Category Archives: Government workers and pensions

VRS Earned Above-Average Return in Fiscal 2017

A welcome piece of good news from state government: The Virginia Retirement System earned an 11.8% return on investment for the fiscal year ending June 30. The performance exceeded the 7% average return the system assumes for purposes of setting state and local contributions, and it is a big improvement from the previous two years. VRS assets now stand at a historic high of $74 billion, reports the Richmond Times-Dispatch.

Those numbers came from Del. Robert D. Orrock Sr., R-Caroline, after a semiannual meeting of the Joint Legislative Audit and Review Commission (JLARC) yesterday. The T-D article did not break down the overall VRS performance by investment category.

According to a March 31 VRS performance summary dated March 2017, investment returns over the first three quarters of the fiscal year were led by a strong performance of the pension fund’s equity portfolio, but most other investment categories did well, too:

Public equities — +13.2%
Investment-grade fixed income — -1.1%
Credit strategies — +8.0%
Real assets — +8.0%
Private equity — +12.2%
Strategic opportunities portfolio — +8.1%

The above-average performance may forestall the perceived need to undertake any additional reforms of the state pension fund or for state and local governments to increase their contributions. A year ago, VRS unfunded liabilities were pegged around $22 billion. The big question now: Can VRS replicate the performance next year? Can U.S. and global stock market averages continue their levitating act?

UVa Attacks Administrative Bloat in HR Consolidation

The University of Virginia has downsized its Human Resources staff from 270 employees to 240, and could slim down by another 40 full-time-equivalent positions as it merges the HR departments of its academic and medical divisions, reports the Daily Progress.

The staff restructuring project, which UVa calls UFirst, is part of the university’s multi-year Cornerstone Plan, passed by the Board of Visitors in 2013, to save money on organizational costs. The current system is afflicted with “systemic inefficiencies and redundancies,” including “70+ disjointed systems that collect HR data and five different learning management systems across three entities,” states the UFirst website devoted to the new HR system.

UFirst is designed to cut down on bureaucratic waste and lead to a better employee experience. “UVa will be positioned to continue to attract and retain the best talent in support of excellence in education, research, patient care and public service,” UVa spokesman Anthony de Bruyn told the Daily Progress.

The university has experienced some pushback on the changes, as evidenced by an anonymous letter to the Charlottesville newspaper signed by “A dedicated and concerned UVa employee.”

The employee claimed that the senior university officials have not kept affected employees in the loop about the latest round of changes, reports the Daily Progress. “This is not the way people should be treated,” the employee wrote. “I have always been very proud of working at UVa and can’t believe we are being treated with such disrespect.”

De Bruyn says the university has posted information on the UFirst website and is holding informational meetings this month.

Bacon’s bottom line: Good for UVa! It’s possible that the university could do a better job of communicating with employees. But, let’s face it, when departments are consolidated, employees lose their jobs, and other people find themselves reporting to new bosses, it’s impossible to make everyone happy. The larger lesson here is that UVa, at long last, is taking concrete action to reduce the size of its burgeoning bureaucracy. A 26% reduction in H.R. manpower is serious business.

Indeed, UVa could be criticized for taking so long to execute the change. Higher-ed restructuring legislation enacted 12 years ago emancipated UVa from rigid adherence to state personnel policies, and the university announced its intention years ago to wring out savings through process and administrative reforms. By private-sector standards, the changes have been sluggish. But this a public university, so we should be happy to see reform of any kind. Hopefully, the administration won’t be spooked by the publicity and will carry through forthrightly.

Virginia Commonwealth University, it is worth noting, just received Board of Visitors approval for major HR reforms as well. As taxpayers and parents of students, let us hope these HR reforms portend even more serious attacks on administrative bloat in the years ahead.

Virginia Pension Liability Gap: Still Worrisome

Graphic credit: Pew Charitable Trusts

Another year of tepid economic growth and another year of no progress on Virginia pension liabilities.

