Category Archives: Government workers and pensions

Unfunded Pension Liabilities a Benefits Problem, Not Just a Funding Problem

Source: Wirepoints, based on Pew Charitable Trust

In the analysis of unfunded state pension liabilities, there are two main components: assets and liabilities. Here in Virginia, most attention is focused on the asset side of the equation — how much money have state and local governments set aside to pay for retiree benefits, and how well is the Virginia Retirement System managing the pension portfolio? Less attention is given to the benefit side — how rapidly are the liabilities increasing?

Wirepoints, a group that provides research and commentary on Illinois’ economy and government, has published a research paper arguing that the Prairie State’s massive pension liabilities are not the result of insufficient funding — asset growth has increased at an annualized rate of 5.9% from 2003 to 2015 — but of runaway increases in pension benefits of 7.5% annually. The difference: a 2.6% gap.

Many other states, including Virginia, have experienced the same problem of mismatched growth rates for assets and liabilities, though not to the same degree. Over the same 12-year period, Virginia’s pension benefits increased at a compounded annual rate of 6.3% while its assets increased by 4.2% annually. The difference: a 2.1% gap.

A few years ago, the increase in pension liabilities became a concern. Under pension reforms enacted during the McDonnell administration, state employees hired in 2014 or after were enrolled in hybrid pension plans, which combine a defined benefit plan with a defined contribution plan and an option for voluntary contributions. In essence the new package shifted some risk for funding retirement benefits from the state to the employees.

Thanks to the bull market in equities, Virginia’s asset performance has been stronger the past few years, and presumably the shift to a hybrid pension system has dampened the growth rate in pension benefits (and will continue to do so over time). Wirepoints’ numbers, based upon Pew Charitable Trusts data, goes only to 2015. More recent numbers might show more favorable trend lines.

Bacon’s bottom line: Growth in pension liabilities is one of the Virginia Retirement System metrics we should be watching. The onus for ensuring that the Commonwealth meets its pension obligations should not fall solely upon taxpayers and VRS portfolio managers. The state needs to keep pension costs under control, too. Legislators should check periodically to see if the hybrid pension plan is working as advertised.

State Employees Not Funding Own Retirement

Source: VRS Report to JLARC

State and local employees, like many of their peers in the private sector, are declining in droves to contribute to their own retirement plans, despite the availability of matching funds, a.k.a. free money which compounds for decades.

The Virginia Retirement System has been putting new hires into a hybrid retirement plan that combines a defined benefit with a defined contribution plan which depends on employee contributions. More than 85,000 active workers are now part of the hybrid plan, but only 18 percent of those are socking away the maximum 4 percent of their pay, which is matched with another 2.5 percent by the state.

Of the rest, 42 percent are contributing nothing, and 36 percent are contributing  only one-half of one percent, or $50 per $10,000.  Most of those are apparently doing so because the state automatically escalated all contribution rates by one-half of one percent on January 1, 2017 and employees had to then intentionally opt out.

The information was part of the annual report on VRS to the Joint Legislative Audit and Review Commission Monday, covering all aspects of an operation vital to 700,000 participants or beneficiaries.  JLARC was presented with a brief oversight, a longer and more detailed overview, and the report of an outside actuary.

Since that first “automatic escalation” the participation has been dropping and it may continue to drop until a second auto-escalation is planned for 2020.  “Current low rates of voluntary contribution by hybrid plan members will result in lower retirement income,” the presentation slide states.   That’s a major understatement, but the hybrid plan and the low participation are saving the taxpayers a bundle in the short run and will save even more as the previous defined benefits plans fade away.

As of March 1, the overall year to date return was 9.9 percent, slightly behind the goal of 10.0.  No figure was given for the end of the fiscal year on June 30 and the last 90 days have been a trade fear-induced roller coaster.  The long-term return baked into VRS funding assumptions is 7 percent.  The five-year average has been 8.1 percent and the 25-year average 8.2, but as the saying goes, past results are not a guarantee.

