States all over the country are grappling with ever
increasing unfunded pension liabilities. My home state of Connecticut trails
such pension liability behemoths like Illinois and New Jersey but still ranks
high on the danger list. In June 2010 the Connecticut public pension fund had
$9.3 Billion in assets but its actuaries calculated that the State still needed
an additional $21.1 Billion to meet all its pension obligations. It was only
44% funded.
By June 2016, six years later, State pension assets grew to
$11.9 Billion, a 28% increase, largely because of the increase in the stock
market. Nevertheless, despite Governor Malloy’s tax increases and commitment to
funding pensions, the pension liability had grown to $32.3 Billion, a whopping
53% increase. After six years under Governor Malloy, the pension system was
only 37% funded. What caused the increase?
The Governor, who will not seek re-election this year after
serving two terms, has placed the blame for rising pension liabilities on his
predecessors in office, as well as on the Legislature which has been controlled
by fellow Democrats throughout his tenure. His complaint is a common one heard
all over the country. If only previous politicians had had the guts to face up
to reality and popular pressure, pension liabilities would be manageable.
Instead, politicians just pushed the day of reckoning down the road.
There is some truth in Malloy’s assessment but actually
there is no way that any of these state public pension plans can ever be
adequately or fully funded. To understand we can use a very simple
illustration. Suppose you were to go to a financial advisor and state that your
goal was to have $40000 a year in income when you retired. It would be simple
for the advisor to say that assuming a 4% rate of return, you would need to
have about $1 Million dollars at retirement. $1,000,000 times 4% provides
$40000 per year. However, if you only assume a 2% rate of return, you would
need $2 Million dollars in your retirement account. $2,000,000 times 2% equals
$40000.
In other words, the expected rate of return that the
actuaries use has a great deal to do with their assessment of future pension
liability. Despite the increase in Connecticut pension assets during Governor
Malloy’s tenure, the pension liability has grown even faster largely because of
the low interest rate environment during those years. If the expected rate of
return is reduced, actuaries must indicate that pension liability is growing.
Politicians have no control over interest rates.
Lack of control is one of the reasons why most business
corporations have dropped their defined benefit pension plans over the past few
decades. A business could be thriving but its pension actuary could kill its
balance sheet by claiming that it had to put billions more into the pension
plan because of a decline in expected rate of return due to circumstance
entirely beyond control. In a defined contribution or 401k type plan, a
corporation’s contribution is a manageable percentage of payroll.
Businesses changed their pension plans years ago because
they lived in a very competitive environment. States and municipalities were
not in the same situation. Not only did public entities not worry about profits
and losses, politicians had little incentive to strike hard bargains with
public service unions. In business, management and labor sit across the
negotiating table from one another. In government, the politicians negotiating
with the unions are usually on the same side of the table.
Not only do governors and legislators rely heavily on union
votes and campaign contributions, but also they, their families, and friends
usually gain from any benefit they grant to union members. For example, during
his tenure Governor Malloy has appointed a number of Democrat legislators to
high paying positions in his administration or on the judicial bench. While
these politicians served in the legislature, actuaries would determine their
pension liability as a percentage of their $35000 part-time salary.
But they need to serve only three years in their new
positions to throw all pension calculations out the window. Instead of getting
60% or 70% of $35000, the actuaries will have to figure that they will receive
the same percentage of some six figure salary. The governor has recently
nominated his long-time Stamford Democrat friend Andrew McDonald to serve as
Chief Justice of the State Supreme Court. McDonald’s minimal contributions to
the pension fund during his eight years in the legislature will come nowhere
near providing a six-figure pension.
What incentive did Governor Malloy have to change the
pension system for non-union employees in his administration or in the state
court system? In the last eight years he could have put all of them into a 401k
plan with the stroke of a pen. While he talked about unfunded pension
liabilities, his actions belied his words.
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