Raimondo,Magaziner to raise Discount rate ?

         In 1997 The RI Actuary and investment consultants advised the Retirement Board to adopt an investment return assumption no higher than eight percent. Against advice, the Board decided on an 8.25 percent rate of return.  The level of subsequent underfunding due to using unrealistically optimistic actuarial assumptions  have in fact increased the unfunded liability over time.

        The discount rate is in theory determined in large part by the yield curve and the prevailing risk free rates. In 1997 rates were significantly higher and so it was a fairly easy to promise to achieve 8 % returns without much risk. As can be seen in the chart below, the 10 yr. risk free rate was 6.5% and the 30 yr. risk free rate was close to 7%. Had the retirement board simply invested in zero coupon bonds @ 6.8% in the 1990’s going forward they would almost fully guarantee normal cost funding.

But the rate scenario can change and generally speaking the lower the risk free discount rates the lower expected returns are on all risky assets. Stocks are the riskiest of the asset classes and as such most fiduciaries, like the State of Rhode Island, have roughly 55 to 65% invested stocks and the remainder in Fixed Income and alternatives. 

Interest Rates in 2015

    Last year 2014 was the fifth year of extraordinary federal monetary intervention and we are still operating under ZIRP (zero interest rate policy). Given those facts, a super majority of U.S. economists and money managers are predicting much lower returns on their portfolios. Now rates look like this: 

 

    Last year’s 2014 RI Treasurer Debates with Ernie Almonte, Seth Magaziner, and Frank Caprio featured Seth Magaziner declaring he that he (Seth Magaziner) was a superior money manager and also stated he would “raise” the discount rate.  In my opinion “RAISING” the discount rate from 7.5% would be truly insane and serve no public purpose but is completely in line with his senior policy advisor Tom Sgouros whose stated  belief is  that Gina Raimondo created a “false crisis” by lowering the rate to 7.5% during the 2011 Pension reform.

     If Treasurer Magaziner were to make his senior advisers  preference   to raise the discount rate, it would lower the "budgeted" amount necessary for funding the pension plan in 2016, 2017 etc. and thus make it easier to spend on other items like social programs  or fill budget holes on the horizon such as probable  lost casino revenue.  Once in effect, Treasurer  Magaziner , Governor  Raimondo  and adviser Sgouros would have fulfilled progressive promises to ignore deficits and  pension or OPEB liabilities . Then they could better balance the near term State budget by kicking – the –can and placing an even larger burden on the next generation.This  has been policy  for 40 years in Rhode Island  and now it will be again.

     This raise  would be completely irresponsible, yet not unheard of in Progressive thought, which increasingly seems to be Governor Raimondo’s path.She appears to be abandoning her belief in "its just math". Political calculation has replace pension calculation. The evidence is real.  If the former Treasurer  does in fact believe that a lower discount rate was necessary in 2011  and she wasn't lying ,then there is even more evidence today 7.5% remains way too high and should be moved toward Warren Buffets 6%. Regardless of what Magaziner decides, both GASB 68 and Moody’s will ignore Magaziner ‘s rookie guess  and use rates approaching 5.4% in calculating unfunded liabilities.  

                                                         New Liability figure explodes

       Here‘s what the new  funded ratio in Rhode Island  will look like in just 3 months when fiscal year 2015 comes to an end.:

	RI State Pension Unfunded Liabilities   (billions)	RI State Pension Funded ratio (80%=healthy)
2011 prior to RIRSA and amortization 8.25%	$2.67	48.6%
RIRSA Raimondo Nov 2011 post reform 7.5%	$1.79	58.6%
RIRSA June 30 ,2014 7.5%	$4.35	58.7%
June 30,2015  5.4% GASB 68, Moody’s  **	$9.11	41.5%

 **Assumes 2.5% fy 2015 return on assets 

                                                   RIRSA is just not Working

        Even under 2011 RIRSA reform and after a massive bull market the funded ratio has not improved, that means that costs have been calculated incorrectly and discounted incorrectly. Using GASB 68 the State and Magaziner will be forced to report a collapse in the funded ratio and a huge increase in Liability. Under current law the State does not have to fund reality but they do need to show a 5 year plan and clearly spell out the current financial condition of the State. That should be interesting.