The charts tracking the funding status of the various individual retirement plans were all inching up and the average overall is now about 77 percent.  Under current assumptions it will take 26 more years to get back to 100 percent funded, where the state was as recently as 2002.  The key phrase there is “current assumptions.”

“VRS is actuarially sound” concluded Lance Weiss of Gabriel, Roeder, Smith and Co. (GRS), the outside auditor.  He praised Virginia for setting that 7 percent target return a few years back, but then reported it is no longer a conservative assumption but merely a reasonable one.  Many of their clients are moving to 6.75 percent, he said.  A figure below 6.5 percent was hinted at.  With an aging workforce looking at starting benefits in the short term, there is even more reason for Virginia to rethink that 7 percent assumption on return.

The assumption on return is what drives the size of employer contributions.  In another report it was noted that if the two largest funds, those for teachers and for general state employees, moved to a 6.75 percent “discount rate” the state would need to increase its annual contribution by $182 million.  Changing that assumption also drives up the unfunded liability on both funds and pushes the 100 percent funded goal further out.

The reports today were merely accepted, with few hard (or easy) questions. It may take a longer period of market uneasiness to undermine the current return assumptions, but House Appropriations Chairman S. Chris Jones told reporters after the meeting he would consider it.

Senate Finance Co-Chair Thomas Norment did ask out loud if the hybrid plan was “worth keeping” but the question received no response.  The defined benefit plan is gone and unless participation patterns change future VRS retirees (86 percent of whom remain in Virginia) will not have the same comfortable income as current retirees.

State Pension Problems Still Getting Worse

Map credit: Pew Charitable Trusts

Another year, and another analysis by the Pew Charitable Trusts on the deteriorating condition of U.S. states’ public employee pension plans. Drawing on data from 2016, Pew concludes that despite scattered actions by the 50 states to shore up their pensions, the funding gap only got worse.

In 2016, the state pension funds in this study cumulatively reported a $1.4 trillion deficit—representing a $295 billion jump from 2015 and the 15th annual increase in pension debt since 2000. Overall, state plans disclosed assets of just $2.6 trillion to cover total pension liabilities of $4 trillion.

There is considerable variability between the states, however. The funding ratio (assets as a percentage of liabilities) ranges from 99% for Wisconsin, which is in fine shape, to 31% for Kentucky and New Jersey, which are in deep doo-doo. The national average is 66%. Virginia is in modestly better condition than the national average with a funding ratio of 72%. Our net pension liability in 2016 was “only” $25.3 billion.

Admittedly, 2016 was a tough year in which state pension plans generated a mere 1% return on their investments, significantly short of the 7% to 7.5% returns that most plans are predicated upon. (Virginia assumes a 7% return.) Investment performance shined last year, which could improve 2017 performance when Pew gets around to calculating it a year from now.

However, investment returns are likely to become more volatile, Pew notes. As the gap between the return on 30-year Treasury bonds and equity returns has widened over the past two decades, pensions have shifted assets to riskier investments in the hope of generating a bigger payback.

The share of public funds’ investments in stocks, private equity, and other risky assets has increased by over 30 percentage points since 1990—to over 70 percent of the portfolio of state pension plans. As a result, pension plan investment performance now tracks equity returns more closely than bond returns.

That’s great news when the stock market goes up, as it did last year. But when interest rates rise and market multiples shrink, as is happening this year, pension funds are vulnerable to setbacks in stocks, private equities, and interest-sensitive real estate investments.

Pew has developed a set of analytical tools that allow a more penetrating look at a state’s pension posture. One of those is “net amortization as a percentage of payroll for each state.”

There are two ways for states to increase the assets in their pension plans. One is to earn a higher rate of return on its investment portfolio. The other is to contribute more (in employee contributions and government contributions) into the plan.

With the “net amortization” metric, Pew assumes that the pension plan earns the assumed rate of return (even though that assumption isn’t always justified). The idea is to determine whether state/employee contributions are putting in enough to cover new benefits earned that year. States the study: “Plans that consistently fall short of this benchmark can expect to see the gap between the liability for promised benefits and available funds grow over time.”

