee pension plans. The Legislature determines all the changes to our pensions.
Help people understand that tax dollars are the price we pay for a civilized society. Let them know that those who have enough money to buy education for their kids, security systems for their property and insurance for their out-sized homes are not exempt them from participating in society. They drive on the highways, they visit the parks, they enjoy the safety and security that surrounds them, and they even hire public school educated workers who help provide that privileged life-style.
Be informed and be engaged. Stay in touch with the work of the Minneapolis Committee of Thirteen here on comof13.org (the blog), http://www.facebook.com/committeeof13/, twitter.com/committeeof13, and coming soon to Google+, and make contributions, learn about events and connect to other resources to the main Website http://www.committeeof13.org.
For those of you in schools, in Minneapolis and across the state, have a great year. Teach the children well and know that teaching is the finest vocation on the planet. You deserve the respect of all Minnesotans, and the rewards you’re earning. What you do makes America; make it Great. 

MN House Republicans Continue War on Teachers

Doing nothing to adjust the TRA fund now will compound the problems. The future costs will be much higher, and eventually, the People of Minnesota will be saddled with a whooping bill. The GOP seem to think that they are not responsible for fulfilling the terms of the State’s contract with its workers, especially those who teach our future generations of citizens. Perhaps they prefer to buy election support with tax breaks and refunds.
Here is the latest from Laurie Fiori Hacking, Executive Director, Minnesota Teachers Retirement Association keeping us informed from the Capitol:
“This evening the House voted 75 to 48 to approve SF 3, a scaled-down version of the pension bill that does not include TRA’s funding stability provisions but does include the funding stability measures for other systems (MSRS, PERA P&F and SPTRFA).  Most of the debate focused on the bill’s preemption and parental leave provisions, provisions which have caused the governor to declare he would veto the bill.
Rep. Mary Murphy (D-Hermantown) stated that the pension elements in the bill were not what had been passed in the regular legislative session nor by the Pension Commission.  Rep. Murphy characterized the process as “broken.”  House Minority Leader Melissa Hortman (D-Brooklyn Park) said there was no reason to tie the fate of pensions to the preemption issue. “

Senate passes doomed bill to House

The Senate just approved the pension bill (SF 3) with a vote of 34 to 30. Most of the debate on the bill centered on the controversial preemption language contained in the bill which the governor opposes. Sen. Scott Dibble (D-Minneapolis) offered an amendment to remove the contentious preemption language, but that amendment failed by a vote of 30 to 32.  SF 3, if it progresses, would next move to the House for consideration.

SF 3 does not contain the TRA funding stability provisions but it does include TRA’s administrative provisions. The stability provisions and funding for the other systems (MSRS, PERA P&F and SPTRFA) are included in the bill.  The bill also contains labor-related provisions such as ratifying parental leave in the various state labor contracts. It also contains the controversial local preemption provision that bars local governments from adopting local ordinances governing wages and benefits provided by private employers. The governor previously vetoed the preemption bill and last night issued a statement indicating he intends to veto the pension/preemption bill.  We will keep you posted if there is further action on this bill.

Courtesy of Laurie Fiori Hacking, Executive Director, Minnesota Teachers Retirement Association

Special Session Deadline Extended

The legislature continues to work, but progress is uncertain as of 8:30 this morning.

From Laurie Hacking, Exec. Dir. of TRA:

“The pension bill (SF 3) was finally posted late last night, however, it has not been voted on yet. It does NOT contain the TRA funding stability provisions but it does include TRA’s administrative provisions. The stability provisions and funding for the other systems (MSRS, PERA P&F and SPTRFA) are included in the bill.  The bill also contains labor-related provisions such as ratifying parental leave in the various state labor contracts, a measure that the governor supports. It also contains the controversial local preemption provision that bars local governments from adopting local ordinances governing wages and benefits provided by private employers. The governor previously vetoed the preemption bill and last night issued a statement indicating he intends to veto the pension/preemption bill (see below).  We will keep you posted as things unfold during the day.”

When all is said and done. Thank Governor Dayton and those legislators who have stood up for Minnesota’s state workers. They have been relentless in putting people before profits. That has been the great thing about Minnesota, and it must never be lost.

Here’s why funding is at issue

Late Sunday night the Senate unanimously approved the pension bill. Action today will move to the House. TRA’s financial stability measures were not initially included in the bill, but a floor amendment added back the TRA sections.  The TRA provisions, however, become effective only “if an appropriation is made to TRA in the 2017 legislative session for the employer contribution increase.”  It remains unclear whether in the final hours of the session legislative leaders and the governor will agree to provide the funding needed to cover the costs.  A summary of the TRA provisions in the Senate-passed bill are described below.  Note that none of these provisions are effective unless funding is provided in the 2017 session.

  • COLA: Reduces TRA’s 2% COLA to 1% for five years, effective 2018-2022; for the next five years (2023-2027), the COLA increases 0.1% per year until reaching 1.5% in 2027.  Eliminates future COLA triggers that would increase COLAs if system funding improved. Also requires LCPR to study COLAs for all plans and make recommendations for the 2021 legislative session.
  • COLA Delay: Delays payment of the first full COLA until a member reaches normal retirement age (age 66 for post-89 hires and age 65 for pre-89 hires). Implementation of the normal retirement age COLA is delayed five years, until January 1, 2023.  Under this proposal a teacher retiring at age 62 would have a frozen benefit for four years until eligible for a full COLA, whereas under current law the wait period for the full COLA is 18 months. Members retiring at age 62+ with 30 years of service or retiring under the Rule of 90 are exempt from this COLA delay. Also exempt are disabilitants and younger survivors of members who die while active.
  • Early retirement benefits: Reduce early retirement benefits by eliminating current-law augmentation rates that are used in calculating benefits.  Early retirement benefit augmentation would be eliminated over a five-year period beginning July 1, 2018 through June 30, 2023.  Members who retire at age 62+ with 30 years of service would retain the more favorable early retirement benefit provisions available to them under current law.  For members not eligible for 62/30 provisions, the proposed change once fully implemented would reduce early retirement benefits by approximately 18% for members retiring at age 60, by 11% for members retiring at age 62 (TRA’s average retirement age), by 8% for members retiring at age 63 and by 6% for members retiring at age 64.  Reductions for members retiring before age 60 would be more significant, ranging from 19% at age 59 to 33% at age 55.
  • Contribution rates: Increases employEE contribution rates from 7.5% to 7.75%, beginning July 1, 2022.  Increases employER rates from 7.5% to 8.75% phased in over six years, 2017-2023). 
  • Deferred augmentation: Reduce augmentation from 2% to 0% for vested deferred members who terminate employment and elect to leave their contributions with TRA.  The elimination of augmentation would occur for future years of deferral beginning July 1, 2018.
  • Refund interest rate: Lowers interest rate paid on refunds from 4% to 3%.
  • Investment return assumption: Lowers TRA’s investment return assumption to 7.5% along with all other pension plans.  Also lowers to 7.5% the interest TRA charges members and employers for repayment of refunds, various leave payments, and omitted contributions.
  • Amortization period: Extends TRA’s amortization period by 10 years from 2037 to 2047.  Most other plans’ amortization periods are also extended to 2047.

Courtesy of MN TRA