Response to JBC Report

Setting the Facts Straight:  A Response to the Josiah Bartlett Center’s Paper on the New Hampshire Retirement System

Executive Summary

This paper is in response to the Josiah Bartlett Center’s (JBC) report titled: “An Updated Look and the New Hampshire Retirement System, the Unfunded-Liability and Troubling Trends” authored by Joshua Elliot-Traficante.  The goal of this paper is to uncover the Josiah Bartlett Center’s distortion of the facts about the New Hampshire Retirement System, and to reveal the facts about the Defined Contribution plan they endorse.  The main conclusions of the Retirement Security Coalition’s paper are the following:

1:  The Josiah Bartlett Center claims that the central challenge facing the Retirement System is a growth in accrued liabilities, which they blame on the current Defined Benefit plan.  The fact is that the average pension provided by the Defined Benefit plan continues to be very modest.  The JBC refuses to acknowledge the real problem: the growth in the unfunded liability caused by the legislature’s continued manipulation of employer rates.

2:   Employer contribution rates have been held at artificially low levels for decades, leading to a current unfunded liability (UAAL) in excess of $4 billion.  Between 2007 and 2011, the Retirement Systems’ unfunded liability grew an astonishing 78%, which is more than twice as much as the growth of the accrued liability. The high levels of growth in the unfunded liability compared to the accrued liability demonstrate the impact of chronic underfunding by employers.

3:  The Bartlett Center report does not detail the history and legislative action that led to the continued employer underfunding of the New Hampshire Retirement System.  The underfunding is the result of employer rates being held artificially low, first by the use of the Open Group Aggregate Method mandated by the passage of HB 51 in 1991, and more recently by the recertification of employer rates mandated by HB2.

4:  The Josiah Bartlett Center suggests that SB 229 mandating a Defined Contribution plan would reduce the growth rate in the Retirement System’s liabilities.  Independent actuaries have reviewed SB 229 and proven the opposite.  If SB 229 is passed, it would immediately increase the Retirement System’s unfunded liability by at least $1.2 billion, raising the UAAL from $4.3 billion to $5.5 billion.

5:  The correct course of action is to maintain the current Defined Benefit plan.  Independent actuaries have demonstrated that with sound contribution rates and smart investment decisions, the unfunded liability can be paid off during the course of the required 26 year amortization period.  Conversely, they found that under SB 229 there would still be a $71 million unfunded liability at the end of the amortization period.

The purpose of the New Hampshire Retirement Security Coalition paper is to demonstrate the facts about the Retirement System, and to clarify some of the misinformation promulgated by the Josiah Bartlett Center.  As the debate over a Defined Contribution plan continues, we hope that our paper will serve as a resource for accurate public information.

Overview:

For the second year in a row, The Josiah Bartlett Center has issued a report on the Retirement System’s Comprehensive Annual Financial Report (CAFR).  The paper’s author, Josh Elliot-Traficante, states in the opening that the: “paper seeks to take apart the complex CAFR and explain the financial status of the pension portion of the System in layman’s terms, as well as look at the troubling historical trends.” Unfortunately, Mr. Traficante’s work accomplishes neither of his stated goals.  Instead he distorts the facts, and he continues to ignore critical portions of the Retirement System’s history.

Mr. Traficante engages in the practice of twisting the facts to fit his own pre-ordained conclusion.  He believes that the path forward for the Retirement System is for the legislature to close the current Defined Benefit plan, and to mandate that all new employees participate in a Defined Contribution plan. This is a recipe for a taxpayer and NH Advantage disaster.

Unfortunately for the Josiah Bartlett Center, the facts are not on their side.  Independent actuaries recently reviewed SB 229, the Defined Contribution proposal from Senator Fenton Groen, and found that it would increase costs for employees and employers (our local communities), as well as grow the unfunded liability.[1]  These conclusions run directly counter to the Josiah Bartlett Center’s purported concerns, and strike at the very heart of their argument.

Economist Ross Eisenbrey recently reviewed the proposed Defined Contribution plan in New Hampshire and stated:  “The only clear winners will be financial services providers who receive higher fees for their services. This might help the economy in New York or Boston, but not in New Hampshire.”[2]  The question is whose side is the Josiah Bartlett Center on: the citizens of New Hampshire, or the big financial interests?

Getting the Facts Right:

The Josiah Bartlett Center argues that the key challenge for the New Hampshire Retirement System “is a liability growth issue.” Josiah Bartlett Center puts the current retirement system liabilities at $9,998,251,000 and the adjusted liability growth rate between 2010 and 2011 at 8.19%. 

