Riley: A Lively Thought Experiment
Michael G. Riley, GoLocalProv MINDSETTER™
Riley: A Lively Thought Experiment
A recent panel on A Lively Experiment contained a political science professor, a newspaper editor, a politician, and myself.
The premise was that Rhode Island currently at 56% funded using a 7.5% discount rate in March 2016 would be fully funded by 2040. The politician agreed with the assessment of Treasurer Magaziner that since over 5 out of the last 6 fiscal years the State earned 9.3% that we would be fine and easily be fully funded in 2040. The newspaper editor immediately agreed despite the fact that neither the politician nor the editor has any actuarial skills or basis for their prediction that we will be “fine."
GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLASTSo first let’s define what “fine” means. In politician parlance, we’ll be “fine” means the comment he made will not be remembered and he can go on pretending he knows something about pension finance for the rest of his political career. In Rhode Island he can sit in the Statehouse next to dozens of others with similar skills. We’ll be “fine," to the editor means that his newspaper will certainly be dead and buried by 2040 and he may need a government job soon. So why not double down on his lack of knowledge, and on his ridiculous endorsement of a kindergarten teacher for the Treasurer of a critical status State like Rhode Island. Wisely the political Science Professor, passed on having any idea how to answer the question and calculate the odds.
My answer was there was a less than 10% chance of being fully funded by 2040. Appropriately “fine" to me was Rhode Island pensions would be 80% or more funded in 2040. There are various ways to calculate this number. In my next article I will get into a few of those methods that will show almost zero chance of fully funded RI pensions by 2040. The danger of remaining critically underfunded is Rhode Island and the cities and towns will need cut spending (fire people), issue more debt or raise taxes very soon.
For now, just assume I am right. Let’s have some fun.
A Lively Thought Experiment!
Years ago there was a TV show called Monty Hall. Audience members were asked make deals. At the end of the show one contestant was asked to face the stage where there were three large doors and a model prepared to reveal what was behind the doors. One door had a valuable prize behind it and the other two doors were gag gifts worth very little.
When I was on Wall Street this was a favorite question of LETCO or Susquehanna who were leading derivative traders tasked with hiring promising candidates from the top universities. After a few difficult math questions the interviewer would pose the following scenario and question.
The Monte Hall Problem
The Monty Hall problem is a counter-intuitive statistics puzzle:
• There are 3 doors, behind which are two goats and a car.
• You pick a door (call it door A). You’re hoping for the $25,000 car of course.
• Monty Hall, the game show host, examines the other doors (B & C) and always opens one of them with a goat (Both doors might have goats; he’ll randomly pick one to open).
• Let’s say he opens B with the goat behind it?
Question 1) What are the odds that your original pick door A was right?
Question 2) Lets say you were happy with the original pick. If Monte offered you $1000 dollars to change your pick to door C would you? Should you?
Question 3) What percentage of people when posed question #1 above would change their pick?
Warning: The internet has improved the world greatly but it has ruined the careers of bar trivia experts and puzzle solvers. Try this without Google.
The findings are very interesting and say a lot about behavioral finance and the false assumptions used in financial academia still today. Now ask yourself if the politician and the newspaper editor would change their answer when presented the facts of pension funding.
Timeline - Rhode Island Pension Reform
2005-2010
January 2009
Governor Don Carcieri makes pension reform a top priority in his emergency budget plan. His three-point plan included:
1. An established minimum retirment age of 59 for all state and municipal employees.
2. Elimination of cost-of-living increases.
3. Conversion of new hires into a 401(k) style plan.
See WPRI's coverage of Carcieri's proposal here.
2009
Rhode Island increased mandatory employee contributions for new and current employees. New Mexico was the only other state to mandate current employees to increase their contributions.
Read the NCSL report here
(Photo: FutUndBeidl, Flickr)
2010
Rhode Island's state administered public employee pension system only held 48% of the assets to cover future payments to its emplyees.
"This system as designed today is fundamentally unsustainable, and it is in your best interest to fix it" - Gina Raimondo
Check out Wall Street Journal's coverage here.
November 2010
Gina Raimondo defeats opponent Kernan King in the election for General Treasurer of Rhode Island using her platform to reform the structure of Rhode Island's public employee pension system. She received 201,625 votes, more than any other politician on the 2010 Rhode Island ballot.
April 2011
Raimondo leads effort to reduce the state’s assumed rate of return on pension investments from 8.25 to 7.5%.