Nationally, the gap between liabilities and assets for state pension systems grew 17% in fiscal 2015, reaching $1.1 trillion, according to an annual survey by the Pew Charitable Trusts. Under-performing investments was the biggest driver, accounting for $125 billion of the gap. But even if investment performance had lived up to expectations, the national gap would have increased $30 billion anyway.

Virginia, which prides itself on its AAA bond rating, is hardly an example of fiscal rectitude compared to other states when it comes to funding its state and local pensions. On the one hand, the Virginia Retirement System (VRS) assumes a modest 7% compounded growth rate for its investment portfolio, while state pension plans on average assume a 7.6% annual return. Virginia’s conservative assumption protects it against the downside risk of disappointing investment returns.

On the other hand, Virginia has not been injecting as much money into the pension as needed. Pew has constructed a measure — net amortization — that tracks whether public pension contributions would have been sufficient to reduce unfunded liabilities had portfolio returns met investment assumptions that year. Explains Pew: “Plans that consistently fall short of this benchmark can expect to see the gap between the liability for promised benefits and available funds grow over time.”

According to Pew’s calculations, Virginia needs to contribute $2.5 billion a year. In 2015, the state did meet that goal — actually, it exceeded the goal by 1%. But 2015 followed a dismal shortfall (visible in the chart above) in 2014.

Virginia’s “funded ratio” was 75% in 2015, about the same as the previous year. That is marginally better than the 72% for the funded ratio of the nation as a whole. Of course, that national figure is skewed by the horrendously low ratios of Kentucky, Illinois and New Jersey, which are more or less destined by the iron law of mathematics to become the next Puerto Rico.

Virginia needs to do better. At the current level of state contributions, the VRS is at the mercy of the markets to perform as expected. If we’re lucky and maintain contributions, things will work out. If not, we’re in for a world of hurt.

What the Obama Giveth, the Trump Taketh Away

Slash and burn

The federal budget sequestration may have kept a lid on escalating federal budget deficits, a good thing, but it was a disaster for Virginia’s economy. The cap on federal spending hammered a Northern Virginia economy built largely around the Pentagon. The ascension of Donald Trump to the presidency signaled a possible return to the region’s glory days as the new president promised to increase defense spending by $50 billion.

But the president has created massive uncertainty with a vow to slash discretionary spending in civilian programs and bureaucracies. The Washington Post is all in a dither:

The cuts Trump plans to propose this week are also expected to lead to layoffs among federal workers, changes that would be felt sharply in the Washington area. According to an economic analysis by Mark Zandi, chief economist for Moody’s Analytics, the reductions outlined so far by Trump’s advisers would reduce employment in the region by 1.8 percent and personal income by 3.5 percent, and lower home prices by 1.9 percent. …

Trump’s emphasis on defense spending might provide a buffer for Northern Virginia, although, as noted previously on this blog, there are some within his administration who believe that the Pentagon civilian bureaucracy needs to be whacked down to size in order to free more resources for fighting forces. Under a serious effort to rebuild the U.S. Navy, Hampton Roads’ military bases and shipbuilders could be big beneficiaries.

We can’t say anything with certainty until Trump releases the details of his plans later this week. But at this moment in time, it looks like the new budgetary policies could be a mild plus for Virginia with boosts in defense spending offsetting cuts in other areas. Conversely, Maryland and Washington, D.C., with their large non-military exposure, could be in for a world of hurt

Adding to Washington’s woes…. The metro area’s job performance in 2016 has been revised downward. Reports the Washington Business Journal: “The D.C. region added 55,600 jobs in 2016, according to final data released Tuesday by the Bureau of Labor Statistics — about 16,800 fewer than the agency had initially counted.”

“We are talking slashing and burning several different agencies on the discretionary, non-defense side. That could have a pretty chilling effect for the local economy,” said Clifford Rossi, a professor of the practice at the Robert H. Smith School of Business at the University of Maryland-College Park.

