In the above interview, Ian Hamilton, head of asset owners at State Street, talks about his research suggesting pension funds are looking to take on more risk to help close funding gaps.
Hamilton also touches on collaboration between pension funds and government on infrastructure projects.
Over at the STUMP blog, actuary Mary Pat Campbell dove into Chicago’s pension troubles and its “asset death spiral” in a recent post.
It is reprinted below.
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Public Pension Watch: How Screwed is Chicago?
SPOILER ALERT: a lot.
Let me point out some language from a recent official report:
Going forward, the Plan’s ability to meet its return objective over the long term will continue to be challenged as invested assets are liquidated to pay monthly benefits. During fiscal year 2013, $496.3 million or approximately 9.8% of the investment portfolio was liquidated to assist in meeting benefit payment obligations. [page 7]
…..
Plan Net Position Restricted for Pension Benefits, as reported in the Statements of Plan Net Position totaled $5,421.7 million, an increase of $239.0 million or 4.6 percent from the prior year. The growth in assets would have been significantly higher if approximately $496.3 million in portfolio assets were not liquidated to supplement the disbursement of benefit payments during the year. [page 14]
…..
Having a negative impact on asset values was the need to liquidate investments to pay benefits on a monthly basis. In all, MEABF liquidated $496.3 million of investments to meet the Plan’s cash flow needs. [page 18]
…..
The Actuary projects that under the current funding policy, if all future assumptions are realized, the funding ratio is projected to deteriorate until assets are depleted within about 10 to 15 years. The current statutory funding mechanism impacts the ability to grow assets because in order to pay benefits, assets have and will continue to be liquidated.[page 20]
…..
In other words, $496.3 million had to be liquidated from the investment portfolio in 2013 to cover the shortfall. Without sufficient contributions, annual funding deficits will grow and overwhelm the Plan over time. [page 56]
…..
The current statutory funding policy impacts the ability to achieve higher returns over the long-term because it is projected that assets may need to be liquidated in order to pay annual benefits. This could result in a change in the asset allocation in the future to more liquid assets with a lower return. We recommend that the funding policy and assumed investment return be reviewed every year. If the funding policy is not strengthened to an appropriate level within the next year, the current investment return assumption will not be supportable for financial reporting purposes. [page 90]
Ah, the asset death spiral.
This is from the Comprehensive Annual Financial Report of the Municipal Employees’ Annuity and Benefit Fund of Chicago for the fiscal year ending December 31, 2013 (and 2012, but that’s an item I don’t want to touch right now.)
Let me explain the asset death spiral, which is when balance sheet weakness manifests itself in something really serious: a lack of cash flow to cover promised benefits.
Having to liquidate assets to cover cash flows is not necessarily a bad sign — if one has a decreasing liability (which means decreasing cash flow needs in the future).
This is not the case for Chicago. Nor Illinois.
One has to sell off assets when investment returns and pension contributions are too low to cover current cash flow needs. This reduces the asset amount for the pension funds…and if cash flow needs are increasing, you find that one has to liquidate more and more assets… until the fund is exhausted.
Remember that the equity markets did extremely well in 2012 and 2013…. and this pension fund had to liquidate almost 10% of its assets to cover cash flows. This is not good.
Let’s see what the incoming city treasurer has to say:
Mayor Rahm Emanuel’s choice to replace retired City Treasurer Stephanie Neely vowed Tuesday to do his part to help solve Chicago’s $20 billion pension crisis — by improving investment returns and reducing millions of dollars in fees paid to investment managers.
The full City Council is expected to ratify the appointment of Kurt Summers at Wednesday’s meeting, but the incoming treasurer is not waiting for the vote before rolling up his sleeves and getting to work.
He’s already meeting with actuaries and pouring over the books of the four city employee pension funds.
They include the Municipal Employees and Laborers funds that have already been reformed and police and fire pension funds still waiting for similar action.
In 2016, the city is required by law to make a $550 million contribution to shore up police and fire pension funds with assets to cover just 29.6 and 24 percent of their respective liabilities.
…..
