Tweak in state pension projection comes with a cost

By LLOYD DUNKELBERGER
THE NEWS SERVICE OF FLORIDA

THE CAPITAL, TALLAHASSEE, October 13, 2016.......... State analysts agreed Thursday to lower the expected rate of return on Florida's $144 billion pension fund, while warning that it may be the first in a series of annual downward adjustments.

The shift from a 7.65 percent rate of return to 7.6 percent may seem slight, but it has implications for the $82 billion state budget, which likely will be tight in the coming year.

A lower expected return on investments means lawmakers will have to increase the state contribution to the pension fund, reducing the overall amount of money the Legislature will have for other needs, ranging from public schools to health-care programs.

Milliman and Aon Hewitt, two financial consulting firms hired to advise the state on the pension fund, had recommended adjusting the long-term rate of return downward to about 7 percent based on economic trends that have resulted in low inflation and interest rates.

The median rate of return for the largest public pension funds in the country is 7.5 percent, according to a Milliman report.

Earlier in the week, analysts meeting as what is known as the Florida Retirement System Actuarial Assumption Conference were deadlocked over whether to lower the rate of return.

Don Langston, staff director of the House Finance & Tax Committee, and Amy Baker, head of the Legislature's Office of Economic and Demographic Research, had pushed for lowering the rate to 7.5 percent. But they were opposed by representatives of the governor's office and the state Senate, who wanted to maintain the current 7.65 percent rate.

Christian Weiss, economic policy coordinator for Gov. Rick Scott, said the governor did not support lowering the rate because there was a "wide array of uncertainty" in some of the long-term factors used to recommend a lower rate, including an assumption that interest rates would remain low during the next 20 to 30 years.

When the conference reconvened on Thursday, the members reached a compromise on a 7.6 percent rate, with Langston and Baker warning it is likely to be the first in a series of downward adjustments, although they also agreed that cutting the rate now to 7 percent would be too disruptive.

"It is a move in the right direction. It is a little baby step, not quite as big of a step as I hoped we would take," Langston said.

But Langston said lawmakers and other state officials involved in the annual budget process need to prepare for a trend of lower returns on investments.

"Unless something radical changes in the world and national economies to turn the long-term outlook around, I think there is going to be continuing pressure on this assumed rate of return in the coming years," he said.

Baker agreed, calling the move to lower the rate "a signal."

"I think what we're setting off is a series of annual changes as the pressure to reduce the rate continues to build," Baker said. "Instead of giving ourselves any respite at all, we're going to be looking at every single year for the next number of years revisiting it."

Lowering the rate means the state will have less money to pay long-term retirement benefits for state and county employees, teachers and other public workers who rely on the fund.

Using the former 7.65 percent rate of return, Milliman had projected the state could pay 85.9 percent of its long-term benefits, representing an unfunded liability of $23.8 billion for the $144 billion fund.

With the new 7.6 percent rate, the report lowers the funded portion to 85.4 percent, representing a $24.9 billion unfunded liability.

As a comparison, lowering the rate of return to 7 percent would have yielded nearly a $38 billion unfunded liability, with the fund only being able to pay 79 percent of its long-term obligations.

In crafting the 2017-18 state budget during the spring legislative session, the Legislature will have to account for the larger unfunded liability in the pension fund using a complicated contribution formula.

Dropping the rate from 7.65 percent to 7.5 percent would have required an estimated $270 million increase in the state's pension contribution, according to Milliman. A cut to 7.6 percent will still require a projected contribution increase in the range of $90 million based on the formula.

That's a significant number given that lawmakers are looking at a meager $7.5 million surplus next budget year, followed by a projected $1.3 billion shortfall in the 2018-19 budget year.

The move to lower the rate of return was supported by State Board of Administration officials, who manage the investments in the $144 billion pension fund.

The fund's investments gained less than 1 percent in the last fiscal year that ended June 30, but have outperformed the 7.6 percent rate over the last 25 years with an 8.39 percent rate of return, according a SBA report. Over the last 15 years, the fund had a 5.93 percent rate of return.