Are we dealing with reality on pensions?

STATE OFFICIALS are lowering the pension funds assumed rate of return to 7 percent from 7.5 percent. / PBN FILE GRAPHIC LISA LAGRECA
STATE OFFICIALS are lowering the pension funds assumed rate of return to 7 percent from 7.5 percent. / PBN FILE GRAPHIC LISA LAGRECA

In June 2011, then-General Treasurer Gina M. Raimondo distributed hundreds of copies of what’s arguably become one of the most important documents of her political career: “Truth in Numbers: The Security and Sustainability of Rhode Island’s Retirement System.”

The 16-page report, used to drum up public and political support for the need to make significant changes, detailed how the state’s pension system was broken and in crisis.

“Today Rhode Island’s pension plans provide neither retirement security nor financial sustainability and are in dire need of redesign,” Raimondo wrote.

The treasurer, who’s now governor, wasn’t the first to propose pension reform. But she helped lead the effort to get it done, championing legislation that curbed yearly increases to benefits, raised the retirement age and created a hybrid plan that no longer relied purely on defined benefits but added a defined-contribution component as well.

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The reform elevated her political profile, giving her a platform for a successful gubernatorial run in 2014. Now it’s Seth Magaziner, the current treasurer, who’s on the pension hot seat.

He’s responsible for the health of the state’s multibillion dollar pension system, which, despite the Raimondo-led reforms, is still an enormous financial burden to taxpayers. Last year, Rhode Island taxpayers paid $466.1 million toward funding the system, including both the defined-benefit and defined-contribution plans. Employees separately contributed $194.6 million.

While Rhode Island is bound by law to fully fund the retirement system by 2035 for state employees and 2038 for teachers, the price of getting there is contingent on a certain amount of guesswork that, if wrong, could cost state and local taxpayers much more than expected in the long run. Already, the state has had to extend its schedule to become fully funded by one year for state employees and three years for teachers.

“I worry on both sides of the spectrum,” said Magaziner. “I worry when people say nothing is wrong, and I worry when people say there’s a looming disaster.” Key questions he and other state leaders must answer in the coming weeks in assessing the financial health of the current system include whether the state is working with accurate projections for annual rates of inflation and return on pension investments.

Since 2011, the pension fund has only twice realized a market return that’s exceeded 7.5 percent, the current assumed rate. But any move to lower the rate, being considered by many such plans across the country, would, under Rhode Island law, boost annual taxpayer contributions to the plan.

While pension metrics rarely capture voters’ attention, any move to increase taxpayer contributions could raise public ire. But failing to make a move could also plant the seeds for another pension crisis.

“Anytime you’ve got retirement futures invested in the stock market, you’re always a little nervous,” said Wendy Schiller, chair of political science at Brown University. “So goes the stock market, so goes people’s futures, and that’s a cause for caution.

“There are two pressure points on Magaziner. [Raimondo’s] political career and [his] political career,” Schiller said. “That’s good for the state of Rhode Island and good for the voters, because it means he’s got to get it right, and he needs to be as responsible as possible.”

Raimondo, who last year made it onto Fortune’s third annual list of the World’s 50 Greatest Leaders, left Magaziner a much healthier pension system than what she inherited. But it’s by no means perfect. A recent U.S. News report ranked it among the bottom half of all states in terms of solvency. Magaziner is tasked with steering the ship, while also dealing with issues related to volatile capital markets and underperforming assets that exacerbate overly optimistic estimates.

Finding the right balance might save taxpayers millions in the long run, which in real terms would open the door for government work that’s more tangible, such as this year’s hot issues of eliminating the car tax, championed by House Speaker Nicholas A. Mattiello, or paying for two years of free college, as Raimondo has proposed.

“I don’t think you could even talk about the car tax without pension reform,” said Schiller, noting how far the system has come. “But pension costs are still expensive, and it’s still a pressure point.”


Rhode Island’s pension system, known formally as the Employees’ Retirement System of Rhode Island, or ERSRI, comprises six defined-benefit plans and one defined-contribution plan.

It serves 79,664 retired and active state employees, teachers, municipal employees, judges and public-safety officials.