“One fund is paying 80 percent more in fees. Another is paying 50 percent more. Yet, there’s one client: The city of Chicago. That’s real money. For fire, the value of that is about $2.5 million-a-year on $1 billion in assets,” he said.“These kinds of things aren’t going to solve the kinds of holes we have. But any benefit we can find to invest more efficiently and less expensively is a benefit to taxpayers and retirees.”
Summers noted that the bill that saved the Municipal and Laborers Pension funds — by increasing employee contributions by 29 percent and reducing employee benefits — assumes an “actuarial rate of return” on investments of 7.5 percent-a-year.
That makes it imperative that the funds invest in the “right type of assets,” he said.
……
“It’s a common misconception to say, `If I invest in the markets or fixed-income [instruments], we’re gonna be protected, but real estate, private equity or hedge funds are risky.’ That’s plain wrong,” Summers said.“The reality is, you have just as much, if not more exposure to risk and volatility in the market with investments in basic public securities than you do with alternative products meant to mitigate risk and limit volatility. That’s the business I was in — trying to do that for clients around the world.”
:facepalm:
While I don’t necessarily have an issue with public pensions investing in equities of various sorts (whether domestic, emerging economies, private, or whatever), and while I definitely have no problem with making sure public plans aren’t getting gouged in fees, the problem is not that the pension funds are in the “wrong type of assets” or that the fees are too high.
It’s that too much has been promised and too little has been paid towards those promises.
Can Chicago dig itself out of its pension hole?
Chicago’s pension debacle was largely precipitated by the fact that the payment schedule is determined by the state legislature rather than by complying with Government Accounting Standards Board (GASB) requirements. The state has a long history of exempting itself and Chicago from annual pension-contribution requirements.
According to a recent Pioneer Institute study that I mentioned in my last post here, “It is hard to imagine how Chicago can avoid a full-blown Detroit scenario … within the next 10-15 years unless the city both 1) finds a way to cut existing benefits and obligations and 2) starts contributing substantially more to its pension plans right away.”
Under state law, Chicago will be required to more than double that $476 million pension contribution by 2016, and the annual tab is scheduled to continue rising rapidly after that. The city says it can’t afford the higher contribution, but even the new payment is barely half of the $2.2 billion payment Chicago should make according to GASB rules.
The city plans to delay increasing its contributions in hopes that the legislature will enact changes to reduce the required payments. But while it’s important for the city to take the time needed to craft a comprehensive solution to its pension problem, waiting for state help doesn’t make much sense. Illinois faces the biggest pension crisis of any state, with $100 billion of its own unfunded obligations.
…..
Together with radical pension contribution increases, the city will need to significantly cut the cost of its existing obligations. If the courts find that such a move runs afoul of the Illinois constitution, Chicago will find itself a long way down the frightening path that leads to becoming the next Detroit.
Good luck with that.
I’m not seeing how they’re going to squeeze extra taxes out of Chicago residents, when one third of them are living paycheck-to-paycheck.
This week, Arizona’s Department of Administration agreed to pay the legal tab of four ex-employees of the Public Safety Personnel Retirement System (PSPRS).
The ex-employees are being sued by a real estate investment firm, Troon, for “defaming” the firm by raising questions about how it values assets.
The employees quit PSPRS last year in protest of the allegedly inflated real estate valuations.
The fact that the government is footing the ex-employees’ private legal bills has divided observers into two camps: the camp that believes the public shouldn’t be obligated to cover private legal bills, and the camp that thinks the state is doing a service to whistle-blowers who tried to expose misconduct within the pension system.
Here’s an editorial from the Arizona Republic editorial board, which falls into the latter camp:
It is hard to fathom that four highly educated, highly paid employees of the state’s pension system for first responders would quit their jobs in protest if they didn’t see something that raised serious concerns.
And so it is right that the state that employed them should protect them now that they are under heavy legal fire.
Last year, three investment managers and the in-house counsel for the Public Safety Personnel Retirement System made a powerful statement: They could no longer work for a system they believed had gone rogue.
The four unwittingly made themselves targets for legal action by asking serious and difficult questions about the valuation of the trust’s real-estate investments managed by Desert Troon.
They wanted to know whether the PSPRS used inflated real-estate values for Troon-managed investments to trigger bonuses.
