In the latest Florida Retirement System (FRS) actuarial valuation report, the expected investment rate of return was lowered from 7.65% down to 7.60% in recognition that the system’s previous investment return assumption was too optimistic. Unfortunately, while it is a small step in the right direction, the downwardly adjusted 7.60% rate is still too high to stem the consistent pattern of overly optimistic assumptions identified by my Reason colleague Anthony Randazzo last fall.
To put Florida’s tiny change in perspective—earlier this year Kentucky changed its assumed return from 7.25% to 5.25%, and Connecticut lowered its assumed return from 8% to 6.9%. Next to these, Florida’s change looks at best meaningless, or at worst irresponsible. And it turns out Florida’s actuarial advisors agree.
The FRS plan actuaries at Milliman (one of the largest actuarial advisors to public plans in the country) wrote in their annual letter accompanying the most recent actual valuation:
The investment return assumption, which was set by the 2016 FRS Actuarial Assumptions Conference, is a prescribed assumption as defined by Actuarial Standard of Practice No. 27 (ASOP 27). The prescribed assumption conflicts with our professional judgment regarding what would constitute a reasonable assumption as defined by ASOP 27.
While this may seem like pretty dry stuff, in actuarial speak it’s a pretty sick burn. The actuaries for the plan are effectively saying: “Just so everyone knows, they gave us these clothes to wear and we are modeling them for you. But even we can see these clothes have no taste.”
Actuaries call this a “qualifying statement,” and professional codes of conduct and ethics guidelines require them to publish statements when their clients (like a public pension fund) give them assumptions to use that they think are unreasonable. By pointing out that they think 7.6% is unreasonable, the plan actuaries are covering themselves and announcing that they’ve been trying to warn the FRS board, but that FRS isn’t listening to their view that the assumed return should be less than 7.6%.
We’ve written extensively on the need to rethink funding policies in public pension plans and the challenges associated with plans being generally reluctant to lower their expected rates of return at a pace or amount commensurate with the global decline in interest rates since the early 2000’s.
Maintaining assumed rates of return that are too high allows pension plans to promise growing benefits to state and local workers while also keeping taxpayer costs artificially low because the plan will incorrectly assume that it will reap higher investment returns over time than it actually will (thus shorting required annual pension contributions from employers and employees. In the long-run, this helps lead to the creation of new unfunded liabilities because the fund expects to have a higher amount through investment returns than it will, and taxpayers will ultimately be responsible for paying off these liabilities plus the interest on the debt that will be required to make promised payments.
The Florida legislature recently took a good step by changing the default retirement plan for new workers in an attempt to reduce the number of people being hired to the FRS defined benefit plan. And a primary reason to reduce that headcount is the unrealistic assumed rate of return being used by FRS. The warning from the actuaries at Milliman helps to make this point too.
Looking forward, there’s a need for serious funding policy reform in Florida. It should start by the legislature, governor, and FRS board taking qualifying statements like Milliman’s seriously so as to not keep kicking the can.