The JBC’s numbers and analysis twist the facts though.  They only deal with the Retirement System’s accrued liabilities, and fail to address the real problem: the growth in the unfunded accrued actuarial liability (UAAL).  The accrued liability of a pension plan is the amount of money needed to pay for benefits and expenses that arise from the participants past service accumulated as of the valuation date.  The unfunded liability (UAAL) is the accrued liability minus the net value of the assets.[3]

Between 2007 and 2011, the Retirement System’s unfunded liability grew an astonishing 78%, which is more than twice as much as the growth of the accrued liability.  This is in part due to poor investment performance and depreciation of assets in the beginning of the period.  However, even between 2010 and 2011, when the Retirement System recognized positive investment returns, the UAAL growth outstripped that of the accrued liability.  The continued high levels of growth in the unfunded liability compared to the accrued liability demonstrate the impact of chronic underfunding by employers.

The fact is the unfunded liability is now over 4.2 billion dollars, and represents 169% of the annual covered payroll of the Retirement System.[4]  That means it would take more than one and a half times the entire combined annual payroll of New Hampshire’s state government, school districts, and municipalities to pay off the unfunded liability today.  The Retirement System does not have a liability growth problem; the benefits provided to retirees continue to be very modest.  The system’s problem is the growth in the unfunded liability caused by decades of employers avoiding the necessary contribution rates to properly fund the system.

Legislative History and Employer Rates:

Pension holidays for employers result in the transfer of payments owed to future generations of taxpayers, and they have led to the unfunded liability we are dealing with today.  The most critical way the legislature has mandated such a holiday over the last two decades has been through the use of the Open Group Aggregate funding methodology. Once again, the Bartlett Center paper fails to identify this significant part of the New Hampshire Retirement System’s history, and how it impacts the system’s current funding status.

The New Hampshire legislature’s long history of artificially depressing employer contributions began in 1991.   That year they passed HB 51 mandating the temporary use of the Open Group Aggregate methodology in place of the widely used Entry Age Normal method.  At the same time the Retirement System raised its’ earnings assumption rate to an inappropriately high level of 9¾%.  The funding level of the pension appeared to increase by nearly 30%.[5]

The result of this mirage was a dramatic decrease in employer contribution rates.  The changes in actuarial assumptions caused the trust fund to appear healthier than it was which artificially lowered their contributions. Mr. Traficante’s own data validates this point.  The Chart on page 4 of his paper demonstrates that in 1991, after the passage of the Open Group Aggregate funding methodology and the increase in the return assumptions, the total liabilities of the system actually decreased by 5%.  HB 51 and the Open Group Aggregate method damaged the funding of the Retirement System until 2007, when the passage of HB 653 finally reinstated the Entry Age Normal methodology, accurately capturing upfront the UAAL and normal pension costs.[6]  This ended a 16-year legislatively created employer pension holiday.

In addition to these practices, the Board of Trustees also smoothes investment returns and losses over five years, which Mr. Traficante referenced in his paper.  The five-year smoothing of assets is employed in the actuarial valuation used to determine the required employer contribution rates.  The benefit for employers is that smoothing loses helps make the contribution rates predictable, allowing employers to keep their contribution rates flat, even when the stock market tumbles.  The risk though, is that in strong years like 2011, there is not an immediate recognition of the total increase in returns.

Recent Legislation and Actuarial Review:

In 2011, the State Legislature passed a budget that further damaged the funding status of the Retirement System.  HB 2 cut benefits for all current employees, while raising their contribution rates 24% to 40% from their prior level.  JBC would contend that this was done to decrease the unfunded liability of the Retirement System, but once again the facts are not on their side.  In FY2011, the NHRS unfunded actuarial accrued liability (UAAL) increased by $537 million, which decreased the pension’s funded ratio by 1.1%.[7]

While the UAAL increased, HB2 continued to lower employer rates even further.  HB2 section 118 mandated that the retirement system recalculate the employer contribution rates based on the impact of the bill, and it prohibited the retirement system from using the new more conservative return assumptions until 2014-2015.  In the process of recertifying the rates, the Retirement System’s actuaries found that the changes to plan benefits would result in a 3% decrease in employer contribution rates between 2012 and 2013.[8] Once again, employer contribution rates continue to be lowered, with a trans-generational transfer of costs to future taxpayers.

HB 2 led to an increase in the Retirement Systems unfunded liability and shifted an even greater burden on to local communities and property taxpayers.  One of the major provisions in HB 2 was to eliminate the State’s 35% cost share to political subdivision contribution rates for Teacher, Police, Fire, and Municipal Employee members.[9]  HB2 only served to continue the process of kicking the can down the road, and refusing to deal with the current realities of the State budget.

Defined Benefit vs Defined Contribution

After distorting the current data about liabilities, Mr. Traficante suggests a factually inaccurate solution: mandating that all new employees be forced to participate in a Defined Contribution plan.

