Ted Ballantine | Pension360

Eric Madiar: Illinois Reform Law Is Unconstitutional

Eric M. Madiar, the Chief Legal Counsel to Illinois Senate President John Cullerton, has written an op-ed today opposing Illinois’ pension reform law on the grounds that the law is unconstitutional. An excerpt:

Anyone following the pension reform debate knows that Illinois has long diverted the moneys needed to properly fund its pension systems to avoid tax increases, cuts in public services or both. Some may not admit it, but they know it. They also know this practice is the primary reason why the systems are underwater.

Since much of my time over the last three years has been spent on our State’s pension problem, I wanted to find out how long it’s been that way and how long we have known about it. Well, as chronicled in an article I wrote now published by Chicago-Kent College of Law, I have an answer.

1917. No, that’s not a typo.

In 1917, the Illinois Pension Laws Commission warned State leaders in a report that the retirement systems were nearing “insolvency” and “moving toward crisis” because of the State’s failure to properly fund the systems. This nearly century old report also recommended action so that the pension obligations of that generation would not be passed on to future generations.

The 1917 report’s warning and funding recommendation went unheeded, as were similar warnings and funding recommendations found in decades of public pension reports issued before and after the Pension Clause was added to the Illinois Constitution in 1970.

[…]

…As early as 1979, Moody’s and Standard and Poor’s advised the State that it would lose its AAA bond rating if the State did not begin tackling its increasing unfunded pension liabilities. Also, in 1982, Governor Jim Thompson succeeded in passing legislation making pension funding far more dependent upon stock market returns to stave off higher State pension contributions.

Further, a 1985 task force report noted that Standard and Poor’s reduced its bond rating for Illinois from AAA to AA+ due to the State’s “deferral of pension obligations,” and that another rating agency viewed the State’s pension funding as a future financial “time bomb.” Finally, the much heralded 1995 pension funding plan was designed to increase the State’s unfunded liabilities and postpone the State’s actuarially-sound pension contributions until 2034.

Given this well-documented history, it’s extremely hard to legitimately believe that our State’s current situation is so surprising that the Illinois Constitution can be ignored and pension benefits unilaterally cut. As noted in my previous legal research, the Pension Clause does not support such a result.

The entire piece can be read here.

Photo by Mr.TinDC via Flickr CC License

New Jersey Pension Commission Releases First Report

It came a little behind schedule, but the New Jersey Pension and Health Benefit Study Commission released its preliminary report yesterday.

This first report was all about identifying and detailing the causes and current state of New Jersey’s pension funding shortfall. As such, no recommendations were made for fixing the system.

Although the report, notably, did not name Chris Christie, it did lay a portion of the blame on politicians for creating the pension mess. From NorthJersey.com:

The report in part blames politicians for failing to properly fund the pensions and siphoning surpluses during robust years resulting in a $37 billion unfunded liability in the state pension funds.

“While high benefit levels are one driver of unfunded liabilities, the lack of state contributions is a critical contributing factor,” the report states. “Put simply, if the state cannot find the economic means and discipline to consistently fund its pension obligations, the system will fail. The funding decisions over the last twenty years are telling examples of bipartisan contribution to fiscal distress.”

The report also said that Gov. Christie’s 2011 pension reforms didn’t sufficiently address the system’s problems.

Matt Arco of NJ.com put the report’s talking points more succinctly:

1. The looming unfunded liability is massive

2. Retiree health care costs are massive (and unpaid for)

3. Blame can be spread across the board

4. Failure to fix the problem will cost millions more

5. The 2011 reforms weren’t enough

The full report can be read here.

The Value of an Investment Policy Statement

Pension funds, both public and private, each have an Investment Policy Statement (IPS). An IPS provides a formal framework for investing the pension fund’s assets, including asset allocation targets and investment objectives.

But what are the values of having such a statement? A recent paper by Anthony L. Scialabba and Carol Lawton, published in the Journal of Pension Benefits, dives deep into that question.

Regarding the value of the statement, it can be used to show that trustees are indeed acting as “prudent investors”. From the paper:

With regard to the duty of prudence, conduct is what counts, not the results of the performance of the investments. An IPS can show that a prudent investment procedure was in place. In addition, an IPS can protect plan fiduciaries from inadvertently making arbitrary and ill-advised decisions. The directions outlined in the IPS can provide the fiduciaries with confidence in bad economic times that they made sound investment decisions in accordance with the plan sponsor’s or administrator’s intentions.

