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State lawmakers who focus on pension issues are faced with the thankless task of trying to predict the financial future as they weigh the health of the state’s public pension plans.

Pension board wrestles with long-range returns

Legislative Commission on Pensions and Retirement chair Sandy Pappas (center), DFL -St. Paul,  said at  Wednesday’s meeting she hopes the commission finishes its legislative recommendations by January. (Staff photo: Peter Bartz-Gallagher)


Legislative Commission on Pensions and Retirement chair Sandy Pappas (left), DFL -St. Paul, said at Wednesday’s meeting she hopes the commission finishes its legislative recommendations by January. (Staff photo: Peter Bartz-Gallagher)

Rate of return assumptions are fraught politically as well as financially 

State lawmakers who focus on pension issues are faced with the thankless task of trying to predict the financial future as they weigh the health of the state’s public pension plans.

The past five years have seen frightening unfunded liabilities open up in the state’s three major pension plans due to the economic calamity of the Great Recession. The funds’ investments are now seeing better returns, but they still have billions of dollars in unfunded liabilities.

As the Legislative Commission on Pensions and Retirement (LCPR) delves into the weeds of pension policy this summer, it’s paying particular attention to the assumptions that the state makes about the future performance of its pension investments. For many years, state law has assumed the combined mix of cash, stocks and bonds would provide an annual return of 8.5 percent. Some years would outperform that number, some would fall short — but the 8.5 percent rate was always deemed realistic for the long haul.

But the steep declines that accompanied the recession prompted many lawmakers to question the efficacy of the 8.5 percent rate. State lawmakers dropped it to a more cautious 8 percent starting in fiscal year 2013, which ended June 30. But the rate is scheduled to revert to 8.5 percent after five years.

At a Wednesday hearing of the LCPR, officials from the three pension plans – the Teachers Retirement Association (TRA), the Public Employees Retirement Association (PERA) and the Minnesota State Retirement System (MSRS) — provided information about the implications of permanently dropping to 8 percent.

Lower rates, higher liabilities

One thing is certain: Projecting a lower rate of return causes long-range unfunded liabilities to grow. That growing gap was borne out by the figures shared Wednesday by the executive directors of the three pension plans. MSRS would see another $469 million in unfunded liabilities added to the $1.9 million it reported on July 1, 2012. (The actuarial data for the 2013 fiscal year, which is expected to be better than the 2012 figures, isn’t yet available.) The drop to 8 percent would make MSRS 79 percent funded, down from 83 percent funded. To cover that increased liability, employer and employee payroll contributions would need to rise by 1.7 percent.

PERA would see a $723 million spike in its unfunded liability based on the 2012 actuarial numbers. The general plan would go from 73 percent funded to 71 percent funded, and contributions would need to be increased by 1.5 percent to make up for the gap.

The biggest impact would fall on TRA. The move to 8 percent would add $1 billion to the $6.8 billion in unfunded liabilities that are projected by TRA’s actuarial firm for the 2013 fiscal year. (TRA’s 2013 estimate shows $16.8 billion in assets and $23.6 billion in accrued liabilities.) TRA would go from being 71.3 percent funded to 68.4 percent funded, forcing an increase in contributions of 2.5 percent.

Rep. Mike Benson, R-Rochester, who serves on the LCPR, is among legislators who view the 8.5 percent rate as a thing of the past. In his view, it should be dropped to 7.5 percent. But he predicted the move would face opposition from the DFL majorities in the Legislature.

“I don’t think you can keep it at the status quo,” Benson said. “And for the people who run these pensions and, I think, the majority party here, even moving it to 8 percent is going to be a chore. But as conservatives, we think we need to do that.”

LCPR chair Sen. Sandy Pappas, DFL-St. Paul, said she hopes the commission finishes its legislative recommendations by January. She said it’s uncertain what sort of policy changes, if any, will materialize on the assumed rate of return.

“I think it’s worthy of thoughtful consideration,” Pappas said. “I can’t say I’ve made up my mind yet. … Are we being too optimistic with our rate of return? Is there a new normal? Can we afford to assume that it is going to smooth out over 30 years?”

Long-term yield has been 10 percent

Laurie Fiori Hacking, the executive director of TRA, has cautioned against large-scale changes to the rate. She said that since 1980, Minnesota’s pension investments have produced a 10-percent return, compounded on an annual basis. She said the pension liabilities are best handled through annual attention to plan provisions, such as adjusting contribution rates and retiree benefits.

“Unless you really think we’ve had a major hiccup or change in the economic foundation, I don’t think it’s reasonable to say we’re going to fall way beyond that in the future. We’re assuming 8 and 8.5 percent, but we’ve been getting 10 over the long haul,” Hacking said.

The prospect of deepening liabilities due to a lower rate of return is a major issue for retirees. The reason is tied to legislation passed in 2010 that took several steps to put the three pension plans on a stronger financial footing. One of the provisions involved reducing the annual increases in retiree benefits and disallowing increases until the plans reach certain funding levels. The 1 percent annual benefit increase for PERA members, for example, can’t go up until the plan becomes 90 percent funded. Prior to 2010, PERA members received annual 2.5 percent increases.

While the rate of return issue is in the formative stages as far as the 2014 legislative session is concerned, there appears to be significant progress on consolidating the significantly underfunded pensions for Duluth and St. Paul teachers, which are among the few remaining local school pensions that aren’t in TRA. The pension bill passed this year called for TRA and the Duluth and St. Paul pensions to investigate consolidation, as St. Paul is 62 percent funded and Duluth is 63 percent funded.

Jay Stoffel, executive director of the Duluth Teachers’ Retirement Fund Association, said his organization’s board is doing extensive study of the issue. “From the Duluth perspective, we are definitely leaning in the direction of merging with the TRA,” Stoffel said. “There are a couple of major challenges, one of them being the demographic issue.”

But before the consolidation happens, policymakers will need to decide how the ailing pensions get absorbed and what the effect will be on the larger TRA fund. Among the issues to be resolved are how the consolidated funds become fully funded, and whether TRA members subsidize the merged funds.


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