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State pension system needs serious reforms

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opinion Detroit Lakes, 56501
Detroit Lakes Minnesota 511 Washington Avenue 56501

The Center of the American Experiment recently released our “Pension Chapter of the Minnesota Policy Blueprint.” It says Minnesota’s public employee pension system reports unfunded liabilities estimated at $17.3 billion and calls for reforms.

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The response from leaders of the state pension plans was swift. They issued a news release reporting what sounds like very good news about the health of the pension funds: the unfunded liability has dropped from $17.3 billion to less than $10 billion. This news is based on preliminary numbers following a reported 18.6 percent return on investment by the State Board of Investment.

Who knew? Well, we actually thought we might see a change in the numbers, but we just did not know what it would be.

Here is some background: The Pension Chapter reported an unfunded liability of $17.3 billion, which comes from the state’s 2013 actuarial valuation report — the main source of pension data for the public.

When I called the spokesperson for a link to public data showing the new $10 billion unfunded liability, I was told that the numbers are preliminary and that the data would not be available to the public until December or January.

We were told that the numbers, however, were expected to hold up.

I also was told the $10 billion unfunded liability was the market valuation,which can vary quite a bit from the actuarial valuation.

So we are talking apples and oranges in terms of data.

We do not know what the actuarial valuation is for 2014 so that we can compare it to the 2013 numbers.

Edward Burek, deputy director of Minnesota’s Legislative Commission on Pensions and Retirement, told the Star Tribune he thinks the plans are underfunded only by about $10 billion and that the commission and the Legislature have been dealing with the underfunding seriously for several years. He cited reforms made in 2010 to help shore up the balance sheet.

“This is really getting to be a nonissue,” Burek told the newspaper. “Let those steps work their way through and let the markets do what they’re going to do to help fund these pension plans.”

While our center welcomes any improvement in the health of Minnesota’s defined benefit plans, and view this as great news, we think $10 billion is still a big number and do not agree that it is a “nonissue.”

As the center explained in the initial report, the state uses two unrealistic assumptions (among other objectionable actuarial/accounting practices) to calculate the unfunded liability. Those are an optimistic rate of return of 8.5 percent and an 8.5 percent discount rate to calculate future liabilities.

Pension experts have recently suggested both the assumed rate of return and the discount rates we use in Minnesota lead to inaccurate reporting — and therefore not enough funding.

In fact, if you calculate a $10 billion unfunded liability using more realistic discount rates (suggested by Minnesota’s state economist) it grows pretty quickly. A $10 billion unfunded liability would be:

  • $12.7 billion — the yield on municipal bond rate of 6.7 percent;
  • $14 billion — the yield on corporate bond rate of 6 percent;
  • $17.8 billion — the yield on 10-year Treasury bond rate of 4.3 percent.

We also note that the returns at the State Board of Investment are quite volatile. If you view returns going back to 1993, the chart resembles a formidable mountain range, with high peaks and low valleys that reveal an asset mix in search of a high average return of 8.5 percent.

The reported gain of 18.6 percent is great but what did SBI have to do to get there? We remind pension watchers that SBI lost more than 18 percent in 2009. Returns go up, and returns go down.

Minnesota’s public pension system needs serious reforms that keep the promise to retirees and current employees while updating the retirement system to meet the needs of today’s public workforce.

More importantly, the system needs to avoid a predictable fiscal crisis that will put school districts, and local and state government in the untenable position of choosing between funding past pension promises and delivering core services.

(This is the opinion of Kim Crockett, American Experiment’s chief operating officer, executive vice president and general counsel. The center’s report is available at http://bit.ly/1nrQzWw.)

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