February 21, 2013
As provided by the State Lodge of the Fraternal Order of Police
Thoughts on LCI’s September 2012 article entitled “Years in the Making: Florida’s Underfunded Municipal Pension Plans”
By Brad Heinrichs, FSA, EA, MAAA
Chief Executive Officer
Foster & Foster Consulting Actuaries, Inc.
- The paper’s underlying premise is that there IS a problem and that Florida cities are “underfunding” their plans. The only public entities that are underfunding their plans are those involved in the Florida Retirement System. Every local municipal plan makes contributions at least as large as the actuary suggests which will ultimate result in 100% funding.
- The LCI’s 2011 and 2012 reports continuously reference the term “funded ratio,” and even go so far as to attach letter grades to plans on this basis. Yes, we concede that nearly every local municipal plan has a funded ratio of less than 100%, and many under 80%, but is that necessarily cause for alarm?
o Funded ratios are calculated using liabilities that have projections of salary baked into the formula. Funded ratios, therefore, do NOT indicate what percentage of the accrued benefits and resulting liabilities have been funded to date. This ratio is probably 5-15% higher than the funded ratio consistently being referenced by the LCI. Instead, the funded ratio referenced by the LCI indicates what percentage of the ultimate benefits earned from service to date (but with pay projected to retirement) can be paid for by current assets. In our opinion, and in the opinion of the Federal Government who makes the rules for determining funded status for private sector plans, using projections of salary to develop a statistic to measure a current funded ratio is invalid.
o Additionally, many local plans haven’t been around for more than 15-20 years. How many homeowners are 100% funded in their homes after 15-20 years? Would 70% funded be a horrible place to be at that point?
o Many funds public safety plans have lower funded ratios because they have improved benefits using a mechanism of funding whereby future state premium tax revenues are earmarked to pay for current benefit improvements. So while the funded ratio may be low currently, there are future premium tax revenues earmarked to drive the funded ratio higher in the future.
The LCI report concludes that the plan managers “tended to underestimate salary growth and overestimate the rate of return” from 2004 to 2010.
o In our opinion, the most noteworthy comment made in their report, on page 6 states “It is important to note, however, that these assumptions are not intended to be accurate every year; rather they are intended to be accurate on average over many years (as much as 30 years).
o The fact is, most of these assumptions HAVE been accurate over the life of the fund, yet have fallen short during the short time horizon that the LCI report references.
o Since 2010, salary increases for governmental workers in Florida have been extremely low, oftentimes near 0%, and investment returns have been extraordinary (nearly 20% in 2012). Again, over a long time horizon, the assumptions are sound.
The LCI report states that the portion of pension contributions used to pay down the unfunded liability has risen.
o Why is this so alarming? Isn’t this a good thing? When the unfunded liability grows, I applaud any funding mechanism which requires additional monies to pay down this increased liability.
o Additionally, in most places, contrary to what the report states, contributions by the members have also increased, although not as much as the plan’s sponsor’s contributions.
The LCI report makes note of a “new troubling trend” which may be emerging where annual payouts exceed contributions.
o This is what happens as plans mature.
As mentioned previously, a majority of these plans aren’t anywhere near being mature, and many were initiated with a group of 100+ members and 0 retirees. Obviously these ratios will change over the next 30-50 years as plans evolve and a full life-cycle of members have passed through.
o There is nothing “troubling” about this trend. In addition to the comment above, the plan contributions are being calculated to achieve 100% funding.
o Actuarially funded plans do not rely on contributions from current employees to pay benefits for current retirees. This line of logic is only applicable to pay-as-you-go plans, like Social Security.
The LCI report remarks about how asset growth has slowed by the financial crisis, and specifically mentions that “the annual growth rate between 2004 and 2010 is approximately 4.6%, far below the plans’ assumed growth rates of 8 percent.”
o The 4.6% statistic being referenced is completely different than the 8.0% investment return assumption being used in actuarial valuations.
o The 4.6% statistic is a function of investment return, but ALSO a function of contributions and benefit payments.
- If benefit payments exceed contributions (as the LCI report points out is now the case), then investments could earn huge returns and yet the assets could see very little growth.
- On the other hand, for plans in their infancy where contributions greatly exceed benefit outlays, the plan could earn 0% and yet the value of the assets could go up 25-50% or more.
o The growth rate of the asset balances, again, is only applicable to pay-as-you go plans.
In closing, the LCI report is intended to cause alarm where it is not needed. It is perplexing to me that the LCI issues a report about so called “Underfunding Pension Plans” yet they seem alarmed that contributions are increasing to fund them. Local governments in Florida are making revisions to the plans as they deem necessary in order to meet budgetary constraints. Making any broad-sweeping legislative changes based upon findings in this report would be unfortunate, as once again, the LCI has missed the mark.
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