To fund the defined-benefit plan, with assets totaling $7.5 billion as of June 30, 2016, the state relies on a yearly cash influx from taxpayers, employees and investment gains, which is offset by benefits paid to retirees and their families.

The system is one big variable, and knowing how to fund it is based on several assumptions rooted in past experience and future projections. If state officials had a crystal ball, yearly contributions and investment returns would equal benefit costs and expenses.

But there is no crystal ball, and the system isn’t perfect, so if assumptions are off, it can come with unexpected costs.

“Unreasonable assumptions were the biggest factor that got us into trouble in the first place,” Magaziner said, referring to pre-reform trends.

The various assumptions are tied to such metrics as inflation, salary increases, retirement trends, mortality rates and capital markets.

Each assumption helps dictate what should be paid toward the pension system each year. None are more important than the state’s 7.5 percent assumed rate of return, which is how much the state assumes it will earn on its pension investment each year.

“The investment return is by far the most powerful and important [assumption],” said Joseph Newton, one of the state’s actuaries with Michigan-based Gabriel Roeder Smith & Co. Holdings Inc.

“It’s twice as important as payroll growth,” Newton told the R.I. Retirement Board, a 15-member panel that oversees the state’s pension system, in February.

Newton is currently crunching numbers for the board to determine whether it should change its assumptions. The funds have not hit the 7.5 percent assumed rate of return in recent years, putting it front and center.

The total value of the fund fell 0.3 percent, or $471.4 million, over the 12-month period through the end of June last year. That decline in value doesn’t bode well for a system for which benefit costs continue to grow each year.

Luckily, the system is set up to try and smooth out big gains or losses in any one year, but if the state is to sustain more losses than gains, the dynamic is worrisome. The average return over the last five years was 5.8 percent. It was 4.8 percent for the past decade.

Investment returns are supposed to fill funding gaps between benefit costs and contributions. When the investment fund underperforms, however, it is possible that taxpayers will have to increase their contribution to the fund by even more than had been scheduled.

If the state were to lower its assumed rate of return to more accurately reflect average returns, it would give taxpayers a better picture about the real cost of the pension system. The state did just that in 2011, when it reduced the rate from 8.25 percent to its current 7.5 percent. The reduction seemed revolutionary at the time, but in retrospect it likely wasn’t enough.

“While [7.5 percent] is a more realistic rate of return, the actuaries have warned that the state only has a 42.5 percent chance of achieving this target,” Raimondo wrote in her 2011 report.

So, what’s keeping the state from lowering the assumed rate of return to something more realistic?


There are cost implications that can come along with changing assumptions.

For instance, if the assumed rate of return were lowered 1 percentage point to 6.5 percent, and all other assumptions remained the same, the pension system’s $5.4 billion unfunded liability (which excludes a smaller plan for judges that uses a lower rate) would increase 25.8 percent to $6.8 billion, according to a fiscal 2016 audit by the R.I. Office of the Auditor General.

If unfunded liabilities increase, the state’s funded ratio – a measure of assets to cover liabilities – falls. The funded ratio currently hovers at 56 percent for state employees and 58.3 percent for teachers, which are the two largest plans. With that 1 percentage point decline in the return assumption applied to those two funds, the funded ratio drops significantly, to 46.1 percent for the state employees and 48.5 percent for teachers. It is unclear how much extra the state’s taxpayers would have to contribute to the pension funds on a yearly basis because of that change.

However, in fiscal 2016 taxpayers paid $356.6 million toward the state’s pension fund (the state collected $3.65 billion in revenue in fiscal 2016).

“If you don’t meet your return rates over an extended period of time, it’s going to cost you down the road,” said Rep. Brian C. Newberry, R-North Smithfield. “Obviously, this should be concerning for everybody.”

The California Public Retirement System, better known as CalPERS, is the largest public pension system in the country, and acts somewhat as a bellwether to other public plans (albeit 37 times the size of Rhode Island’s pension system).

With nearly $300 billion in assets, covering 1.8 million workers and retirees, CalPERS in December announced it would lower its assumed rate of return from 7.5 percent to 7 percent over the next three years.

In Rhode Island, the state retirement board is undergoing its own review of assumptions, dubbed an “experience study,” and invited a group of public-pension and capital-market experts to discuss market trends.