Some states are doing a horrible job — Kentucky, New Jersey, and Illinois are ticking time bombs. Kentucky paid in only 41% of its benchmark in 2016, and New Jersey only 33%. The national average was 88%. Virginia looked pretty good by comparison, paying in 101% and whittling down its net liability by one whole percentage point! Continue reading

Bacon Bits: Film Flam, State Workers, Fun & Games with Chicago Debt

Yummmm. So tasty.

Film incentives a money loser for state. Incentives for producing films in Virginia doubled under the McAuliffe administration, reaching $14.3 million in 2015-2016 and totaling $43 million over five fiscal years. But Virginia’s film industry has returned about 20 cents for every dollar it received in tax credits and 30 cents for every dollar in grants over the five-year study period, according to testimony yesterday before the Joint Legislative Audit and Review Commission (JLARC). Legislative auditors concluded that 95% of the productions would not have been filmed in the state were it not for the credits, reports the Richmond Times-Dispatch.

State employment compensation needs reform. Compensation for the state’s 105,000 employees is “nearly equivalent in value” to that of private-sector employees in Virginia. Although salaries lag the private sector by about 10%, the state makes up the difference with generous health insurance policies. The compensation package does have challenges, however, hiring employees in the fields of health care, health and safety inspection, public safety, and information technology, finds a new JLARC report. “State employee salaries could be more strategically managed if they were … prioritized for jobs that exhibit the most pressing workforce challenges.”

Boomergeddon watch: Chicago. Despite $36 billion in public pension debt, a prospect of $550 million in budget deficits over the next three years, and a reliance upon the state of Illinois, the budget of which also is in a shambles, Chicago just issued a AAA-rated bond. How is this possible? Chalk it up to creative financial engineering. The city is selling off its right to receive sales-tax revenue from Illinois to a separate public corporation, which will issue new bonds backed by those funds. This securitization insulates bondholders from the city’s finances. Chicago is using the proceeds to pay off old, higher-coupon paper, so it will ease its interest burden for a while. However, writes financial blogger John Rubino, “since [the city] runs a chronic deficit, it will soon be back in the market to borrow more, at which point it will have to pay up – since those AAA bonds are siphoning off so much money. Then the downward spiral will resume, with no more tricks available to delay the inevitable.”

VRS Earned Above-Average Return in Fiscal 2017

A welcome piece of good news from state government: The Virginia Retirement System earned an 11.8% return on investment for the fiscal year ending June 30. The performance exceeded the 7% average return the system assumes for purposes of setting state and local contributions, and it is a big improvement from the previous two years. VRS assets now stand at a historic high of $74 billion, reports the Richmond Times-Dispatch.

Those numbers came from Del. Robert D. Orrock Sr., R-Caroline, after a semiannual meeting of the Joint Legislative Audit and Review Commission (JLARC) yesterday. The T-D article did not break down the overall VRS performance by investment category.

According to a March 31 VRS performance summary dated March 2017, investment returns over the first three quarters of the fiscal year were led by a strong performance of the pension fund’s equity portfolio, but most other investment categories did well, too:

Public equities — +13.2%
Investment-grade fixed income — -1.1%
Credit strategies — +8.0%
Real assets — +8.0%
Private equity — +12.2%
Strategic opportunities portfolio — +8.1%

The above-average performance may forestall the perceived need to undertake any additional reforms of the state pension fund or for state and local governments to increase their contributions. A year ago, VRS unfunded liabilities were pegged around $22 billion. The big question now: Can VRS replicate the performance next year? Can U.S. and global stock market averages continue their levitating act?

UVa Attacks Administrative Bloat in HR Consolidation

The University of Virginia has downsized its Human Resources staff from 270 employees to 240, and could slim down by another 40 full-time-equivalent positions as it merges the HR departments of its academic and medical divisions, reports the Daily Progress.