An IPS can also be a good communication tool, both for plan participants and for trustees:

An IPS can enhance employee morale in providing clear communication of the plan’s investment policy to participants. A plan sponsor can post a plan’s IPS on the Internet to provide participants with helpful insight into how the plan’s investments are chosen and maintained. This can reassure employees and encourage participation because they know that the investment fiduciaries have a sound investment structure in place. In addition, an IPS can enhance the morale of management if its members serve on the investment committee of a plan, as they are given guidance by which to judge their decisions and performance.

The authors also note that having a strong IPS – and sticking to it – can translate into strong investment performance.

There are some drawbacks to IPSs as well. To read about them, and read the rest of the paper (titled “Investment Policy Statements: Their Values and Their Drawbacks”), click here [subscription required].

Pennsylvania Not Cutting Hedge Funds Despite State Auditor’s Skepticism

CalPERS’ decision to pull out of hedge funds is having a ripple effect across the country.

On Wednesday, Pennsylvania Auditor General Eugene DePasquale released this skeptical statement on the state pension system’s hedge fund investments:

“Hedge fund investments may be an appropriate strategy for certain investors and I trust that SERS and PSERS weigh investment options carefully,” DePasquale said in a statement. “But, SERS and PSERS are dealing with public pension funds that are already stressed and high fees cost state taxpayers more each year. I support full disclosure of hedge fund fees paid by our public pension funds and we owe it to taxpayers to ensure that those fees do not outweigh the returns.”

Spokespeople for both the State Employees Retirement System (SERS) and the Public School Employee Retirement System (PSERS) have now responded. The consensus: the pension funds will not be cutting their hedge fund allocations.

From Philly.com:

SERS has no plans to cut hedge funds further. “Hedge funds play a role in our current board-approved strategic investment plan, which was designed to structure a well-diversified portfolio,” SERS spokeswoman Pamela Hile told me. With many more workers set to retire, hedge funds (or “diversifying assets,” as SERS prefers to call them) combine relatively steady returns with low volatility “over varying capital market environments.” By SERS’s count “difersifying assets” are now down to $1.7 billion, or 6% of the $28 billion fund and returning 10.7% after fees for the year ending June 30, up from a 10-year average of 7.4%.

Says PSERS spokeswoman Evelyn Williams: “We agree with the Auditor General that hedge funds are appropriate for certain investors. Not all investors can or should invest in hedge funds. Clearly CALPERS reviewed their hedge fund allocation and acted in their own fund’s best interests.

“PSERS also sets our asset allocation based on our own unique goals and issues. We do not have any immediate plans to change our hedge fund asset allocation at this time… PSERS’ hedge fund allocation provides diversification for our asset allocation and is specifically structured so it does not correlate with traditional equity markets…PSERS hedge fund allocation has performed as expected and provided positive investment returns over the past fiscal year, one, three, and five years.”

SERS allocates 7 percent of its assets, or $1.9 billion, towards hedge funds. PSERS, meanwhile, allocates 12.5 percent of its assets, or $5.7 billion, towards hedge funds.

Photo by TaxRebate.org.uk

Moody’s: Strong Returns Can’t Keep Up With Obligations

Moody’s released a strongly-worded report today on the state of public pension funds in the U.S. The report claimed that strong investment returns haven’t improved the funding gap facing pension systems, because unfunded liabilities have grown even more than assets.

From Bloomberg:

The 25 largest U.S. public pensions face about $2 trillion in unfunded liabilities, showing that investment returns can’t keep up with ballooning obligations, according to Moody’s Investors Service.

The 25 biggest systems by assets averaged a 7.45 percent return from 2004 to 2013, close to the expected 7.65 percent rate, Moody’s said in a report released today. Yet the New York-based credit rater’s calculation of liabilities tripled in the eight years through 2012, according to the report.

“Despite the robust investment returns since 2004, annual growth in unfunded pension liabilities has outstripped these returns,” Moody’s said. “This growth is due to inadequate pension contributions, stemming from a variety of actuarial and funding practices, as well as the sheer growth of pension liabilities as benefit accruals accelerate with the passage of time, salary increases and additional years of service.”

U.S. states and cities are contending with underfunded worker retirement systems. The 18-month recession that ended in June 2009 wiped out asset values and forced cuts to contributions. Now, liabilities are crowding out spending for services, roads and schools.

For the report, Moody’s gathered data on the 25 largest pension funds in the country, which control about 40 percent of all pension assets in the U.S..

The New York Common Retirement Fund had the best average return over the past 10 years. The fund returned 8.67 percent annually.