Troon manages large swaths of trust real estate in Arizona, Colorado, Texas and Utah. In return, the trust has paid Troon at least $12 million per year. And Troon enjoys a minority-ownership stake.
As reported by The Republic’s Craig Harris, Troon-managed properties are among the poorest-performing real-estate investments for the system in recent years.
Lost value from the Troon-managed real estate is adding to the larger problem of a pension system for police and firefighters that is short more than half the money it needs to fund current and future retirement payments for those enrolled.
The trust also manages pension systems for public officials and correctional officers. Those funds, along with the others, creak under an unfunded liability of $7.78 billion.
After PSPRS investment managers Anton Orlich, Mark Selfridge and Paul Corens and in-house counsel Andrew Carriker quit their jobs, they found themselves defendants in a Troon lawsuit accusing them of engaging in a conspiracy to defame senior management at the company and the pension system.
The legitimacy of the four men’s concerns will play out over time, but those concerns can’t be called frivolous. They’ve led to a federal criminal investigation into the PSPRS. And a federal grand jury has gone after 100 trust documents, many involving Troon-related real-estate investments.
The former employees have paid dearly for sounding the siren on the state’s pension system. Legal bills have stacked up, and until recently, they did not know how much financial and emotional strain they would have to bear, given they were sued after they left the PSPRS.
Fortunately, the state has affirmed it will cover their legal defense, and there are no financial limits to that coverage. In fact, the state is required to provide legal defense for current or former employees when sued for “acts within the course and scope of employment.”
Without that protection, Arizona would be compelling silence in its employees who perceive wrongdoing in the workplace. It would also make whistle-blowers susceptible to punitive lawsuits meant to shut them up.
Unless we’re looking at the unfathomable, and these four former employees were motivated by malice when they quit their jobs, they did something courageous and decent that requires the state of Arizona to have their backs.
We learned on Wednesday that the Kentucky Teachers’ Retirement System (KTRS), one of the most under-funded education retirement funds in the country, was seeking funding help from the state legislature.
Now, many more details have emerged about the proposals the System has presented to lawmakers. KTRS presented lawmakers with two options. The Courier Journal has the details:
KTRS suggested Wednesday that lawmakers consider two borrowing scenarios in the 2015 legislative session, and supporters say the proposals could reduce taxpayer cost in the long run while helping the system cope with $13.8 billion in unfunded liabilities.
One option involves a $1.9 billion bond to help fully fund the retirement system for the next four years and eventually decrease annual pension costs about $500 million by fiscal year 2026.
A second option includes a $3.3 billion bond that could fully fund the system for eight years and reduce annual costs in 2026 by around $445 million.
Both plans are based on 30-year bonds with interest rates in the range of 4 percent, and either option could be funded by re-purposing debt service and revenue streams that already exist in the state budget, according to KTRS.
Beau Barnes, KTRS general counsel and deputy executive secretary of operations, said the system is not “wild about bonding.” But he argued that liabilities are growing at 7.5 percent a year and compared the proposal to refinancing a home at a lower interest rate.
“We were asked what we could do for the pension fund without requiring additional dollars out of current budgets, and these were the only things we could think of,” Barnes said. “We didn’t really see any other alternative.”
KTRS has at least one lawmaker on their side. House Speaker Greg Stumbo voiced his support for the plan, according to MyCn2 News:
“I think we need to listen very carefully to it and work with them to try to craft some form of a proposal, which hopefully we can get enough support to pass in both chambers because these market rates won’t be favorable much longer in my judgement,” Stumbo, D-Prestonsburg, said in the committee meeting, noting the Federal Reserve will likely get pressure from banks to raise interest rates as the economy improves.
“… What they’re saying is we can’t tarry. If we wait too long, we’ll lose this window of opportunity.”
KTRS manages $18.5 billion in assets.
The Kentucky Employees Retirement System (KERS-Non-Hazardous) is already notorious for being one of the worst funded pension plans in the United States.
But the situation got worse Wednesday, as KERS revealed the funding status of the plan has fallen from 23 percent to 21 percent over the course of the last fiscal year.
