SADOW: The Reckoning Has Come For Louisiana’s Underfunded Pensions

Even as Louisiana seems to have Wuhan coronavirus pandemic expenses covered and adequate unemployment insurance reserves, it will see significantly higher expenses from Medicaid and the earned income tax credit as a result of the economic attenuation from gubernatorial responses to the virus. But the real busting of its fiscal year 2021 budget comes when adding in extra pension costs.

Currently, those two extra expenditures for the budget year starting July 1 track at about $140 million. But this doesn’t include additional obligations due to pension funds because of the large market downturn as economic consequences of the pandemic began to bite.

This is because accounting standards dictate that a government pension fund should not have an excessive unfunded accrued liability, or the amount predicted paid out minus contributions and investment changes, 30 years in the future. Thus, in Louisiana each year a computation is made about the amount left unfunded and amortized over the next 30 years, which then should be paid that year above forecast investment gains (according to statute an assumed rate of return fixed by a panel) and contributions. These contributions are a mix of an employee share, 8 percent for most, and an employer share which starts at a base but then elevates to whatever level necessary to make the next year’s payoff of the UAL.

However, there’s another component in Louisiana’s extra annual payments. A constitutional amendment that took effect in 1989 required the UAL from the four statewide systems – Louisiana State Employees Retirement System, Teachers Retirement System of Louisiana, Louisiana School Employees Retirement System, and Louisiana State Police Retirement System – from their inceptions to that year be paid in full in 40 years, Unlike the other from then on with its rolling requirement 30 years out, this remaining amount must go off the books in the next nine years. The remaining initial amounts for LASERS and TRSL, systems which together have 95 percent of the current total UAL of $18.2 billion for all statewide funds, are $3.1 billion.

State taxpayers face the most exposure with LASERS and, to a lesser degree with TRSL. For the latter, local taxpayers pick up most of the costs, with the state on the hook for just the one-eighth of the total membership in higher education.

Unfortunately, LASERS and TRSL have aggravated this exposure through historically poor performances with their investments. Regrettably, for many years the state allowed systems to forecast unrealistically high assumed rates of return that set employer contribution rates too low, and even with that decreasing over the last several years it still remains above the national average of such pension funds, which itself may be too optimistic.

The pair could have compensated for that gap with superior investment returns. Instead, over the past ten years, LASERS treaded water compared to other similar plans among the states and performed 1.2 percentage points worse that those for the past five years, at only 5.6 percent annual increases, while TRSL has done better than its peers by about a point for each period, at 7.8 percent average return over the past five years.

Still, the Standard and Poors 500 index increased 49 percent over this period, so that’s nothing to write home about. And, in any event those averages didn’t match the assumed returns. Focusing on LASERS given the limited taxpayer exposure on TRSL, it particularly found itself vulnerable because of the declining number of state employees that lead by 2019 its number of active members – paying into the system – to annuitants – drawing from the system – is at a stunningly low 0.8 (or more retirees than payees), compared to the national average of 1.5.

A decade ago raising the average required contributions from the state would have to offset the folly of not funding the system for nearly 40 years now that it began to shed contributors (and keep in mind its UAL problems would have become far more aggravated if the state hadn’t reduced the size of the workforce). So, it doubled its contribution over the past decade, but that still wasn’t enough to make any significant dent in the UAL. For nearly a decade it has seem more outflows than inflows into its fund – meaning the employer contribution never reached high enough – to the tune of $3.5 billion while its balance hovered around roughly $10 billion to $12 billion. Its UAL improved only from 60.8 to 64.1 percent funded, well below the national average of 75.4 and recommended level of 80.

Thus, by FY 2020 the average LASERS contribution rate was a massive 40 percent. And because of a 25 percent market downturn heading into FY 2021, expect those rates to jump significantly because the funding ratio will drop significantly. History shows a similar-sized drop between 2008-09 shaved 6.8 percentage points off that ratio.

For FY 2020, LASERS was in line to collect around $760 million from state contributions. Assuming a percentage increase in the UAL similar to that between 2008-09 that requires offsetting, and that the “normal” increase from 2019-20 (needed draw down the UAL) was about the same percentage but in a bull market, that implies a 20 percent total state share increase, or $152 million more for FY 2021. Keep in mind about three-quarters of that total around $912 million goes to paying off the initial UAL plus keeping the remaining UAL within preferred boundaries.

Throw in the small portion, about 15 percent (given the higher salaries of higher education employees) of TRSL – with about 50 percent more assets – liable to state taxpayers, and that’s another $34 million. Even discounting the few million more needed to back the other, smaller state systems and the other two state systems (and subtracting out half of the increase because it already was budgeted prior to the crisis), and you’re looking at $93 million extra personnel expenses due to the financial aftershocks of the crisis (assuming equity markets don’t move much through June).

It’s an imprecise figure, because LASERS has only just over half its investments in equities. Unfortunately, compared to national peers, it has relatively less in cash, less in fixed income (which suffered fewer losses) investments, and more in riskier alternative investments that likely did even poorer than equities. It’s quite possible LASERS’ portfolio fell in value even more than equities markets.

Overall inferior management of Louisiana pension funds along with an indifferent policy-maker attitude historically towards rectifying the past twin mistakes of underfunding an overgenerous set of retirement benefits (only recently initiating catch-up efforts) set the state up for a large reckoning when markets turned sour. To state taxpayers’ chagrin, that day has come.



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