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For much of the past decade, state lawmakers have reacted with alarm as volatile financial markets opened up multibillion-dollar shortfalls in the long-term outlook for the state’s pension system.

GOP bills tackle ghost of pensions future

Rep. Morrie Lanning contends that the current 8.5 percent assumed rate of return for public pension funds is far too rosy, saying the state may be “making promises we can’t keep.” (Staff photo: Peter Bartz-Gallagher)

Lanning, Banaian proposals aim to reduce  pension fund growth assumptions

For much of the past decade, state lawmakers have reacted with alarm as volatile financial markets opened up multibillion-dollar shortfalls in the long-term outlook for the state’s pension system.

Even though Minnesota’s pension investments have regained ground from their lows during 2008-09 Wall Street meltdown, lawmakers remain concerned that unwisely optimistic projections about the future rate of return on pension investments are providing a distorted picture of the funds’ future stability.

House and Senate lawmakers are pursuing an omnibus pension bill that would lower the assumed rate of return in years to come. Key legislators, including Rep. Morrie Lanning, R-Moorhead, and Rep. King Banaian, R-St. Cloud, contend that the current 8.5 percent assumption is far too rosy.

“I have felt all along,” Lanning said, “that an assumed rate of return at 8.5 percent is too high. It’s the highest in the country. If we keep making promises to pensioners based on that kind of return and we continue to have the performance we’ve had in the last 10 years, we’re going to be making promises we can’t keep.”

Minnesota has three statewide pension plans: the Minnesota State Retirement System (MSRS), the Public Employees Retirement Association (PERA) and the Teachers Retirement Association (TRA). Thanks in part to bipartisan legislation from 2010 that increased contribution rates and reined in the growth of benefits, the plans’ financial stability has improved. But they still sport unfunded liabilities: TRA, for example, is 78 percent funded. (In 2010, the fund paid benefits to 51,800 retired teachers or their survivors.)

Bills differ on rate of future return

Lanning, who chairs the Legislative Commission on Pensions and Retirement, has introduced a bill that lowers the 8.5 percent rate to 8 percent. His proposal also changes assumptions about employment and payroll in the state workforce that also affect the plans’ future outlook. After a 10-year period of time, the 8.5 percent rate could be reinstated if the financial outlook warrants as much.

Banaian, an economics professor at St. Cloud State University, is proposing a steeper rate reduction — to 7.5 percent. His bill doesn’t contemplate a future restoration of the old rate.

“The question really is, should we assume that what we had in the last 30 years is the environment going forward?” Banaian said. “And I say no. But reasonable people will disagree.

“The problem with 8.5,” he continued, “is it can act as a target rate that encourages, I think, more risk taking than we should do. These are obligations we have and we should pay for. If you keep 20 percent of your fund in bonds that are returning 2 percent on average, that means the remainder of your portfolio has to earn 10 percent to make it happen.”

But the move to reduce the rate would put the funds in worse financial shape. In the case of TRA, the reduction to 8 percent would knock TRA’s funding level from 78 percent to 74 percent, based on TRA’s June 30 valuation. The reduction would likely have financial consequences for retirees because of a cap on benefit increases that was part of the 2010 legislation. Teachers’ annual benefits increases, which have currently been suspended, will begin increasing 2 percent a year in 2013, which is less than the 2.5 percent annual increase that was the law before the 2010 legislation. The 2.5 percent annual hikes are set to be reinstated when the plan reaches 90 percent funding — but it will take longer to get there if the annual return projections are lowered.

“Any change in those assumptions would likely increase the unfunded liabilities,” Lanning said, “but [the liabilities are] nothing new. It would take longer to get them back up, and, down the road, it might take further action by the Legislature like we took in 2010.”

TRA most resistant to changes

Among the three plans, TRA has expressed the most concern about the prospects of reducing the assumed rate. Laurie Fiori Hacking, the executive director of TRA, said long-term evaluations of pension investments have shown the state has weathered previous economic downturns. All three plans are against permanently reducing the assumed rate to 7.5 percent, as Banaian is proposing. But Hacking said the TRA board is willing to accept a temporary move to 8 percent.

“Basically, we’re reasonably comfortable with the interest rate change for 10 years,” Hacking said.

Concerns that Minnesota’s pension policy might not be sustainable have fueled a heated debate on newspaper editorial pages and among national public policy blogs.

Mark Haveman, the executive director of the Minnesota Taxpayers Association, ruffled the feathers of pension plan officials last month when he wrote an op-ed in the Star Tribune that noted the three plans still have $10.5 billion in unfunded liabilities even after the 2010 fix. Haveman’s concern that Minnesota’s pension assumptions are unsustainable drew national attention: Walter Russell Mead of The American Interest cited the op-ed in a post titled “The Great Minnesota Pension Scam.”

The presidents of the boards of the three Minnesota pension funds issued a rebuttal in the Star Tribune claiming that Haveman’s analysis is a “distorted view of the plans’ health.” They noted that Minnesota’s contribution levels to pensions and higher expected retirement ages have put the state on better financial footing than other states.

This week Haveman groused at the characterization that he’s forecasting doom for Minnesota’s pension system. But he doesn’t think the state’s current policy is sustainable for the long term, especially if the economy founders again.

“Are Minnesota’s defined benefit plans better than a lot of states’? Absolutely,” he said. “But the larger issue is: What is the sustainability of these things going forward? For me, benchmarking against other states is like being in the urgent care waiting room, proud of your 102 degree fever when everybody is at 105.”

Other changes weighed

Adjusting the assumed rate of return isn’t the most far-reaching change to pension policy that lawmakers are mulling, even if it’s the one most likely to happen this session. Lawmakers are also studying ways to change the current “defined benefit” pension policy, in which the state assumes the risk for making good on its bottom-line pension obligations. Republicans have long called for the state to put all new hires into a so-called defined contribution system in which employees are responsible for managing their own pensions and the state offers no guarantees regarding total benefits paid out.

Since the conversation about a defined contribution switch-over has been broached, officials from the three pension funds have reported that the transition to a new system would be extremely costly. The future of pension reform, however, could include a hybrid system that slims down benefits and gives individuals some control over their personal retirement accounts.

Lanning thinks that approach is on the not-too-distant horizon for pension policy.
“We’re going to continue to have basically a defined benefit program,” he said. “We’re exploring adding some elements of defined contribution, which I think gives employees more control over their own funds.”


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