Rossi agreed that the revised job growth numbers reveal an economy that was weaker than it originally appeared, and that the federal spending cuts proposed by Trump could have a compound effect on the regional economy.

Bacon’s bottom line: Actually, the loss of 1.8% employment and 3.5% income is no worse than what dozens of other metros experienced in the last recession. But have compassion! Washington has never been through anything like this before.

(Hat tip: Rob Whitfield)

The Biggest Lie of All: Government Can Pay Its Pensions

State-local pensions are just one aspect of unsustainable government spending.

State-local pensions are just one aspect of unsustainable government spending.

Many people get infuriated by President Trump’s many inconsequential falsehoods — does it really matter how big his inaugural crowds were? — but they remain sanguine about the trillion-dollar untruths that our public pension system is built upon. The big lie that governments will make good on retirement promises to their employees is not merely mendacious but it is destructive. Millions of Americans have built their retirement plans around a fiction. And when the Ponzi scheme collapses, government workers won’t be the only ones to suffer.

In his latest column, George Will recites some of the more glaring examples of how the big lie is unraveling.

The Dallas police and fire fund recently sought a $1.1 billion transfusion, a sum roughly equal to the city’s entire general fund budget yet still not close to what is needed. Last year Illinois reduced its expected return on its teacher retirement fund portfolio from 7.5% annually to 7% (which is arguably still too optimistic), meaning that the state needs to add $400 million to $500 more to the fund — annually. Last September, the vice chair of the agency in charge of Oregon’s pension system wept when speaking about the state’s unfunded pension promises of $22 billion. Nationally, unfunded liabilities for teachers, not counting other government employees, amount to at least $500 billion.

And don’t get me started on the fact that the Medicare hospital trust fund is expected to run out in only 12 years and Social Security trust fund in 16 years, at which point payroll tax revenues will be insufficient to maintain full benefits… Or the fact that the pensions run by companies in the S&P 1500 Index were unfunded to the tune of $562 billion.

Some of the shortfall can be attributed to absurdly generous provisions of pension plans in particular states and localities, some to fiscal indiscipline by government at all levels, and some to the Fed’s seven years of near-zero interest-rate policies that have depressed returns on bond portfolios and juiced stock market gains that cannot possibly be replicated in the years ahead.

Will concludes with the salient point:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

Few elected officials are willing to deal with the issue that offers no immediate political reward. Here in Virginia, one of the few, House Speaker William J. Howell, R-Stafford, has announced that he will not seek re-election.

Thanks in part to Howell’s stewardship, Virginia’s budget, backed by a AAA bond rating, is in better shape than those of many other states. But the U.S. learned after the 2007 real estate crash what AAA bond ratings are worth when the economy shifts from normal conditions to crisis conditions. Boomergeddon is coming. The only question is when.

Thinking Sensibly about Virginia State Police Salaries

Lawmakers proposes big increase for Virginia State Police salaries.

Virginia State Police graduates. Lawmakers propose a big increase in starting salaries. Photo credit: InsideNova.com.

Virginia State Police troopers would receive a $7,000 pay raise — a 22.3% boost for starting salaries — under a budget proposal that also would provide a 3% pay raise for all state employees, reports the Richmond Times-Dispatch. The dramatic pay hike comes in response to deteriorating morale and a surge in state trooper departures.

Is such a big pay raise justified in the midst of a budget crunch in which lawmakers are forced to cut other programs?

Clearly, the state police have a massive problem. In November, the agency had 257 vacancies in a sworn force of 2,148, according to the Daily Press. Over the past few years, the state police averaged six departures monthly, reports the T-D. That number increased to 13 per month in last year and shot up to 22 in just the first 20 days of 2017.

By my back-of-the-envelope calculations, paying 2,150 officers an extra $7,000 each will cost the state about $15 million per year. That is a considerable sum. However, if the pay increase staunches the loss of manpower, it will be offset by a reduced training costs. The Times-Dispatch article notes that it costs the City of Richmond about $100,000 to get a recruit trained and on the street. Assuming that the cost to the state police is roughly comparable, and assuming the pay hike reduces the number of departures back to the pre-crisis norm of six per month, the state police will need to train 80 to 90 fewer troopers each year. That would represent a savings of $8 million to $9 million. (I have made several assumptions here, which undoubtedly can be refined, but you get the gist.)