The staff restructuring project, which UVa calls UFirst, is part of the university’s multi-year Cornerstone Plan, passed by the Board of Visitors in 2013, to save money on organizational costs. The current system is afflicted with “systemic inefficiencies and redundancies,” including “70+ disjointed systems that collect HR data and five different learning management systems across three entities,” states the UFirst website devoted to the new HR system.

UFirst is designed to cut down on bureaucratic waste and lead to a better employee experience. “UVa will be positioned to continue to attract and retain the best talent in support of excellence in education, research, patient care and public service,” UVa spokesman Anthony de Bruyn told the Daily Progress.

The university has experienced some pushback on the changes, as evidenced by an anonymous letter to the Charlottesville newspaper signed by “A dedicated and concerned UVa employee.”

The employee claimed that the senior university officials have not kept affected employees in the loop about the latest round of changes, reports the Daily Progress. “This is not the way people should be treated,” the employee wrote. “I have always been very proud of working at UVa and can’t believe we are being treated with such disrespect.”

De Bruyn says the university has posted information on the UFirst website and is holding informational meetings this month.

Bacon’s bottom line: Good for UVa! It’s possible that the university could do a better job of communicating with employees. But, let’s face it, when departments are consolidated, employees lose their jobs, and other people find themselves reporting to new bosses, it’s impossible to make everyone happy. The larger lesson here is that UVa, at long last, is taking concrete action to reduce the size of its burgeoning bureaucracy. A 26% reduction in H.R. manpower is serious business.

Indeed, UVa could be criticized for taking so long to execute the change. Higher-ed restructuring legislation enacted 12 years ago emancipated UVa from rigid adherence to state personnel policies, and the university announced its intention years ago to wring out savings through process and administrative reforms. By private-sector standards, the changes have been sluggish. But this a public university, so we should be happy to see reform of any kind. Hopefully, the administration won’t be spooked by the publicity and will carry through forthrightly.

Virginia Commonwealth University, it is worth noting, just received Board of Visitors approval for major HR reforms as well. As taxpayers and parents of students, let us hope these HR reforms portend even more serious attacks on administrative bloat in the years ahead.

Virginia Pension Liability Gap: Still Worrisome

Graphic credit: Pew Charitable Trusts

Another year of tepid economic growth and another year of no progress on Virginia pension liabilities.

Nationally, the gap between liabilities and assets for state pension systems grew 17% in fiscal 2015, reaching $1.1 trillion, according to an annual survey by the Pew Charitable Trusts. Under-performing investments was the biggest driver, accounting for $125 billion of the gap. But even if investment performance had lived up to expectations, the national gap would have increased $30 billion anyway.

Virginia, which prides itself on its AAA bond rating, is hardly an example of fiscal rectitude compared to other states when it comes to funding its state and local pensions. On the one hand, the Virginia Retirement System (VRS) assumes a modest 7% compounded growth rate for its investment portfolio, while state pension plans on average assume a 7.6% annual return. Virginia’s conservative assumption protects it against the downside risk of disappointing investment returns.

On the other hand, Virginia has not been injecting as much money into the pension as needed. Pew has constructed a measure — net amortization — that tracks whether public pension contributions would have been sufficient to reduce unfunded liabilities had portfolio returns met investment assumptions that year. Explains Pew: “Plans that consistently fall short of this benchmark can expect to see the gap between the liability for promised benefits and available funds grow over time.”

According to Pew’s calculations, Virginia needs to contribute $2.5 billion a year. In 2015, the state did meet that goal — actually, it exceeded the goal by 1%. But 2015 followed a dismal shortfall (visible in the chart above) in 2014.

Virginia’s “funded ratio” was 75% in 2015, about the same as the previous year. That is marginally better than the 72% for the funded ratio of the nation as a whole. Of course, that national figure is skewed by the horrendously low ratios of Kentucky, Illinois and New Jersey, which are more or less destined by the iron law of mathematics to become the next Puerto Rico.

