Rhode Island’s Pension Problem

Rhode Island has a pension fund problem.  This shouldn’t come as a surprise to educated readers – many states will be facing similar problems over the next decade or generation.

“In most places, as in Rhode Island, the big issue is pensions. By conventional measures, state and local pensions nationwide now face a combined shortfall of about $3 trillion. Officials argue that, by their accounting, the total is far less. But with pensions, hope often triumphs over experience. Until this year, Rhode Island calculated its pension numbers by assuming that its various funds would post an average annual return on their investments of 8.25 percent; the real number for the last decade is about 2.4 percent. A phrase that gets thrown around here, à la Rick Perry describing Social Security, is “Ponzi scheme.” “

I’ve written about this topic before.  The return assumptions for pension funds are, quite simply, too high. I don’t want to get into the “untouchables” debate about what we should do with the benefits of current pensioners, but there is something that every pension fund in the country should be doing to lessen this problem going forward:  LOWER THEIR RETURN ASSUMPTIONS TO MORE REALISTIC NUMBERS.

Rhode Island actually did just that:

“Analysts also took a close look at the projected long-term investment return for the pension system: 8.25 percent. Everything rested on hitting that target, but the state’s actuary said there was less than a 30 percent chance that would happen over the next 20 years. The board voted to lower the assumption to 7.5 percent. (Given the recent run in the financial markets, even that figure may seem optimistic.) “

Is there a reader out there who wouldn’t like a 7.5% guaranteed return over the next 30 years?    Sign me up.    (As I write this, the US 30 Year Treasury bond yields 3.26%.)

Of course, REALITY is politically unpopular:

“As a result of that change, the state’s pension shortfall instantly rose to $9 billion from $7 billion. The unions said Ms. Raimondo had manufactured a crisis.

She denied it. “This is about the truth,” she said, “and about doing the right thing.””

It’s not “manufacturing a crisis” – make no mistake – the crisis is already here.  The “crisis” arises from guarantees that were made based on over-optimistic assumptions.   This is about trying to prevent the crisis from getting worse for the next generation of new workers – about NOT propagating this mistake.

Lower the return assumptions (which will of course result in other changes: higher contributions from workers, longer careers,  or lower benefits), fix the system going forward, and then we can have the even harder debate about how to solve the current dilemma of States not having the funds to pay current benefits.

-KD

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