Thus, while the $15 million departmental pay raise will not fully pay for itself through reduced turnover, the adjusted cost when taking training expenses into account will be considerably lower.

Are there other ways to offset the expense? Presumably, some state police functions are more critical than others, and some offer more law enforcement bang for the buck than others. Could the troopers be relieved of low value-added tasks that soak up manpower?

For example, lawmakers enacted a policy last year as part of a bipartisan compromise on gun control, in which state police conduct background checks at gun shows. Implementing that policy cost $300,000 annually to pay for three full-time civilian positions, as the Times-Dispatch reports here. In its first six months, the program resulted in only one person being denied the purchase of a weapon at 41 Virginia gun shows. The man was wanted for failing to appear before a grand jury in September. Was that one detention worth $300,000?

Six months may not be sufficient time to fairly judge the effectiveness of the program. But that’s the kind of question we need to be asking. Instead of stroking the state police a $15 million check, legislators should ask the top brass to enumerate all the tasks state troopers are called upon to perform. How much manpower do those jobs require? What value do they provide? Can we reduce the number of troopers on payroll without harming public safety?

It seems clear that we need to increase Virginia State Police salaries, and equally clear that the state will recoup some of that expense through reduced training expenditures. However, we should not assume that the only way to pay for higher salaries is to pump more money into the agency. Perhaps we can scale back tasks of marginal value. Unfortunately, I see no indication in the news coverage of this issue that anyone has even considered that alternative.

Budget Shortfalls Will Dog States for Decades

Projected state/local budget shortfalls as percentage of GDP absent policy changes.

Projected state/local budget shortfalls as percentage of GDP absent policy changes.

Over the next 44 years, state and local governments face chronic budget shortfalls driven by Medicaid spending, government employee health care costs, and underfunded pensions, warns the U.S. Government Accountability Office (GAO) in a report issued earlier this month.

“Absent any intervention or policy changes, state and local governments are facing, and will continue to face, a gap between receipts and expenditures in coming years,” states the report. Closing that gap would require cutting spending by 3.3%, increasing revenues by a like amount, or implementing some combination of the two, stated the report.

Budgets eventually will come back into balance around 2060 when the demographic bulge of the Baby Boomer population passes from the scene, reducing pressure on Medicaid and pensions. However, fiscal pressures could become acute long before then.

The increase in health care expenditures will be relentless, drip-drip-drip year after year, driven not only by the cost of delivering care but the cost of providing care to an aging poor population. Unfunded pension liabilities are easier to sweep under the rug in the short-term but could become a crisis as pension funds burn through their accumulated assets.

States the GAO report:

While most state and local government pension plans have assets sufficient to cover benefit payments to retirees for a decade or more, plans have experienced a growing gap between assets and liabilities over the longer term. Our simulations suggest that state and local governments will need to increase their pension contributions, absent any changes to benefits or employee contributions in the future. Alternatively, state and local governments may need to take steps to manage their pension obligations by reducing benefits or increasing employees’ contributions.

Bacon’s bottom line: Analyzing the state/local government sector as a whole, the GAO report did not differentiate between the states. Clearly, some states will experience more severe budget shortfalls than others. My impression is that Virginia is better off than the average but that we still face a reckoning.

Virginia’s exposure to higher Medicaid costs should be less than the national average because Republican legislators blocked Governor Terry McAuliffe’s bid to expand the program as encouraged by the Affordable Care Act. Long-term, Virginia would have been responsible for funding 10% of the expansion. There is a trade-off, of course. The Old Dominion is foregoing an injection of federal dollars to fund medical coverage for the near-poor.