Retiree advocacy group Kentucky Government Retirees issued this statement:
The audit committee of Kentucky Retirement Systems learned today that the funding ratio for the pension plan covering most state employees dropped to an alarming 21 percent in the fiscal year that ended June 30. The funding ratio compares current assets to total long-term liabilities. The KERS non-hazardous fund dropped by 2.1 percentage points over the fiscal year. Meanwhile, the fund continued to lose assets in the first three months of the fiscal year. The fund held only $2.48 billion in assets at the end of September, representing a decline of $95 million. Given these alarming figures, and in view of the commendable efforts of the Kentucky Teachers’ Retirement System to secure funding for its financially challenged pension plan, we as stakeholders urge the KRS board of trustees to actively engage Frankfort decision makers in a funding solution for the nation’s worst-funded state pension plan.
Here’s full video of a panel discussion that was held on November 14 as part of the 2014 National Lawyers Convention. The discussion was titled “”Intergenerational Equity and Social Security, Medicare, Obamacare, and Pensions”; the panelists discuss the sustainability of Social Security, the pension system, and similar programs.
The panelists:
–Hon. Christopher C. DeMuth, Distinguished Fellow, Hudson Institute, Inc., and former Administrator for Information and Regulatory Affairs, U.S. Office of Management and Budget
–Prof. John O. McGinnis, George C. Dix Professor in Constitutional Law, Northwestern University School of Law
–Prof. David A. Weisbach, Walter J. Blum Professor of Law and Senior Fellow, The Computation Institute of the University of Chicago and Argonne National Laboratory
–Moderator: Hon. Frank H. Easterbrook, U.S. Court of Appeals, Seventh Circuit
From the video description:
Several major federal programs directly tax the young to provide benefits to the elderly. This is a main feature of the Affordable Care Act, the Social Security System as it currently works, and of the laws guaranteeing pensions. In addition, the national debt raises intergenerational equity issues. What obligations do these debts impose on the young? Are they all of a piece or are the answers different in each case? Is it true that this generation is likely to be poorer than the previous one? What role does our legal system play in this? How will the law address pensions that contribute to bankrupting cities or states? What is the nature of the Social Security contract?
The Illinois House passed a measure today that aims to prevent full pension benefits from being paid to public officials who have been convicted of felonies related to their public service.
It passed the House by an overwhelming 99-14 count.
More from the Chicago Tribune:
The Illinois House voted Wednesday to give the attorney general the ability to go to court to stop future cases in which a pension is being paid to a convicted public official even if a retirement board had approved payments.
The bill is inspired by disgraced former Chicago police Cmdr. Jon Burge, who did not lose his $4,000-a-month pension despite costing the city tens of millions in legal costs because of police torture and abuse in the 1970s and 1980s. This measure would not affect Burge’s pension.
[…]
After his conviction, the police pension board deadlocked 4-4 on a motion to strip Burge of his pension. The key issue before the board was if Burge’s conviction was related to his police work. Four of the current or former Chicago police officers elected to the pension board by their fellow officers supported Burge, while four civilian trustees appointed by then-Mayor Richard Daley voted in opposition.
Attorney General Lisa Madigan filed suit to challenge the decision, but the Illinois Supreme Court ruled she did not have the standing to take up the matter.
The bill now heads to the Senate.
What obstacles do institutional investors face when making cross-border investments? And what strategies do they use to overcome those obstacles?
A survey was recently conducted to find out, and the results have been published in the Rotman International Journal of Pension Management.
The survey asked respondents to identify and rate the biggest obstacles to cross-border investment:
We first asked respondents to rate, using a five-point Likert- type scale (1 = strongly disagree, 5 = strongly agree), to what extent 20 different issues identified in the investment obstacles literature would “decrease the likelihood your fund will invest in another country.”
[…]
The top two issues, as identified by summing the percentages of “agree” and “strongly agree” responses, were “financial regulation uncertainty” (FP, 80%) and “unfavorable comments by government officials in recipient country” (IC, 73%). While the latter is an IC factor, it focuses on the nation-state and the use of informal suasion by officials, and thus is related to FP factors. Following these items almost two-thirds (64%) of the funds agreed or strongly agreed that “unfavorable tax treatment of your fund type” (FP) and “non-transparent investment review policies” (FP) would reduce the possibility of their fund’s investing in another country. Of these four factors, “financial regulation uncertainty” (FP) and “non-transparent investment review policies” (FP) elicited the highest proportion of “strongly agree” rankings.