Photo by www.SeniorLiving.Org

Washington Pension Board Declines to Divest From Fossil Fuels

The Washington State Investment Board (WSIB), the entity that handles investments for the state’s pension systems, at its latest board meeting weighed whether to divest from fossil fuel-based companies.

The Board ultimately decided against divestment. But the members said they would continue to evaluate whether climate change posed any risk to pension investment returns, and would use their power as major shareholders to push companies for transparency about financial risks posed by climate change.

The WSIB has major stakes in oil and coal investments.

Further details on the board’s decision, from the Olympian:

When evaluating a future investment, the SIB said it will consider whether climate change poses any financial risk to its expected returns.

It should not stop investing in lucrative but controversial energy projects. That would expose the board to potential legal action over its failure to produce as much value as possible.

Outgoing SIB Chair Jim McIntire, who is also the state Treasurer, proposed a more responsible strategy for showing sensitivity to environmental issues. He said the SIB should press companies for greater transparency about the risk from climate change, and how they are mitigating that risk.

A large institutional investor such as the state of Washington can use its leverage to change company policies. McIntire said that’s the SIB’s preferred approach.

[…]

The SIB’s legal mandate is to make money for the pension funds it manages. Its fiduciary duty is simply to get the best return possible for the individuals who will someday depend on those pensions.

But setting investment policy is more complex than that. The SIB members are responsible for examining the short- and long-term risks of its investments. And that requires assessing both internal and external factors that might influence an investment’s return.

The WSIB presents an argument many pension funds have made over the past few months: divestment isn’t as effective as lobbying for change as a major shareholder.

No public pension funds in the U.S. have yet divested from fossil fuel companies on the grounds of climate change.

Pulitzer Prize Winner: Hedge Funds Not Worth The Risk For Pensions

David Cay Johnston, former Pulitzer prize-winning reporter for the New York Times and lecturer at Syracuse University, has written a column calling for pensions to stop risking assets with hedge funds.

He says the nature of hedge funds make the investment “not suited” for pension funds. First, he takes hedge funds to task for their fee structure. From the piece, published on Al-Jazeera:

Hedge funds charge hefty fees. Many hedge funds charge what is known in the trade as 2 and 20. That is for a 2 percent annual management fee, or $20,000 per $1 million, and 20 percent of all gains. Julian Simon’s Renaissance Technologies charges a 5 percent base and 44 percent of gains. From 1982 through 2009, when it averaged extraordinary 35 percent annual returns after expenses, that was a great deal, but since then, Simon has underperformed the market.

Compare these numbers with the very well-managed ExxonMobil pension fund, which its latest disclosure reports show has overhead charges of less than $1,200 per $1 million. Vanguard 500 investors pay as little as $500 annually to manage $1 million.

To get a better sense of the numbers, consider a year when the market return is 5 percent and a hedge fund earns that. On a $1 million investment, after a 2 percent management fee and a 20 percent profit performance fee, the hedge fund investor will be ahead by $19,200, or less than 2 percent; the Vanguard investor will be ahead by $49,950, or almost 5 percent.

The other facet of his argument is that hedge funds, while not necessarily a bad investment for other entities, are not a “prudent” investment for pension funds to make. From the editorial:

Hedge funds simply are not appropriate for taxpayers and public-sector workers. They are, rather, for wealthy speculators willing to take big risks in the hopes of earning big rewards while being able to tolerate the chance that an investment will shrivel or even be wiped out.

Pension money should be invested prudently. “Prudent” comes from the word “provident,” meaning to prepare for the future. And while its origins are in religious concepts, failing to prudently handle earthly money can turn the end of life into hell.

Given survivor benefits in pension plans, these pools of money should be treated as widows-and-orphans money. Under ancient and well-tested principles, the money of such vulnerable people must be invested with exceptional care to safeguard from loss. That means investment-grade bonds (more on that below) and either blue chip stocks or broad indexes.

Only with the rise in the last six decades of modern portfolio theory — investing in many different arenas to spread risk — have we gotten away from the idea that for widows, orphans and pensioners, only high-grade corporate bonds and a few blue chip stocks paying big dividends are appropriate investments.

The rest of the piece can be read here.

Gina Raimondo Suddenly Pulling In Union Endorsements

Heading into the primary that took place earlier this month, Rhode Island’s democratic candidate for governor Gina Raimondo had notoriously little union support.

That was due to the 2011 pension reforms she spearheaded. Unions, aside from disliking the policy, thought they never got a fair shake during negotiations.