Simona Mocuta, senior economist at State Street Global Advisors, the investment division of State Street Corp., explained that projections of insignificant world gross domestic product growth would constrain capital-market returns between 2017 and 2025 to an estimated 5.8 percent.

“Does that mean that it becomes impossible to reach returns that are higher than that?” Mocuta asked hypothetically. “No,” she said. “But it implies that to outperform the broadest measure of the market consistently, you have to be consistently smarter than more people, and smarter by a larger degree.”

Magaziner, chairman of the retirement board, says it’s unlikely the panel would lower the assumed rate of return by a full percentage point, and wouldn’t speculate on the fiscal impact of other amounts until he receives estimates from GRS.

He does admit, however, that capital-market trends lean toward an amount less than 7.5 percent.

State actuaries also think mortality, retirement and disabilities incidence assumptions combined could slightly increase taxpayer contributions.

The treasurer and other board members are eyeing inflation as one place where the state might trim. Currently, the state assumes inflation is 2.75 percent, which is the most basic building block for how it determines its assumed rate of return.

That 2.75 percent assumption, however, is optimistic. The rate of inflation measured by the Consumer Price Index for all urban consumers has met or exceeded 2.75 percent only once since fiscal 2010, when it reached 2.9 percent in fiscal 2012, according to data provided during the state’s November Revenue Estimating Conference.

“Reducing the assumed rate of inflation is a prudent and fair thing to do,” said Paul Dion, chief of revenue analysis at the R.I. Department of Revenue.

Dion is also an active employee representative on the state retirement board.

“Given the compounding nature of the assumptions, the assumed general inflation rate of 2.75 percent implies that price inflation growth was 20.9 percent from fiscal 2010 through fiscal 2016, when in actuality it was 11.1 percent,” he added.

Inflation is also the building block for other economic assumptions, including individual salary increases, general wage inflation and contingent cost-of-living adjustments. By reducing it, the state contribution toward those other costs could be less, which would offset unfunded-liability increases triggered by lowering the assumed rate of return.

“I’m concerned with the 2.75 percent inflation, as it’s higher than anything we’ve seen in a long time, and it’s higher than what you could sustainably expect with an aging demographic,” Magaziner said. “If there’s going to be a change, I think it’s more likely to be a change to inflation, and it won’t be as high a cost as [changing] the real rate of return.”

Whatever changes are made will inevitably impact taxpayers and ultimately the state budget, where policy lives and dies at the mercy of funding.

This year’s budget has already pitted Raimondo, who wants to pay for two years of college tuition at state schools, against Mattiello, who wants to gradually eliminate the $220.6 million car tax. Raimondo’s college proposal, she estimates, would eventually cost $30 million per year, which is 15.5 times less than what the state paid toward the pension system last fiscal year. Getting the fund in good shape could give much greater flexibility for state spending priorities, but the day when taxpayer contributions drop significantly remains two decades off.


The state retirement system includes the Municipal Employee Retirement System, or MERS, which consists of 113 plans and 15,395 plan participants from cities, towns, fire districts and other special districts.

“If there’s any significant financial impact [from pension adjustments] … we want to make sure there’s a very thorough [review] process,” said Brian M. Daniels, newly appointed executive director of the Rhode Island League of Cities and Towns.

Daniels agrees with Magaziner and Dion, saying there’s an opportunity to re-examine the inflation assumption. But he warns any decision will likely be met with “healthy skepticism” from local officials, taxpayers and retirees.

Why? Because the municipalities with plans administered by the state would feel the budgetary pain of increased contribution requirements that a change in investment-return assumptions would bring, just like the state would.

“There’s a sense from cities and towns that state costs keep trickling down to them,” he said. “People want to pay for services, and certainly you need to invest properly, but there’s a feeling that cities and towns are getting approached from numerous organizations repeatedly nickel and diming for a fee here and a cost increase there,” he said, referring specifically to an effort this legislative session to increase how much it will cost municipalities to dump waste at the state’s central landfill.

“Now we’re talking about the pension fund,” he added. “Everybody thinks it’s small increases, but when you add them all up it becomes frustrating.”

