Thursday, April 5, 2012

The Problem with Rhode Island's Pension Plan....

….is that it has too much in assets that don’t offer much return potential.

Gillian Tett had a column in this morning's Financial Times discussing some of the reforms that state treasurer Gina Raimondo has been implementing in Rhode Island's pension system.

Tett start out by noting the dismal condition of the public sector pension system in the United States. With nearly $3 trillion in unfunded pension liabilities, she writes, the outlook is truly frightening, especially given the gridlock in our political system.

However, Tett says that some of the changes occurring in Rhode Island can offer a ray of hope.  After Ms. Raimondo was elected in 2009, she moved to try to address some of the problems that Rhode Island is facing:

..once in office, she raised the retirement age from 62 to 67, temporarily suspended cost-of-living increases for benefits, cut the annual assumed rate of return on pension assets from 8.25 per cent to 7.5 per cent, and replaced defined benefit schemes with a hybrid, partially defined contribution scheme.  In total, that lopped $3 billion from the state's public pension bill.

However, Tett does not address the issue of asset allocation, which regular readers of Random Glenings will recognize has been a favorite topic of mine over the past few weeks.

So I wrote Gillian Tett an email this morning in response to her column.  While I doubt my thoughts will get much notice, I thought I would share them with you here:

Rhode Island had only 23% in US stocks as of the date of the last report, and less than 50% in stocks overall.

Meanwhile, it has 23% in bonds (i.e. the same percentage as in US stocks) that are yielding probably 3% or less, and have huge capital risk once rates starting moving higher*. If you add its allocation to “real return” products (which are hedging against non-existent inflation pressures), RI has about 1/3 in low yield assets.

It also just made a major allocation to hedge funds, which has been a losing proposition for many states like California and Oklahoma.

While I agree with your column today that they are more responsible in other ways than other states (including my home of Massachusetts), I would be willing to wager that Rhode Island will not make its 7.5% actuarial rate.
I’m a big fan, by the way.


Dave Glen

*even if rates go lower – to, say, 1% - this would only be a 1 year boost to performance of the bonds.  You would then be faced with the same problem the Japanese banks and insurance companies have been facing for years.