Mr. Traficante gives an endorsement of current bill SB 229 as a way to reduce the growth in liabilities.  This conclusion is utterly false.  A recent actuarial report by Gabriel Roeder Smith proves that SB 229 would cause the unfunded liability to grow.   If this legislation is passed, it would immediately increase the Retirement System’s unfunded liability by at least $1.2 billion, raising the UAAL from $4.3 billion to $5.5 billion.  The funded ratio would decline from 57.4% funded to 51.1% funded.  Accordingly, the total employer contribution rate would drastically escalate, increasing by at least 3.97% of payroll.[10]

The actuaries conclude in their report that: “In all areas, over time, transitioning to the proposed Defined Contribution plan will be more expensive for the employees and employers than maintaining the current Defined Benefit plan”[11].  Despite the fact that it would increase cost for not just employers, but also plan members, Mr. Traficante dismisses this, and claims that a Defined Contribution plan would be good for employees and it would protect them because:  “Once those funds are deposited into their accounts, that money is theirs and only theirs, no legislative actions can change that.”

What Mr. Traficante refuses to recognize is that this is actually the case right now under the New Hampshire State Constitution.  Article 36-a of the Constitution to say that the money paid by the members must be used for solely for members’ benefits, and all contributions, assets, and proceeds: “shall be held, invested or disbursed as in trust for the exclusive purpose of providing for such benefits and shall not be encumbered for, or diverted to, any other purposes.”[12]

The recent changes that have been made to the Retirement System to change members’ benefits and raise their contribution rates potentially violate the State Constitution and the New Hampshire Retirement Security Coalition is currently engaged in litigation to overturn them.  Therefore, the assertion that a Defined Contributions plan will protect Retirement System member’s benefits is completely baseless, since they are already protected under current statute and the State Constitution.

In arguing for a Defined Contribution plan Mr. Traficante also asserts that: “an added benefit of a defined contribution system is that since the employees own the accounts, it travels with them when they change jobs. We live in an era where people typically do not work in the same industry for 30 years.”  The portability argument is frequently made by proponents of Defined Contribution reform, but unfortunately it is not backed up by current labor force data.  The US Bureau of Labor Statistics measures workers’ “median years of tenure with current employers” and finds that the median tenure for both local and state government employees increased between 2000 and 2010.[13]

The advantages of a Defined Benefit pensions are especially obvious in the public sector, where the stability of the workforce reduces the cost of employee turnover for the state and local communities.  For example, a large body of research has shown that teachers are more effective after they’ve been teaching for at least three to five years, and pension benefits help promote teacher retention through their years of peak effectiveness.  The same general rule on recruitment and retention can also be applied to Public Safety employees.  The Deputy Commissioner of the New Hampshire Department of Safety, Earl Sweeney, recently testified that SB 229 and a Defined Contribution plan:  “will be a retirement system that is relatively worthless as an incentive to attract and hold good people”.[14]

Finally, Mr. Traficante points to the State of Michigan, as an example of where a state pension system has successfully implemented a Defined Contribution plan.  However, there are numerous examples of state and local pension systems that have had poor experiences with Defined Contributions plans.   The Executive Director of the National Conference on Public Employee Retirement Systems, Hank Kim, recently testified that:  “In several cases, states have replaced DC plans with DB plans because of the inadequacy of plan benefits or increased costs.”  He cites Nebraska, North Dakota, and West Virginia as prominent examples.[15]

Conclusion:

The bottom line is that the facts are not on the side of the Josiah Bartlett Center and Mr. Traficante in the debate between Defined Benefit and Defined Contribution plans.  Our paper counters with a factual and accurate look at the history of the New Hampshire Retirement System, and the realities of the Defined Contribution proposal.

The right approach to the challenges facing the New Hampshire Retirement System is to maintain the current Defined Benefit plan.  Independent actuaries have demonstrated that with sound contribution rates and smart investment decisions, the unfunded liability can be paid off during the course of the required 26 year amortization period.  Conversely, they found that under SB 229 there would still be a $71 million unfunded liability at the end of the amortization period.[16]

Unfortunately, we expect that the Josiah Bartlett Center and many in the state legislature will continue to obscure the real issues.  On March 9^th, the Josiah Bartlett Center will hold a special presentation for the legislature with outside “Defined Contribution experts”.  Many of these experts will likely be high powered financial executives with a definitive interest in promoting the spread of Defined Contribution plans.  The NHRS is a platform that benefits approximately 50,000 active works and 27,000 retired workers. Transitioning to a DC plan would benefit Wall Street by introducing 77,000 new individual customers.  We hope that the public will be able to use this paper to see through the spin and understand the real facts about the Retirement System and the Defined Contribution proposal.