Her proposal includes plans to suspend the Cost of Living Adjustment (which allows for raises corresponding with rates of inflation for retirees), changing the retirement age to match Social Security ages, and adding a defined contribution plan.
May 2011
Raimondo releases “Truth in Numbers”, a report detailing the pension crisis and offering possible solutions. She continues to work to raise public support for her proposal.
"Decades of ignoring actuarial assumptions led to lower taxpayer & employee contributions being made into the system." - Gina Raimondo (Truth in Numbers)
Read GoLocalProv's analysis of the report here.
Read the Truth in Numbers report here.
October 2011
Governor Lincoln Chafee and General Treasurer Gina Raimondo present their pension reform legislation proposal before a joint session of the General Assembly.
“Our fundamental goal throughout this process has been to provide retirement security through reforms that are fair to the three main interested parties: retirees, current employees and the taxpayer…I join the General Treasurer in urging the General Assembly to take decisive action and adopt these reforms.”- Gov. Lincoln Chafee
October 2011
Head of Rhode Island firefighters’ union accuses Raimondo of “cooking the books” to create a pension problem where one did not exist. Paul Valletta Jr. states that Raimondo raised Rhode Islanders’ assumed mortality rate to increase liability to the state, using data from 1994 instead of updated information from 2008, and lowered the anticipated rate of return on state investments.
“You’re going after the retirees! In this economic time, how could you possibly take a pension away?” Paul Valletta Jr (Head of RI Firefighters' Union)
Read more from the firefighters' battle with Raimondo here.
Check out the New York Times' take on RI's pension crisis here.
November 17, 2011
The Rhode Island Retirement Security Act (RIRSA) is enacted by the General Assembly with bipartisan support in both chambers. RIRSA’s passing is slated to reduce the unfunded liability of RI’s pension system and increase its funding status by $3 billion and 60% respectively, level contributions to the pension system by taxpayers, save municipalities $100 million through lessened contributions to teacher and MERS pension systems, and lower the cost of borrowing.
Read more from GoLocalProv here.
November 18, 2011
Governor Lincoln Chafee signs RIRSA into law. According to a December 2011 Brown University poll, 60% of Rhode Island residents support the reform. Following its enactment, Raimondo holds regional sessions to educate public employees on the effects of the legislation on their retirement benefits.
Read about how Rhode Islanders react to RIRSA here.
January 2012
Raimondo hosts local workshops to explain the pension reforms across Rhode Island. She also receives national attention for her contributions to the state’s pension reforms. The reforms are given praise and many believe Rhode Island will serve as a template for other States’ future pension reforms.
Read about the pension workshop here.
Read Raimondo's feature in Institutional Investor here.
March - April 2012
Raimondo opposes Governor Chafee’s proposal to cut pension-funded deposits. She continued to provide workshops on the pension reforms.
December 5, 2012
Raimondo publicly opposes Governor Chafee’s meetings with union leaders in an effort to avoid judicial rulings on the pension reform package. In response, Chafee issues a statement supporting the negotiations.
Read more about Raimondo's opposition here.
Read about Chafee's statement here.
March 2013
Led by the Rhode Island State Association of Fire Fighters, unions protest the 2011 pension reform outside of the Omni Providence where Governor Lincoln Chafee and General Treasurer Gina Raimondo conduct a national conference of bond investors.
Read about Raimondo's discussion of distressed municipalities here.
April 2013
The pension plan comes under increased scrutiny as a result of the involvement of hedge funds and private equity firms. Reports show that $200 million of the state pension fund was lost in 2012.
"In short, impressive educational credentials and limited knowledge of investment industry realities made Raimondo ideally suited to champion private equity’s public pension money grab." - Ted Seidle (Forbes)
Read GoLocalProv's coverage of the State Pension Fund's losses here.
Read Ted Seidle's criticism of Raimondo in Forbes.
June 2013
Reports show that the State’s retirement system increased in 2013 by $20 million despite the reforms being put into effect the previous year.
Read GoLocalProv's investigation into the rising pension costs here.
September 2013
Matt Taibbi publishes an article in Rolling Stone detailing Raimondo’s use of hedge funds as a questionably ethical tool to aid with pension reform.
Read Taibbi's article in Rolling Stone.
Read GoLocalProv's response to Taibbi here.
October 2013
As Raimondo eyes the role of Governor of Rhode Island in 2014, more behind-the-curtain information about the 2011 pension reform comes to light.
Read more from GoLocalProv about the players in the pension battle here.
