South Carolina’s State Pension System – Playing The Blame Game
I was asked recently who was to blame for the rising unfunded liability in our state retirement system. Pension plans are complex and assigning blame assumes a simple cause where none exists.
Many factors are used to determine the future value of a lifetime payout for a state retiree. Certain assumptions are made such as the assumed annual rate of return that an employee should expect during his participation in the plan and the employee’s life expectancy.
The assumptions are used in a formula to determine “what should be.” This should be amount is compared to “what has happened” – i.e. the actual amount of contributions that have been paid into the plan and the real annual rate of return. The difference is the unfunded liability.
What caused our unfunded liability to increase 30% over the last 20 years? Federal mishandling of the economy and a series of reactive decisions made by the Legislature, the voters and the state plan fiduciaries overseeing the pension plan. These decisions involved the plan investments and the contribution rates for employees and employers.
The investment decisions by our pension plan managers were a defense to decisions made in Washington during the 1990’s. During that decade, Congress passed several acts that deregulated our banking system. Banks were allowed to merge with other banks across state lines. They were allowed to expand their services beyond loans and savings accounts. We ended up with large banks providing all types of commercial, investment and insurance services nationwide. Then the economy expanded again and the Federal Reserve played around with interest rates more than normal to control growth.
The Fed’s interest rate manipulation cracked the foundation of fundamental pension investment strategy – a strategy that historically depended upon a viable fixed rate of return from conservative investments. Simply put, the lower rate earned from bonds and cash accounts forced pension investors to take greater risks in stock investments to meet the plan’s assumed rate of return. Increased risk meant increased investment fees.
In reaction to the lack of return from fixed investments – investments that our pension assets were constitutionally required to be invested in, our Legislature put a constitutional referendum on the November 1996 ballot that allowed our state pension funds to be slowly invested in stocks (equities). The referendum passed and from 1997 to 2008 the percentage of total pension plan assets invested in equities increased dramatically as the stock market became increasingly volatile. Let’s just say that our timing was about as good as most individuals who invested in the market during those years.
In the years since the 2008 market crash and bank failures, the Federal Reserve has held interest rates at almost zero. Their decision has accelerated the unfunded liability crisis in pension plans across the country. Whether the plans have been corporate or governmental, almost all of them have been negatively impacted. South Carolina is one of thirty-five states addressing unfunded liability problems. The other fifteen states were just lucky, like your contrarian neighbor who always seems to win in a down market.
The other series of decisions were the annual ad hoc cost of living adjustments (COLAs) granted to retirees to counteract inflation. Generally, they ranged from 1% to 2% each year but were not specifically funded. These decisions added to the unfunded liability, but on a smaller scale than the investment decisions. Ad hoc COLAs were stopped in 2008.
During our first meeting of the Joint Committee on Pension Systems Review, someone asked how we had gotten to this point. The consensus of the committee was that our purpose was not to assign blame. Personally, I do not believe that any voter, legislator, investment manager, state employee group, state retiree group or lobbyist intended to harm the state pension plan. I do believe that most did not understand the complexity of what they faced or the ramifications of their decisions.
However, I do hold the Federal Reserve and our Congress responsible for meddling in a market economy that they do not understand and cannot possibly control for any length of time. Their interest rate manipulations have turned this country into a nation of debtors and has all but killed the incentive to save money. They have put a trillion dollars of pension benefits at risk with no solution but the doubtful hint of a government bailout. That’s who I blame.