There has been much talk about the looming crisis in the public employee retirement systems nationwide. Well- maybe saying that there is "much" talk is an overstatement- there has been precious little on the part of the governments involved. Most of what we hear on the subject is coming from lone "voices in the wilderness" writing in various newspapers and magazines. To discover a politician warning of the coming financial crackup of these retirement systems would be a find indeed. At the local levels of government, we see the problem firsthand, as the amounts of money needed to pay into the system have sharply spiked upward.
A regular ‘Grok reader forwarded the following piece on the retirement issue as it relates to us here in NH. It was written by Mike Murray who has given permission to share it here on the blog…
Little attention has been paid to the New Hampshire Retirement System, the 4.5 billion dollar public pension system on which fireman, policemen, teachers and municipal workers depend for retirement income. When Governor Benson was in Concord he tried to reform the system but was ignored. Many times over the last 5 years I have wondered when the obvious problems with the pension system would come home to roost..Only about 2/3rds of the present value of the promises made to public employees have been met. The story is one of human error, bad judgment, hubris, arrogance and ignorance. In short, the problems with the pension system start with very poor assumptions about return expectations that any prudent person would know are too high. From there the contributions from employees are too small, particularly when compared to the contribution rates that private investors are taught are adequate in their own un-guaranteed plans. Return assumptions should be lower and contributions higher..The fees the NHRS has paid its investment managers over the years are excessive. Here are the fees other pensions have paid, using 2002 as an example (as a percentage of net assets):
• NH: .70 percent
• WV: .20 percent
• MT: .10 percent
• NE: .20 percent.
It’s also important to note that during this year each of the above paid much less and got higher returns..This might not sound like much until going over an actual example. Say the 4.5 billion dollar fund pays .65 percent (as NH did in 2002), or about 30 million dollars per year as investment fees. Ok, so what that this is .40% too much? Nebraska would have paid 9 million per year. That’s almost 20 million per year less. Well, over 20 years this equals a simple figure of 400 million dollars. This is a simplistic analysis and does not take into account the growth of the fund over time, but certainly if the NHRS had been paying what other like pensions were paying the problem today would be much smaller. Why has the NHRS continuously paid so much in extra fees?
We don’t know because they refuse to answer this, although the latest scandal at the NHRS has forced them to address the fee issue. Two simple things that would have gone far in reducing fees would be to demand fees comparable to the rest of the market and to use passive investments for asset classes where doing so is as good as paying managers. Abundant evidence indicates this works..Fees are not the only answer, of course. When a pension figures how it needs to invest the money of its beneficiaries they start with some assumptions. When will people retire? How much have we guaranteed them in retirement? How much do we have now? What will we add, and what will they add? What return must we get to make this all work? Simple future value math, but little mistakes add up. The NHRS has used very optimistic return assumptions and excessively small contribution demands on employees, and now there is a problem..Using optimistic expectations is a common enough mistake but should not be made by professionals. The employee contribution issue is more complex. Workers in the public sector make more money, on average, than the private sector. The benefits that go along with this relatively lavish compensation are also much better. It’s very rare for pensions to exist that are as generous as those enjoyed by public workers. Negotiating higher employee retirement fund contributions is a political game that few “leaders” have been willing to play, for short-sighted reasons..Other pensions and institutions with future obligations have adjusted return assumptions and contribution limits over time and have controlled the funding gap. NHRS failed to do this and now wants to go to taxpayers for the difference. So a public pension system that represents the interests of public employees that make more compensation and benefits than the private sector (which supports the whole concept through taxes) mismanages a colossal pension fund and then goes back to its financial supporters for more. Not surprising, but a crisis in the making..The NHRS must appoint board members who understand capital markets, simple future value math and that have other necessary qualifications now that its been proven that the politically appointed boards and “friend of a friend” consultants don’t have the wherewithal to handle money linked to all taxpayers in the state. The risk of a failing pension system cannot be ignored..Mike Murray
(Hat Tip Bill A. of Dover)