R.I.’s pension-return conundrum

The R.I. State Retirement Commission last month decided to cut its roughly $1 billion investment into hedge funds in half, saying the asset has underperformed and cost the state too much in fees over the last five years.

The precarious balancing act of asset allocation for public pension funds is being played out throughout the country, as money managers are dealing with funds that produce lower returns at a higher risk – especially in recent years.

The state’s $7.5 billion fund, as of June 30, showed a one-year loss of 0.3 percent, a five-year return of 5.8 percent and a 10-year return totaling 4.8 percent.

Despite the lackluster results, however, the state for years hasn’t touched its 7.5 percent assumed rate of return.

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“That’s too high,” said Michael D. Ice, professor of finance at the University of Rhode Island. “The 10-year treasury is at 1.6 percent, so the state is almost 600 basis points above the risk-free rate. How does it expect to make that return without taking some pretty excessive risks?”

General Treasurer Seth Magaziner has also indicated the assumed rate is based on unrealistic assumptions, but hasn’t said whether it should be changed.

That’s because there’s an unfortunate math problem attached to any decision that reduces the assumed rate of return: A lower rate of return translates into greater long-term liabilities.

Rhode Island last fiscal year paid $136.7 million toward the state employees’ retirement system. The state also contributes each year to other funds for teachers, state police and judges, but the state employees’ fund requires the largest contribution.

The state’s payment each year is calculated based on a number of variables, including the system’s $2 billion unfunded liability – also known as its net pension liability – which is the amount liabilities exceed assets.

According to a fiscal 2015 audit, lowering the state’s assumed rate of return by just 1 percent – from 7.5 percent to 6.5 percent – would increase the plan’s unfunded liability by roughly one-quarter, to $2.5 billion.

The resulting effect would force the state to pay more each year toward the fund, which would draw money away from other facets of state government, require new tax revenue or ask for a larger contribution from employees.

Ice believes the state’s assumed rate should be lowered. But even if the state reduces its rate tomorrow, no change will be realized in the state’s operating budget until 2019 at the earliest, as yearly contribution calculations are based on a two-year lag because of the state’s budgeting calendar.

Magaziner, who’s up for re-election in 2018, says his office is re-evaluating the fund’s newly adjusted asset allocations to determine whether the rate should change. He expects to propose that decision to the investment commission next spring.

“It’s too early to say. We just got through a very intense process figuring out the investment side,” he said. •

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