Virginia needs to do better. At the current level of state contributions, the VRS is at the mercy of the markets to perform as expected. If we’re lucky and maintain contributions, things will work out. If not, we’re in for a world of hurt.

What the Obama Giveth, the Trump Taketh Away

Slash and burn

The federal budget sequestration may have kept a lid on escalating federal budget deficits, a good thing, but it was a disaster for Virginia’s economy. The cap on federal spending hammered a Northern Virginia economy built largely around the Pentagon. The ascension of Donald Trump to the presidency signaled a possible return to the region’s glory days as the new president promised to increase defense spending by $50 billion.

But the president has created massive uncertainty with a vow to slash discretionary spending in civilian programs and bureaucracies. The Washington Post is all in a dither:

The cuts Trump plans to propose this week are also expected to lead to layoffs among federal workers, changes that would be felt sharply in the Washington area. According to an economic analysis by Mark Zandi, chief economist for Moody’s Analytics, the reductions outlined so far by Trump’s advisers would reduce employment in the region by 1.8 percent and personal income by 3.5 percent, and lower home prices by 1.9 percent. …

Trump’s emphasis on defense spending might provide a buffer for Northern Virginia, although, as noted previously on this blog, there are some within his administration who believe that the Pentagon civilian bureaucracy needs to be whacked down to size in order to free more resources for fighting forces. Under a serious effort to rebuild the U.S. Navy, Hampton Roads’ military bases and shipbuilders could be big beneficiaries.

We can’t say anything with certainty until Trump releases the details of his plans later this week. But at this moment in time, it looks like the new budgetary policies could be a mild plus for Virginia with boosts in defense spending offsetting cuts in other areas. Conversely, Maryland and Washington, D.C., with their large non-military exposure, could be in for a world of hurt

Adding to Washington’s woes…. The metro area’s job performance in 2016 has been revised downward. Reports the Washington Business Journal: “The D.C. region added 55,600 jobs in 2016, according to final data released Tuesday by the Bureau of Labor Statistics — about 16,800 fewer than the agency had initially counted.”

“We are talking slashing and burning several different agencies on the discretionary, non-defense side. That could have a pretty chilling effect for the local economy,” said Clifford Rossi, a professor of the practice at the Robert H. Smith School of Business at the University of Maryland-College Park.

Rossi agreed that the revised job growth numbers reveal an economy that was weaker than it originally appeared, and that the federal spending cuts proposed by Trump could have a compound effect on the regional economy.

Bacon’s bottom line: Actually, the loss of 1.8% employment and 3.5% income is no worse than what dozens of other metros experienced in the last recession. But have compassion! Washington has never been through anything like this before.

(Hat tip: Rob Whitfield)

The Biggest Lie of All: Government Can Pay Its Pensions

State-local pensions are just one aspect of unsustainable government spending.

State-local pensions are just one aspect of unsustainable government spending.

Many people get infuriated by President Trump’s many inconsequential falsehoods — does it really matter how big his inaugural crowds were? — but they remain sanguine about the trillion-dollar untruths that our public pension system is built upon. The big lie that governments will make good on retirement promises to their employees is not merely mendacious but it is destructive. Millions of Americans have built their retirement plans around a fiction. And when the Ponzi scheme collapses, government workers won’t be the only ones to suffer.

In his latest column, George Will recites some of the more glaring examples of how the big lie is unraveling.

The Dallas police and fire fund recently sought a $1.1 billion transfusion, a sum roughly equal to the city’s entire general fund budget yet still not close to what is needed. Last year Illinois reduced its expected return on its teacher retirement fund portfolio from 7.5% annually to 7% (which is arguably still too optimistic), meaning that the state needs to add $400 million to $500 more to the fund — annually. Last September, the vice chair of the agency in charge of Oregon’s pension system wept when speaking about the state’s unfunded pension promises of $22 billion. Nationally, unfunded liabilities for teachers, not counting other government employees, amount to at least $500 billion.

