What IS East Greenwich’s Pension Liability? Part 2

by | Sep 15, 2017

The ‘Rate of Return’ Misconnect

For those of you still with me on this journey into East Greenwich’s unfunded pension liability, this article tackles the vexing “rate of return” issue.

The first installment of “What IS East Greenwich’s Pension Liability?” covered what the state has projected is the town’s unfunded liability. To recap, the state pegs our unfunded pension liability at around $34 million. Add to that an unfunded OPEB (other post employment benefits – i.e. health care for retirees) liability of $11 million and you have a total unfunded liability of around $45 million.

But Town Council President Sue Cienki continues to defend her figure of an upwards of $86 million unfunded liability.

Why the difference?

While Cienki has not offered an exact breakdown of her number, she has said her number is based on a rate of investment return of 4.3 percent, which was the average rate of return on pension investments over the past 10 years. Alternatively, the state’s $34 million number was based on a 7.5 percent rate of return.

(The state lowered the rate of return to 7 percent this year, which will increase the unfunded liability – and the town’s required contribution – by a few hundred thousand dollars, but those exact figures are not yet available.)

How can the official rate of return be 7 percent if, over the past 10 years, the average rate was 4.3 percent?

According to Evan England of the state Treasurer’s office, the rate of return is calculated over what, over 30 years, the state can realistically expect as the average return.

The past 10 years included the financial crisis of 2008, where the state lost $2 billion, England said. Looking at the last five years, the average rate of return was 7.9 percent. It was 5.2 percent for the last three years (2016 was “flat,” said England). In fiscal year 2017 (which ended June 30, 2017), the rate of return was 11.6 percent.

“When we seek to set that [7 percent] rate, of course that becomes a target we want to hit every year, but there will be years we will be above it, there will be years we are below it,” England said. “There will be a lot of fluctuation year to year…. Last year’s exceeding 7 or 7.5 percent is certainly positive but really not consequential to adjusting our forecast.”

England said Rhode Island’s forecasted rate of return is similar to that of other states around the country and that it would only hurt communities and the state to inflate the rate of return, since it would cost more down the road to bridge the unfunded gap if the forecast was wrong.

“The goal there is to be as realistic as possible.”

– Elizabeth F. McNamara

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Eugene Quinn
Eugene Quinn
September 15, 2017 4:54 pm

Once again thank you for your diligence and professionalism.

David Caldwell
David Caldwell
September 16, 2017 3:40 am

Really fantastic. Thanks for getting all perspectives out on this – the state’s, Cienki’s, and the three-, five-, ten-, and thirty-year averages. That truly helps a reader make up her own mind, and helps me make up mine.

Brian Wu
Brian Wu
September 22, 2017 2:56 am

What’s realistic? That’s the $34M or $86M question.

Quoting from “Many Unhappy Returns” in The Economist, Nov 21, 2015: “Elroy Dimson, a professor at both the Cambridge and London Business Schools, is the co-author of a study of investment returns, covering 23 countries and more than a century of data. He thinks the likely future long-term real return on a balanced portfolio of equities and bonds will be 2-2.5%. AQR, a fund-management group, has come up with a remarkably similar figure, 2.4%, by assuming annual growth in dividends and profits of 1.5% for a portfolio priced at current valuations and split 60-40 between equities and bonds. It applied the same formula to valuations over the past century, and found that the current projected return is lower than at any time in the past (see chart). Assuming an inflation rate of 2%, such a real return equates to a nominal one of 4-4.5%, far short of the estimates used by pension funds and endowments.”

The average public pension plan assumed 7.6% as of 2015.

If you accept Dimson’s prediction, then meeting a 7% assumed rate of return requires a substantially more aggressive investment strategy (with higher risk), and that has been happening in state pension portfolios with the inclusion, for example, of hedge funds, which are like four-letter words to some people. Maybe 1% of assets should go into Powerball tickets.

Look at our country and around the world and the pessimists can be pardoned for seeing geopolitical, environmental and economic catastrophes ahead.

4.3% seems realistic to me. Then again, Rhode Island’s motto is “Hope.”

Barring a timely investment in tulips, our political process has to decide how (and when) the pain is going to be allocated. And this is where I think past performance is an indicator of future results. We’ve sucked at it before, and we’ll suck at it again. We don’t presently have the leadership in EG or the collective mindfulness and sense of shared sacrifice to avoid sucking.

Please prove me wrong.


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