PBN last year reported the total unfunded liability for 34 independently managed local pension plans in 24 Rhode Island municipalities totaled $2.3 billion.

The state estimates 12 plans are funded at less than 40 percent and seven plans are funded between 40-60 percent. Anything below 60 percent is considered “critical” by the state Department of Revenue.

Failing to make yearly required contributions to local plans often comes as the result of paying full amounts to the state system, which drives up long-term liabilities on municipal balance sheets. Those liabilities inevitably cost local taxpayers.

Last fiscal year in Providence the required annual cost paid toward its local pension plan totaled $73.2 million, equaling 20.8 percent of the city’s entire tax levy.

The dynamic is worrisome to local and state leaders.

“There’s a lot of talk, and study, and not a lot of action,” Magaziner said of local plans. “That’s something we want to change.”


Along with the state retirement board’s experience study, a separate state-led committee is trying to find ways to incentivize locally run pension plans to improve funding levels.

The experience study, mandated every three years, is expected to produce results in the next few weeks. Magaziner hopes to vote on any changes by May.

Roger Boudreau, who represents retirees on the state retirement board, was involved during the 2011 reform, and more recently when the retirement board did an experience study in 2014.

He says the studies are important.

“Any adjustments that are made could have an impact on the annual required contribution by employers,” he said. “We’re sensitive to that.”

Boudreau looks to 2030-31 longingly, as that’s when the fund is supposed to reach 80 percent funded, and cost-of-living adjustments – which came to a halt during the pension reform of 2011 – would kick back in.

Boudreau worries the state could again try and slash benefits, and claw back existing agreements in the event of an economic crisis, but he feels there’s a long-term commitment to meeting the funding goal.

“I’m also hoping that we’re going to live longer and will make up some of the money that we lost” during the reform, he added.

Meanwhile, on the investment side, the state has changed its strategy to try and offset extreme volatility in the market.

“The more volatility there is, even if the return is good, the harder it is to hit a target over time,” Magaziner said.

Last fall, the state approved a new strategy called “Back to Basics,” which included a plan to unload about half – or $500 million – of its assets from hedge funds. The plan is to reallocate those funds into more predictable investments, to cut back on fees and to better protect the fund from downturns in the market and economy.

At the end of the day for Magaziner, it’s about trying to keep a steady hand on the tiller.

“Everything looked fine in the year 2000, and then we got ourselves into trouble,” he said. “I want assumptions that are reasonable, because I don’t want to make the same mistake.” n

Bringing the locals in

The state legislature last year formed the R.I. Advisory Council to Locally Administered Pension Plans, which is tasked with finding ways to help the locally run systems.

Magaziner – who also heads the council – plans to submit two pieces of legislation this session designed to incentivize – but not mandate – local plans to join MERS.

It’s unclear whether the proposals will garner legislative support, or how local bodies – which have to deal with pushback from bargaining units and unions, which oftentimes have pension benefits that are more generous than those in the MERS portfolio – would react. But Auditor General Dennis E. Hoyle, who also sits on the advisory council, says just getting people in the same room to talk about local pension plans is important.

“I like the idea of creating some options,” he said.


  1. “Truth in numbers” is manipulation of numbers. She cooked the books. And if you believe what it says (she had it written not 3 months in office- what does that tell you….and never put in information on the high fees as she did her transfer of wealth from pensioners-retirees to her Wall St hedgefund investors) as she never fixed the pension- she lied- it is not fixed but still bleeds a million dollars a day…And she with the GA hid the decades of malfeasance..If you believe her BS, then maybe someone can sell you the Chris Christie bridge he got in trouble with!

  2. Unfortunately, Mr. Sherman excluded the negative effect of the $ 1 B that Ms. Raimondo dumped into the pension fund in 2012. At the time, then-Treas Raimondo promised that the pension was “fixed” forever and would never run out of money. Sadly, only five years later, that is not the case today. In fact, when previous Treas. Frank Caprio left office on December 31, 2010, the pension fund was at $ 7.25 B. Today,
    more than seven years later, it is at $ 7.9 B. Something is wrong with the picture and it calls for a thorough
    assessment of how the investments faired the past seven years under both Ms. Raimondo and Mr. Magaziner.