RI State Pension Has Not Grown Under Raimondo and Magaziner

RI State Pension Has Not Grown Under Raimondo and Magaziner

It's been five years since the state of Rhode Island enacted its monumental pension reform. Afterwards, there were at least three bull market years. Despite that, the state of Rhode Island's pension fund today finds itself exactly where it was five years ago.

According to the State Investment Commission report based on data from January 31, 2016, the state pension fund was worth $7.26 billion dollars. According to data based on a report from January 20, 2011, as of December 31, 2010, the pension fund was worth $7.25 billion. 

Rhode Island Treasurer Seth Magaziner's spokesman David Ortiz said that shouldn't raise red flags, saying the fund will remain solvent. The pension fund will also be fully funded in 25 years, he said.

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Does Size Matter?

"That was the whole point of the state pension reform from 2011," said Ortiz.

The pension fund is an old pension fund. That means it has a great deal of retirees that it pays benefits to every month. Last year, the pension fund paid out about $900 million in benefits. The fund has paid more in benefits than it's received in contributions since 1991.

There are currently 24,466 active employees, comprised of state workers and teachers currently paying into the system according to documentation provided by the Treasurer's Office. There are 21,493 retirees collecting pension benefits.

Negative Cash Flow

That's led to a negative cash flow in the pension fund. In fiscal year 2015, which began on July 1, 2014 and ended June 30, 2015. The state paid out $378.5 million more than it took in. In fiscal year 2014, it hemorrhaged $406 million. The year prior, it paid out $427 million more than it took in.  Over the last 5 full fiscal years, the fund has paid out $1.8 billion more to retirees than it's taken in through employee contributions.

The state pension reform of 2011 reduced the state's liability to retirees by changing the system from a defined benefit plan by capping retirees benefits at 30 percent percent of salary (and creating a defined contribution system). It was previously 70 percent. But it also reduced employee contributions to the plan. That's put a downward pressure on the pension fund's size. 

To understand why size doesn't mean everything when judging a pension fund's performance, it helps to think about the inverse. Imagine a newly formed fund that didn't have any retirees. Even if the fund lost money every year, it would still grow. That's because employees would put money into the fund and nobody would get benefits.  

Investment Questions

That's why Michael Riley, a finance professional from Narragansett who is a partner at Beach Street Financial Services and also writes MINDSETTER columns for GoLocalprov.com, agrees with Treasurer Magaziner's assessment on the size of the fund.

"The significant factors are the level of contributions and calculation of ARC and the cost of benefits. The state is in a negative cash flow condition. If there were zero investment returns the fund would decline, because they are paying out more than they are taking in," said Riley.

"Just because they made a return doesn't mean there will be more money in the fund over time."

Overly Complex Investments?

That doesn't mean Riley agrees with the management of the Rhode Island pension. While Riley is a proponent of alternative investments (hedge funds, private equity), he said the state has done a poor job in selecting them.

"The pension fund is way too complex and expensive and there are a lot of cracks in monitoring their investments," said Riley. 

"The state should not be betting on junk bonds and Puerto Rican debt, but they are exposed to those through their hedge fund holdings that were supposed to reduce risk."

$1.5 billion Left On Table?

Edward "Ted" Siedle, a Forbes contributor known as the nation's most outspoken critics of public pension investments in alternatives agrees. He acknowledges that the Rhode Island pension fund pays out significantly more money than it takes in. But that doesn't mean the fund shouldn't have grown after years of bull markets, he said.

"We calculated that the fund has under performed by $1.5 billion, regardless of its significant cash outflow," said Siedle. 

"My take is that if the fund had been managed properly, the value would be closer to $9 billion right now."

What Would Buffet Do?

Siedle refers to billionaire Omaha-based investor Warren Buffet's famous $1 million bet. Buffet bet a New York fund manager that the S&P 500 would outperform a composite average of hedge funds. The bet takes place over a 10-year period. About 6 years in, he's way ahead.

"Why doesn't Rhode Island just invest the same way Warren Buffet recommends? It's because there's little political advantage in generic, index fund investments," said Siedle.

The state pension fund has posted an average return of 9.77 percent over the last five fiscal years, according to Ortiz. The S&P 500, by comparison, posted a return of 14.1 percent over that same time period. 

Diversification Tactic

But Ortiz said that the state invests in alternative investments to diversify the fund. That protects it from bad market years, he said. Ortiz pointed to the market downturn of 2008, the ensuing recession and investment losses to the pension fund that resulted, as proof that the state should diversify its investment. 

"Volatility is something we seek to avoid. When you're less funded than you'd like to be, a diversification strategy is a good way to protect against volatility," said Ortiz.

Siedle said that he's never seen a politician acknowledge poor investment decisions. 

"You're never going to see a public pension fund acknowledge under performance," said Siedle.