Also, Virginia did reform its state/local government pension plans under the McDonnell administration, keeping the old “defined benefit” plan for older state employees but implementing a hybrid defined benefit/defined contribution plan for new employees. State funding to the Virginia Retirement System also assumes a 7% annual return on VRS’s investment portfolio, less than the 7.5% assumed by other states. The actual return likely will be lower, I have argued, requiring everyone to pony up more cash than expected. Regardless, Virginia’s adjustment to economic reality will be less traumatic than that of many other states.

Meanwhile, House Speaker William J. Howell, R-Stafford, has been exploring a second round of reform at VRS. The state could save millions of dollars a year by paying less to outside money managers. Also, Howell has backed a 401(k)-like defined contribution plan for new employees, which shifts the risk of under-performing stock and bond indices from the state to employees.

Press reports have suggested that Howell is having difficulty getting traction. Perhaps Virginia should emulate the Social Security and Medicare Trust Fund trustees who annually publish projections of how long the Social Security and Medicare trust funds will last before the money runs out. It would be useful to know (1) how long the money in the Virginia Retirement System will last before the coffers run dry, (2) how much it will cost the state at that point to restore benefits to promised levels. Such knowledge might focus Virginians’ attention on the need to act sooner rather than later.

(Hat tip: Tim Wise.)

Tackling Virginia’s Hidden Budget Deficit

Like a black hole, Virginia's hidden budget deficit is invisible but immense.

Like a black hole, Virginia’s hidden budget deficit is invisible but immense.

Restoring a pay raise for state employees outranks pension reform in the recommendations of the Commission on Employee Retirement Security and Pension reform. The legislative commission voted yesterday to prioritize a 3% pay raise for state employees that Governor Terry McAuliffe has proposed putting on hold in the face of $1.5 billion revenue shortfall.

House Speaker William J. Howell, R-Stafford, who chaired the commission, “struggled” to keep the panel’s focus on his own priority, creation of an optional 401(k)-style retirement plan for newly hired state employees, reports Michael Martz with the Richmond Times-Dispatch. Under the current arrangement, new employees have a hybrid defined benefit/defined contribution plan.

Virginia faces a long-term unfunded liability of $23 billion for the $70 billion Virginia Retirement System (VRS). The liability mounted in the past two fiscal years as the VRS fell short of an assumed 7% investment, although the VRS reported Monday that investment returns the past 12 months, spurred by a booming stock market, achieved 8.7%.

While pushing for the pay raise, the commission gave a watered-down endorsement of Howell’s priority, recommending that the General Assembly “consider” creating a defined contribution plan.

Bacon’s bottom line: In theory, the Virginia Constitution requires the Commonwealth of Virginia to balance its budget every year. The trick is, what constitutes a “balanced” budget? Accruing $23 billion (and that’s probably under-stating the problem) in unfunded pension liabilities technically does not count as “deficit spending.” Neither does short-changing the compensation of state employees, which creates major issues for recruiting and retaining a competent workforce when long-term Baby Boomer employees retire. But these shortfalls are only one step removed from a budget deficit. They pile up future obligations just as the state would if, say, it deferred maintenance on roads and highways year after year.

Legislators face hard, hard choices in a world in which sluggish economic growth and expanding Medicaid enrollment crowd out other spending.  Short of raising taxes, which would create a new set of problems, Virginia has no choice but to radically re-think government from stem to stern.

First principle: State and local governments should focus exclusively on core functions, excel at those functions, and abandon the rest. Corollary of the first principle: It takes good employees to achieve excellence. Second corollary: It takes competitive pay and benefits to recruit and retain good employees.

Second principle: State and local government should not rack up a budget deficit disguised as unfunded future obligations that will bedevil the next generation.

Govern accordingly.

Paying University Executives for Performance

Michael Rao, Virginia's highest-paid state employee

Michael Rao, Virginia’s highest-paid state employee

The Richmond Times-Dispatch published its annual ranking of highest-paid state employees Sunday and, no surprise, university presidents and Virginia Retirement System (VRS) executives dominate the list.

