Pay attention retirees: Unrealistic decisions by the state could hurt Florida pensioners

american dollars
American dollars. Credit: WIkimedia Commons

The Florida Retirement System Actuarial Assumption Conference will meet this month. The room will not be crowded.

But the decisions the financial analysts on the committee make will be critical to the more than 1 million public workers in Florida who rely – or will rely – on the state pension system for their retirement benefits.

A key decision by the panel will involve the $160 billion-plus pension fund’s “assumed rate of return” during the next budget year, which begins July 1.

Ash Williams, head of the State Board of Administration, which oversees the pension fund, describes that decision as “an unexciting, highly arcane issue.” But he also told Gov. Ron DeSantis and Cabinet members last month: “It’s an important issue.”

The crux of the matter is this: Independent financial analysts have been warning the state for several years that the pension’s fund assumed annual rate of return – which is now 7.4 percent – is too high.

If that rate is unrealistic, it may mean the pension fund, in the long term, could come up short when paying benefits to retired teachers, county workers, state workers, university personnel, and other public workers who rely on the state pension system.

In a report to the pension fund’s Investment Advisory Council last month, an independent consulting firm said that, as of July 1, 2018, the fund could pay 83.9 percent of its future retirement obligations, leaving a long-term, so-called unfunded liability in the range of $30 billion.

But that unfunded liability estimate is based on the assumed 7.4 percent annual rate of return for the pension fund.

If that number is too high – as analysts suggest – the unfunded liability could be much higher, leading to a more heavily underfunded retirement system in the future.

In a Sept. 16 memorandum to DeSantis, Attorney General Ashley Moody and Chief Financial Officer Jimmy Patronis, who together oversee the State Board of Administration, the chairman of the Investment Advisory Council raised concerns over the 7.4 percent assumed return rate.

Bobby Jones noted that Aon Hewitt Investment Consulting had identified a 6.59 percent rate as a more “reasonable estimate of likely portfolio returns over the next 15 years.”

“The fact that this number is substantially below the 7.4 percent return assumption Florida currently uses to calculate pension contributions is troubling and should be addressed as soon as possible,” Jones said in the memo.

“Using an inflated actuarial investment return assumption effectively suppresses pension contributions in the short term, to the detriment of long-term soundness,” Jones wrote. “Given the long-term nature of pension liabilities and the power of financial compounding, today’s underfunding will be magnified dramatically over time.”

Williams, who also supports a reduction in the fund’s assumed rate of return, told DeSantis and the Cabinet members that the rate has been “a number of some conjecture in recent years.”

He said the advisory council’s concern has been heightened by market conditions, with interest rates on bonds at historic lows and with a stock market that might be near its peak.

“So, the expectation for equities to continue rising at the rate they have over the past 10 years is diminished and the likelihood of bond returns going up dramatically, not great, either,” Williams said. “Between the two, the sense is the more prudent course is to reduce that return assumption.”

Williams noted that before the Great Recession in 2008-09, the Florida retirement system was over-funded, at about 107 percent, heading into the economic downturn.

Now, with uncertainty in the financial markets, Florida would have to deal with any major downturns with a pension funding level of around 84 percent.

“Think where we are at this time,” Williams told DeSantis and the Cabinet members. “If we hit another major air pocket in the markets, we don’t have anywhere near that cushion of over-funding and, by virtue of being in this downtrend, we’re on risky ground.”

The easy fix would be for the state to reduce the assumed rate of return for the pension fund. But that comes with a costly catch. It would mean Florida counties, school districts, the state government, and other pension participants would have to increase their annual contributions.

The larger the reduction, the greater the cost to those state and local government budgets.

For instance, last year the actuarial conference recommended a reduction in the rate to 7.4 percent, down from 7.5 percent.

The 2019 Legislature adopted that rate. But it will cost those state and local governments some $123 million this year in additional contribution costs to the pension fund.

Cutting the rate from 7.4 percent to the recommended 6.59 percent could cost those governments something in the range of $1 billion – which analysts don’t consider a realistic budget move in one year.

Florida is not alone in facing a long-term pension funding challenge, according to a June report from The Pew Charitable Trusts.

“After nine years of revenue growth and strong investment performance, the pension funding gap – the difference between a retirement system’s assets and its liabilities – for all 50 states remains more than $1 trillion, and the disparity between well-funded public pension systems and those that are fiscally strained has never been greater,” the report said.

The Pew analysis, which was based on 2017 data, showed Florida with a 79.2 percent funding rate for its pension, compared to a 69 percent average for funds in all 50 states.

Florida was much healthier financially than some of the states facing severe funding challenges, such as Illinois (38.4 percent) and Kentucky (33.9 percent), according to Pew.

In his memo to state leaders, Jones, the head of the advisory council, said Florida can avoid those problems by addressing the rate issue quickly.

“Florida has a long history of prudent financial management and responsible pension funding, which has led to the state’s current triple A credit rating,” Jones wrote. “We respectfully recommend that this tradition be honored by using realistic, prudent inputs to the actuarial valuation process.”

In recent years, the actuarial conference has recommended annual incremental reductions in the assumed return rate for the pension fund. The rate has dropped from 7.75 percent in 2013 to its current 7.4 percent.

Jones said further reductions in the rate will have to be weighed against other budgetary priorities, but he noted that “larger moves up front will be rewarded and delay will be penalized.”

The 2020 Legislature, which begins its annual 60-day session in January, will ultimately decide what rate to adopt and how to fund it.

As of June 2018, about 643,000 active workers were participating in the Florida pension program, with some 416,000 retired workers relying on the benefits.

Teachers and school district employees represent nearly half of the active workers, followed by county workers at 23 percent and state workers at 20 percent.

Workers in the pension system annually contribute 3 percent of their salaries to the fund.

The Florida Phoenix provided an overview of the pension’s fund in this story.

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