State Pension Disaster!

Rhode Island general treasurer Gina Raimondo told a room full of politicians and union heads Monday that the pension problem can’t be fixed without cutting benefits to longtime “vested” workers, and even retirees. Raimondo was talking about cutting benefits like the annual cost of living adjustments (COLAs) of 3%, which put current retirees on a path to double their pensions in 25 years. Roger Boudreau, who heads the local retiree chapter of the American Federation of Teachers, said, “I would be opposed to it, because people have made financial plans for their retirement based upon that assumption, and I think the courts will ultimately decide what property rights have accrued to retirees relative to that question.”

If you’re a Rhode Island taxpayer, Mr. Boudreau’s plans seem to take precedence over yours since he’s a member of the state Retirement Board that oversees the state pension. Seven of the 15 members of the Rhode Island Retirement Board, including Mr. Boudreau, tend to vote in favor of the unions.

Governor Chafee has been essentially voting “present” on the issue, while using words like “collective solutions”—no doubt a nod to unions. Asked Monday if he still felt that vested and retired workers are untouchable, he said, “A decision by the court on the validity of the 2009 and 2010 pension amendments will bring welcome legal clarity, will give state policymakers a better idea of the range of options available to them and will set the table for meaningful negotiations on pension reform.”

There is a docket entry for a motion for summary judgment on June 21 before Superior Court judge Sarah Taft-Carter, appointed by former Republican governor Donald Carcieri in 2010, regarding the 2009 and 2010 pension amendments. An impartial decision may be impossible since, as a participant in the state pension system subject to the less generous pension changes made for judges hired after January 1, 2009, she is directly impacted by this issue.

No matter what the ruling, it would seem that an appeal to the Supreme Court would be the next step by either taxpayers or the unions. With four of five justices appointed by former Governor Carcieri, including chief justice Paul Suttell, the Supreme Court might rule for the taxpayers. But we’re looking at possibly until 2012 for changes to employee contributions installed back in ’09 and ’10 to take effect. Talk about the inmates running the asylum.

Gina Raimondo’s report is pandering to the unions by allowing a way-too-aggressive discount rate assumption of 7.5%. There’s no way I would advise my wealthy investors in Rhode Island to assume this level of return, which, in the case of the state pensions, needs to be essentially guaranteed. For the 10 years ending in June 2010, the Rhode Island pension system returned 2.28% and a slightly improved 4.4% through February. Performance will be hard pressed to improve in the future 10 years, with the dual headwinds of T-bills’ paying next to nothing and, as Ms. Raimondo’s report points out, U.S. total credit market debt as a percentage of GDP at 354%.

The unfunded liability figure Ms. Raimondo and the unions like to use is $6.8 billion, which is based on the much-too-high discount rate (or expected rate of return) of 7.5%. Even using AA corporate bond yields of 6.22%, as she does in the report (they’re yielding 5.22% more recently), returns are too low—though doing so raises the unfunded liability to the higher end of her $6.8- to $9-billion liability.

Companies use the lower AA rate, as their plans are deemed to be riskier than states’ because they don’t have the power to tax. I would say Rhode Island is as risky as they come because there will never be enough tax revenue to pay both essential services and the pension liability. Rhode Island is such a risk that I would advise using the 30-year zero-coupon bond yield of 4.357% as the discount rate.

As the report shows, the unfunded liability assuming a 4.4% discount rate surges to $11.4 billion. It would be prudent for Ms. Raimondo, as a fiduciary for the state, to use a more realistic figure rather than playing into the hands of unions that prefer a higher discount rate to make the pain more palatable to misinformed taxpayers. You can be sure that if the state got rid of the pension and offered to cut employees a check, the union heads would be screaming for a lower discount rate, which makes the present value worth much, much more.

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E.J. Smith - Your Survival Guy

Preparing your investments and family for when disaster strikes.

E.J. Smith is the Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH, where he completed course-work in Practical and Defensive Handgun, Conceal Carry Pistol, Shotguns, Precision Scope Rifle and Kidnapping Prevention. E.J. plays a Yamaha Recording Custom drum set with Zilldjian cymbals. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com. Sign up here to receive all the best content from Richardcyoung.com each week.