I’m of two minds. On the one hand, if you want the best people running your universities and your pension funds, you have to pay them competitive salaries. Basically, you get what you pay for. Don’t expect exceptional results if you hire mediocre leaders.

The compensation of top VRS executives is largely tied to investment results. Investment mangers get rewarded if they deliver superior returns, a metric that is directly aligned with the interest of Virginia citizens. I have no problem with that. On the other hand, what do Virginia’s public university presidents get rewarded for? I know one thing: not for restraining tuition hikes.

Let’s take a look at Virginia Commonwealth University’s president, Michael P. Rao, the highest-paid state employee last fiscal year. According to T-D calculations, he earned $901,000 in fiscal 2016.

As befitting a public employee, Rao earned a base salary of $183,000. That’s a modest sum for a man running an organization with operating expenses of roughly $1 billion a year, so it’s no surprise that the Board of Visitors supplemented his base salary with:

  • $191,500 in deferred compensation
  • $72,000 housing allowance
  • $50,000 to cover personal expenses relating to his role as president
  • $7,000 for tax preparation
  • $5,000 for disability insurance from his previous contract
  • $2,160 for wireless communications
  • $42,500 for an automobile provided by VCU (and not included in the salary calculation)

Plus, he got paid a $50,000 bonus paid for meeting performance goals in 2014-2016. The T-D noted that the board will meet next week to evaluate Rao’s last-year performance and a new set of measurements to reflect the university’s objectives this year, but did not say what the performance goals were.

The VCU president’s page refers vaguely to three “themes” relating to the universty’s vision and goals: (1)  “provide all students with high-quality learning/living experiences;” (2) “attain distinction as a fully integrated urban, public research university;” and (3) “become a national model for community engagement and regional impact.”

What metrics would demonstrate progress toward achieving those goals? I’m hard-pressed to imagine.

Suggestion to the T-D: Next year, it might be worthwhile to find out exactly what performance metrics were used to calculate Rao’s bonus. As a matter of fact, it would be useful to obtain that information for every public university president. There could be no clearer indicator of university boards’ top priorities. I would be very much surprised to find that “holding the line on tuition charges” is among them.

Quantitative Squeezing

Bond yields have declined steadily for thirty years. As long-term and mid-term bonds expire and get rolled over at lower yields, pension funds generate much lower returns on their bonds portfolios. State and local funding for public pension funds has not kept pace with this market reality. Graphic credit: Wall Street Journal.

Bond yields have declined steadily for thirty years. As bonds expire and get rolled over at lower yields, pension funds have been generating lower returns on their portfolios. State and local funding for public pension funds has not kept pace with this market reality. Graphic credit: Wall Street Journal.

It’s nice to see mainstream media highlighting an issue that I’ve been hammering here at Bacon’s Rebellion for a couple of years now. A front-page Wall Street Journal article discusses how the zero-interest rate policies of central banks around the world are crippling returns on pension portfolios, making it difficult for nations and municipalities to meet their obligations.

Among the numbers cited in the article… Global pensions on average put roughly 30% of their assets in bonds. Investment-grade bonds that once yielded 7.5% a year now deliver almost no income at all. Low rates helped pull down assets of the world’s 300 largest pension funds by $530 billion in 2015.

The California Public Employees’ Retirement System (CALPERS) posted a 0.6% return in fiscal 2016. Its investment consultant, reports the Journal, recently estimated that annual returns will be closer to 6% over the next decade, shy of its 7.5% annual target.

If CALPERS is ready to admit that investment returns will remain depressed over the decade ahead, maybe it’s time for the Virginia Retirement System to do the same. The VRS assumes a 7% annual return on its portfolio — not as divorced from reality as many states, but significantly more than justified by bond returns. The problem, of course, is that acknowledging reality will expand Virginia’s public pension unfunded liabilities by billions of dollars — and nobody knows where the money will come from. So, we’ll pretend the problem doesn’t exist… until it becomes a crisis.