And don’t get me started on the fact that the Medicare hospital trust fund is expected to run out in only 12 years and Social Security trust fund in 16 years, at which point payroll tax revenues will be insufficient to maintain full benefits… Or the fact that the pensions run by companies in the S&P 1500 Index were unfunded to the tune of $562 billion.

Some of the shortfall can be attributed to absurdly generous provisions of pension plans in particular states and localities, some to fiscal indiscipline by government at all levels, and some to the Fed’s seven years of near-zero interest-rate policies that have depressed returns on bond portfolios and juiced stock market gains that cannot possibly be replicated in the years ahead.

Will concludes with the salient point:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

Few elected officials are willing to deal with the issue that offers no immediate political reward. Here in Virginia, one of the few, House Speaker William J. Howell, R-Stafford, has announced that he will not seek re-election.

Thanks in part to Howell’s stewardship, Virginia’s budget, backed by a AAA bond rating, is in better shape than those of many other states. But the U.S. learned after the 2007 real estate crash what AAA bond ratings are worth when the economy shifts from normal conditions to crisis conditions. Boomergeddon is coming. The only question is when.

Thinking Sensibly about Virginia State Police Salaries

Lawmakers proposes big increase for Virginia State Police salaries.

Virginia State Police graduates. Lawmakers propose a big increase in starting salaries. Photo credit: InsideNova.com.

Virginia State Police troopers would receive a $7,000 pay raise — a 22.3% boost for starting salaries — under a budget proposal that also would provide a 3% pay raise for all state employees, reports the Richmond Times-Dispatch. The dramatic pay hike comes in response to deteriorating morale and a surge in state trooper departures.

Is such a big pay raise justified in the midst of a budget crunch in which lawmakers are forced to cut other programs?

Clearly, the state police have a massive problem. In November, the agency had 257 vacancies in a sworn force of 2,148, according to the Daily Press. Over the past few years, the state police averaged six departures monthly, reports the T-D. That number increased to 13 per month in last year and shot up to 22 in just the first 20 days of 2017.

By my back-of-the-envelope calculations, paying 2,150 officers an extra $7,000 each will cost the state about $15 million per year. That is a considerable sum. However, if the pay increase staunches the loss of manpower, it will be offset by a reduced training costs. The Times-Dispatch article notes that it costs the City of Richmond about $100,000 to get a recruit trained and on the street. Assuming that the cost to the state police is roughly comparable, and assuming the pay hike reduces the number of departures back to the pre-crisis norm of six per month, the state police will need to train 80 to 90 fewer troopers each year. That would represent a savings of $8 million to $9 million. (I have made several assumptions here, which undoubtedly can be refined, but you get the gist.)

Thus, while the $15 million departmental pay raise will not fully pay for itself through reduced turnover, the adjusted cost when taking training expenses into account will be considerably lower.

Are there other ways to offset the expense? Presumably, some state police functions are more critical than others, and some offer more law enforcement bang for the buck than others. Could the troopers be relieved of low value-added tasks that soak up manpower?

For example, lawmakers enacted a policy last year as part of a bipartisan compromise on gun control, in which state police conduct background checks at gun shows. Implementing that policy cost $300,000 annually to pay for three full-time civilian positions, as the Times-Dispatch reports here. In its first six months, the program resulted in only one person being denied the purchase of a weapon at 41 Virginia gun shows. The man was wanted for failing to appear before a grand jury in September. Was that one detention worth $300,000?

Six months may not be sufficient time to fairly judge the effectiveness of the program. But that’s the kind of question we need to be asking. Instead of stroking the state police a $15 million check, legislators should ask the top brass to enumerate all the tasks state troopers are called upon to perform. How much manpower do those jobs require? What value do they provide? Can we reduce the number of troopers on payroll without harming public safety?

It seems clear that we need to increase Virginia State Police salaries, and equally clear that the state will recoup some of that expense through reduced training expenditures. However, we should not assume that the only way to pay for higher salaries is to pump more money into the agency. Perhaps we can scale back tasks of marginal value. Unfortunately, I see no indication in the news coverage of this issue that anyone has even considered that alternative.