But now Raimondo is pulling in union endorsements by the dozen. Her stance on pensions hasn’t changed. So how is she doing it? The Providence Journal asked the same question:

What did Raimondo tell these unions to win their support?

Neither Raimondo, the state’s general treasurer, nor her Republican opponent, Cranston Mayor Allan Fung, has been willing to make public their written answers on any candidate questionnaires they submitted in pursuit of endorsements.

Why not? They won’t say.

[…]

Gina Raimondo is on a roll, with a new endorsement almost every day this past week.

In the last week alone, the Democratic nominee for governor has picked up glowing endorsements from the International Brotherhood of Electrical Workers Local 99 and an arm of the Service Employees International Union that represents “nearly 1,000 contracted janitors at office buildings in R.I.”

A week earlier, she netted the endorsement of the separate wing of the SEIU that won the right to unionize at-home child-care workers.

Raimondo has now picked up endorsements from 15 unions.

Unions have vocally opposed Raimondo’s 2011 reform efforts for years.

But it could be that they see her as the lesser of two evils; unions could have reason to believe they’d have better luck with Raimondo in office than her Republican challenger, Allan Fung.

But without the release of the questionnaires, we won’t know for sure.

Russia’s Pension Put-Off Could Have Consequences

Since 2013, Russia has diverted more than $30 billion worth of pension contributions to plug holes elsewhere in the country’s budget.

Pension360 covered a brief, abrupt press conference earlier this month where Russia’s Economy Minister hinted the country could take money from the pension fund to assist companies hurt by Western sanctions.

Now, that has come to fruition – Russia will withhold over $8 billion from its pension fund, and much of that money will go to a “reserve fund” to aid state-owned companies affected by sanctions.

But there are consequences to this decision, writes Mark Adomanis, a Forbes contributor. From his editorial in the Moscow Times:

Rather than long-term improvements to Russia’s economic competitiveness, this money will be spent, in business parlance, “just to keep the lights on.”

…The costs [of withholding pension payments] will grow exponentially more severe the longer they are incurred.

Due to demographic changes that have seen the number of young adults halved, one of two things will happen: Russia’s pension system will need a lot more money, or pensions will become a lot less generous. There is simply no other way to make the math work. Maybe there is a better example of the tension between the short and long terms, but I can’t think of a more illustrative example than raiding the pension fund to give a bunch of money to Rosneft.

Russia can get away with such short-term-focused policies for a while. As Adam Smith noted, there is a lot of ruin in a nation, and even with all of the mounting difficulties Russia will likely find a way to stumble through. But in mounting such a panicky and reactive response to U.S. and EU sanctions, Russia is setting itself up for some really serious difficulty a few years down the line.

Earlier this year, a decision by Russia to freeze its pension contributions caused “deep disagreement” among government officials. The money was used to plug budget holes elsewhere.

Georgia Candidate Wants Pension Funds to Invest In Start-Ups

Jason Carter, Georgia’s Democratic candidate for governor, released his economic plan this month, and in it there’s an idea of particular interest to pensions: Carter wants to make it easier for the Teachers Retirement System of Georgia to invest in Georgia-based start-ups.

From the Atlanta Journal-Constitution:

The Democrat argues in his economic pivot that he wants teacher pensions to be able to pump funds into local startups “so long as we’re making sure that we can manage the risk in ways that make sense.” He sees it as a way to boost a state-backed effort to invest in venture capital firms that, as you’ll see in today’s AJC, has lagged.

“The things that concern the teachers is to make sure you’re stewarding the pension appropriately. So it’s crucial to make sure that we are managing the risk in ways that works,” he said. “But we shouldn’t have those pension funds losing out on higher growths and higher returns just because of artificial caps on what it can do.”

Georgia lawmakers cleared the way for pension funds to invest up to 5 percent of their assets in alternative investments, such as venture capital firms, that had at least $100 million on the books. But the law excluded the Teachers Retirement System of Georgia, the state’s largest public pension with nearly $59 billion in assets.

North Carolina and other nearby states allow their teachers’ fund to invest in startups, but Gov. Nathan Deal and other Republicans have raised red flags. Lawmakers signaled they were reluctant to include the teachers fund in the 2012 legislation because the group’s board hadn’t approved the changes.

Critics are wary of the risk attached to investing in unproven companies. Other critics say it would open the door for cronyism and make pension investments increasingly political.

A 2012 state law enabled most Georgia pension funds to invest in alternatives for the first time. But the law prohibits alternatives from making up more than 5 percent of total assets.

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