The survey also asked respondents to identify the strategies they used to address the barriers:
Respondents were asked to indicate whether or not they used eight specific strategies to address the 20 possible barriers: increase transparency; co-invest; use external managers; restrict voting rights; accept outside investors; use debt; other strategies; and no strategy. Respondents could select all applicable strategies used to address each issue. The strategy identified most often (124 times) to address all three factor classifications was “no strategy,” followed by “external managers” (68) and “increase transparency” (55). Rounding out the top five were “co-investing” (34) and “other strategies” (30). The fact that “other strategies” was selected least often suggests that the survey included the most commonly used strategies.
Finally, the survey asked respondents to rank ten long-term investing objectives. The aggregate results:
The article, authored by Rachel Harvey, Patrick Bolton, Laurence Wilse-Samson, Li An, and Frédéric Samama, can be read in full here.
Photo by Satya via Flickr CC License
Louisiana’s annual payment to its pension systems will be cut by $120 million next fiscal year.
The state retirement systems’ actuaries approved the payment reduction on Wednesday.
From the Advocate:
State agencies and local school boards won’t have to pay as much next fiscal year to cover pension costs for active employees after action Wednesday by a special panel.
All told, the Public Retirement Systems’ Actuarial Committee, called PRSAC, approved a $120 million reduction.
The committee must sign off on financial evaluations of the four statewide retirement systems, which among other things, sets the benchmark for investment earnings as well as required employer contribution rates.
Healthy investment earnings — and to some degree — reductions in work force contributed to the coming budget relief on employers.
State agency contributions to the Louisiana State Employees Retirement System, better known as LASERS, are projected to decline by $62.8 million in the fiscal year that starts July 1, 2015.
Meanwhile, school boards’ contributions to the Teachers Retirement System of Louisiana are anticipated to drop by $46 million and to the Louisiana School Employees Retirement System by $13 million.
The Louisiana State Police Retirement System remains flat.
“This is good news for the state as we begin the budgeting process for the next fiscal year,” Commissioner of Administration Kristy Nichols said in a statement issued by her office. “Saving money here helps free up funding for other areas.”
Louisiana School Boards Association executive director Scott Richard, who attended the meeting, praised the committee action. “The fact that school board contribution rates will go down for 2015-16 is welcome news – at a time when the costs to educate students in Louisiana continues to rise,” Richard said.
“The reduction in costs reverses the trend of recent increases that negatively affected local district budgets,” he added.
Employee contributions remain unchanged.
Photo by TaxRebate.org.uk via Flickr CC License
The State of Wisconsin Investment Board (SWIB), the entity that manages assets for the state’s retirement systems, has made two separate commitments to real estate totaling $300 million.
The Board committed $150 million to one fund that invests in retail, office, and apartment properties. It also made a second commitment of $150 million to another fund that acquires grocery stores.
From IPE Real Estate:
State of Wisconsin Investment Board (SWIB) is increasing its investment in the UBS Trumbull Property Fund and has awarded two separate account mandates.
The $150m commitment is the second made by SWIB to the core open-ended fund in the past three years, having made an initial $125m allocation in 2012. The investment was worth $165m in September.
UBS Trumbull, managed by UBS Realty Investors, invests in US office, industrial, retail and apartment sectors.
SWIB said it invests in core real estate for its stable income return with low leverage. The investor is expecting its commitment to be called by the manager in the next 12 months.
SWIB has also commited $150m to a new separate account managed by AmCap and $158m to a separate account managed by Heitman.
In a new relationship for the pension fund, AmCap’s Wilson AmCap I fund will be looking to acquire core grocery-anchored/necessity-oriented US retail.
Jake Bisenius, chief investment officer for AmCap, said its total assets under management are now over $1bn.
The real estate manager has a large concentration of assets in Colorado, buying off-market in cash.
“Most of our purchases are done with cap rates that come in the high-5% to low-6% range,” Bisenius said.
The SWIB manages over $100 billion in assets for the state’s retirement systems and trust funds.
