Curb Your Enthusiasm

Minnesota pension reforms proposed this session, yet again, are necessary but insufficient

Last Sunday, the Editorial Board of the Star Tribune chimed in on the status of the omnibus pension bill, which is on its way to the House after passing 66-0 in the Senate.  In encouraging the House to give the bill “prompt, no-nonsense attention” the Strib listed several reasons why enthusiastic support is merited.

According to the Strib, among other features, this “robust” bill will “ensure financial stability and peace of mind to some 175,000 retirees today and many more in future years.”  It will “improve the fiscal health of state and local governments.”  It accomplishes all this in a way that is "favorable to taxpayers” – which according to the Strib is rather superfluous because “Minnesota taxpayers are already are getting a pension bargain."

It certainly appears the research and analysis behind this editorial involved swallowing pension interest group talking points with the enthusiasm of a largemouth bass hitting on a crankbait.

To be clear, the overarching message of the editorial is on target.  Minnesota lawmakers should act on this bill and – unlike last year – keep the political gamesmanship out of it.  But the over-the-top praise is not justified and the accompanying claims of the great things it will do are far more fiction than fact.

In reality, the substance of this bill is very similar to the sustainability fixes of past years – the primary difference being the market was not orbiting around all time highs when those previous repairs were enacted.  Temporary cuts in cost of living increases, phased-in contribution increases, new general fund aid appropriations, and a fresh 30 year amortization period to keep current costs down while giving the “on a path to full funding” claims the appearance of legitimacy on paper – it’s become rather routine stuff.

But in the big picture this bill fundamentally changes nothing and the “uncommonly wide support” it has is likely indicative of that truth.

Consider the signature, high profile achievement this year -- reducing the expected investment return assumption to 7.5% per year injecting greater conservatism into pension finance.  But when that expected return continues to be improperly used as a discount rate, liabilities grow at the same rate as investment expectations.  And when the pool of liabilities exceeds the pool of assets (like today), assets actually have to grow faster than expectations just to keep up with the liabilities.

As a very simplified example, let’s say a public pension fund has an 80% funding ratio, which means that it has assets equal to 80% of liabilities.  For greater simplicity, let’s say that plan has assets of $80 and liabilities of $100, and therefore an unfunded liability of $20 ($100-$80).  Because we employ expected investment returns as a discount rate, liabilities grow 7.5% per year.  As a result, those $100 in liabilities today will equal $107.50 a year from now, all else being equal.  For the unfunded liability to stay at $20 one year from now, that means assets have to grow from $80 to $87.50 ($107.50 - $87.50 = $20).  Which means that the pension fund needs to earn 9.3% ($80 times 1.093 = $87.50) just to tread water.  Anything less than 9.3% and the unfunded liability will grow, again all else being equal. 

That doesn't portend financial stability, peace of mind, or a taxpayer deal. Rather it's a recipe for more shared sacrifice.

In short, the incremental cost saving measures and new cash infusions in this bill, while real and beneficial to plan health, continue to be undermined by:

  • a continued unwillingness to come to grips with the true economic cost of these promises,
  • the ongoing creation of stealth unfunded liabilities through dubious accounting practices which can’t be found in any other area of public or private sector finance compounded with,
  • elevated risks associated with mature plans in which far more money goes out of plans than is contributed in

all of which together perpetuates an unacceptable and irresponsible transfer of both cost and risk to future citizens and public employees.

We appreciate the Star Tribune’s call to action on this topic.  Unfortunately, the actions being taken while necessary are insufficient and essentially guarantee this same editorial will have the opportunity to be recycled in the future.