As promised by Chairman Morrie Lanning, the pension commission (LCPR)  met last week to tackle the “big issues.” The quieter interim is a good time for members to study this complex subject. Now let’s see what the commission and legislature do with this opportunity for clarity.

On the Agenda: The pensions study ordered by the 2010 legislature, along with a look at the 8.5% assumed rate of return that the State Board of Investments is asked to earn. Next month, the LCPR is expected to face the draft GASB guidelines that will rock the pension ship like nothing else we have seen. (For more on GASB, see two articles by Girard Miller. “Get Ready for GASB” and “Investing in a Downturn”  )

Legislative Study: The study is a good example of how things work (or do not work) at the Capitol. The study sounded like a good idea but its reliability is in doubt and leaves at least some pension commission members (both GOP and DFL) looking for independent sources of information for where to go from here. Some members appeared content and even very defensive of the current system (again both GOP and DFL).

(The study design and exercise reminded me of my years as a city councilwoman. We used to joke that the staff viewed us as “temporary help”. Staff, which often holds key information, can patiently wait as the enthusiasm for change by elected officials slowly fades or gets bogged down. )

Rather than hire an independent consultant, the DFL dominated 2010 legislature directed the pension plans administrators (at TRA, PERA and MSRS) to evaluate plans that they guard more ferociously than a wet hen on her last egg. (Take a look at their websites; they have a strong point of view that is very protective of their members.)

The study concluded, among other things,  that a move away from the current defined benefit system (“DB”) in favor of a defined contribution system (“DC”) had high transition costs (we already knew that but we did not know how much and I am not sure we do now).

A draft of the study was released to the press last spring as if it was final, complete with a list of terribles (a DC might lead to increased elder poverty and public employees on public assistance and so forth, along with lots of editorializing about the virtues of the current system).  I am worried about elder poverty, too, as we are not good savers in part because we have become reliant on government. But how do you justify asking taxpayers to guarantee pension plans that pay 85% of pre-retirement income when those very same taxpayers are struggling to save and provide for their own retirement?

The study did not attempt to incorporate the public comments into the final draft (the public comments were not published along side the study which is standard practice). The study conclusions were weighted heavily in favor of sticking with the current defined benefit system (which is seriously underfunded and guaranteed by taxpayers).

An LCPR staff memo, along with public comments by the Minnesota Taxpayers Association (very readable for the average wonk with great policy insights) and Dr. Norman Ehrentreich (highly readable for actuaries and economists, again with great economic insights) and the Minnesota Free Market Institute, were critical of the report and/or the missed opportunities to fairly evaluate Minnesota’s approach to public pensions and policy alternatives.

The LCPR staff memo by Larry Martin, which was not presented to the commission members at the meeting, has been likened by one close observer to a “howitzer blast”.  Larry Martin is the talented and sometimes inscrutable executive director of the LCPR. He took the study to task in his usual even-handed manner.  As Minnesota pension geeks know, Martin’s  memos are famous for their rigor and also for “hiding” nuggets of gold in high pension-speak for those disciplined and patient enough to wade through the “Martinesque” attention to detail.

This is all good if the right people are reading them. We, therefore, urged the commission to read the Martin memo (if they had any lingering affection for the study) as well as the other public comments.

Where do we go from here?

There are several competing goals to keep in mind: public employees should enjoy a retirement plan that is competitive with the private sector and offers choices and control without creating too great a burden on state and local operating budgets or unreasonable taxpayer guarantees.

Important Testimony about Hybrid Plans by Mercer: In the context of discussing the high transition costs from a DB to a DC pension plan, the Mercer representatives testified that those high transition costs would be “mitigated” in a transition to a hybrid plan. That testimony was not reflected in the study. This is important because there is a great deal of interest in a hybrid system (and other states have moved in that direction ; here is an Issue Brief  from the Center for State and Local Government Excellence).   There was also testimony that the hybrid plans could be managed by the State Board of Investment. More on that in a later post.

Assumed Rate of Return:  the lengthy staff memo examining the 8.5% assumed rate of return was also not presented to the commission. Minnesota is one of several states that still assumes this high rate of return. If Minnesota lowers the rate of return, the rest of the actuarial assumptions must also change. It would put pressure on the system, for example, to raise the contribution by both the state and employees (or to change the system once the real costs were revealed). Contributions by the state (taxpayers) and employees (also taxpayers) already occurred under the 2010 Omnibus bill  so further increases would present a fiscal and political challenge.

Rep. King Banaian (R-St.Cloud) who is an economist at MnSCU, testified that we have enjoyed a sustained period where abnormally high returns were earned, which lulls us into thinking we can have them forever (see, long term asset Deutsche Bank study). We are now facing a period of very slow economic growth and cannot continue to expect an 8.5% rate.  Minnesota is at the top of the range of assumed rates; 8 is the median and mode, and prudence, according to Banaian, suggests we go to 7.5%.  (Or at least see what that more realistic assumption tells us about our current pension promises and our ability to meet them. More on that, also, in a later post.)

Howard Bicker, who runs the State Board of Investment (“SBI” a $61 Billion fund, about $50 Billion of which is pension money), acknowledged my reference to the news that the market had tanked (it dropped hundreds of point on the two days of testimony). Nonetheless, the pension plans once again reported “recovery” of their funds as of June 30, 2011. (I have called this a “Lullaby” in the past. It is not a lie but it is misleading.) Bicker, noting the cutoff date of June 30, told the commission that the next report on unfunded liabilities and SBI’s performance might not contain good news. (Here is the link to the asset allocation as of June 30, 2011.) He also called the draft changes to GASB “a real problem”. Indeed.

According to former GASB board member, Girard Miller, “Once the rules become final as expected, pension liabilities will be displayed on the balance sheet, and the “true cost” of pension benefits must be reported in the operating statement — even if the employer fails to make the necessary annual contributions. That true cost will be higher than most employers now pay.”

We’ll have to see what that means for Minnesota. Stay tuned.