Investment Strategy Explained in Response to Recent Report on State Pension System

A statement from the State Retirement Agency’s Chief Investment Officer responds to the most recent critical report of the Maryland Public Policy Institute.

About half of Maryland’s counties participate in the State Pension System for pension coverage for their employees. Those counties pay employer contribution to the System. All counties provide funding for teacher pensions, also a part of the State Pension System, through contributions to local Boards of Education. Maryland counties and municipalities have two seats on the State Pension Board of Trustees.

The Maryland Public Policy Institute has regularly offered criticism of the State Pension System’s investment strategies, and specifically, to the fees paid to active investment managers on Wall Street.

The recent report by the Institute points to fees paid by the State Pension System to investment advisors might be better spent on reducing the System’s unfunded liability, stating,

In 2017, the total estimated fees for Maryland was $506 million. For all 33 states, the total fee load was $9.83 billion, despite the median state underperforming a passive
composite index. Capitalizing the fee load at 5 percent suggests a reduction in unfunded liability of $200 billion, assuming the indexes continue to outperform the states’ complex constructed portfolios.

In a statement in response to this report, entitled, “Think Tank’s” recent work of fiction, the State Retirement Agency’s Chief Investment Officer provides a pointed critique of that report, and offers information to explain the basis for the System’s investment strategy and past practices.

CIO Andrew Palmer states that the figures used in the MPPI report are inaccurate,

MPPI claims that the System paid $505.6 million in management fees in the fiscal year ending June 30, 2017, which includes an assumption for performance-based compensation (known as carried interest) earned by the System’s asset managers. This is an assumption not based on actual historical experience or quantitative modeling, but rather, it was simply made-up. This fabricated number overstates the amount of the System’s most recent performance-based fee calculation by an astonishing $84.6 million, or nearly 97%. Errors of this magnitude have a profound impact on the results of the report, rendering it completely unreliable.

Later in the report, Palmer shares how the Pension System’s careful mix of active and passive investment strategies has paid off, stating,

The System pays careful attention to ensure that it is compensated for the higher fees it pays to active managers. In efficient asset classes where the likelihood of successful active management is low, the System employs a predominantly passive strategy. As of March 31, 2018, the passive investments represented 18.3% of the total fund, or roughly $9.5 billion. In inefficient asset classes and asset classes that cannot be managed passively, active strategies are utilized. Table 2 below shows that the System has added value, net of all fees and expenses, over a fully passive alternative to its asset allocation. While not shown, the System achieved these superior returns while experiencing lower return volatility than the Passive Benchmark.

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From “Think Tank’s” recent work of fiction, by Andrew Palmer, CIO

For more information, read the letter from State Pension Chief Investment Officer Andrew Palmer.

For background, see the 2018 State Pension Fund Investment Performance Report from the Maryland Public Policy Institute.

Article Offers Practical Solutions to the Public Pension Crisis

A retired Harvard-educated lawyer argues for sharing risk as a fix to underfunded pension systems.

An article on MuniNet Guide offers a model pioneered in New Brunswick as a solution that could be implemented by states and local governments throughout the US.

risk
A shared-risk model could fix public pensions, a lawyer leading the non-profit, Pro Bono Public Pensions, argues.

The shared-risk model would bring employees and employers to the table to define a set of sustainable pension benefits, including pension payments computed solely on base salary, and contribution costs shared proportionally by employers and employees.

The shared-risk model would also set out a goal of 120% funding for pension liabilities.

Sit-and-wait strategies dependent on long-time improvements in revenues or investments are eschewed by the article’s author, who also laments the push to convert public pension plans to 401(k)s. Both of these methods have been present in policy discussions relating to Maryland’s pension system, in which about half of Maryland’s counties participate.

The article describes the urgency of the public pension crisis, stating,

It’s time to solve this policy dilemma, which is straining state and local budgets and crowding out vital investments in education, healthcare, and infrastructure. It’s time to stop believing that anything less than 100% funding is realistic and that future legislatures and taxpayers will fund any shortfall. It is time to account properly for future liabilities by adopting a risk-adjusted rate of return and budget with realistic contributions.

For more information see Embracing Shared Risk and Chapter 9 to Create Sustainable Public Pensions.

 

Round-up of the 2018 Session for Counties

MACo’s legislative efforts earned an 80% success rate – and as usual, the counties’ voice makes a difference in Annapolis. Bills we support are more likely to pass, and bills we oppose are more likely to fail.

2018 Legislative Results Infographic

MACo’s legislative initiatives, priorities, and positions are directed by its Legislative Committee. This body comprises elected representatives from all of MACo’s members – the 24 county jurisdictions (including Baltimore City).

The “one county, one vote” system of deciding the Association’s legislative strategies, ensures that all counties have an equal voice. All 24 jurisdictions participated regularly in the weekly meetings throughout the session – where they also engaged with policy leaders and advocates who joined the meeting to address county leadership.

Our policy staff have compiled updates and results on all of the bills the Legislative Committee decided to take action on this year.

For the 2018 End of Session Wrap-up for each subject MACo covers, click below:

2018 End of Session Wrap-Up: Assessments and Taxation

2018 End of Session Wrap-Up: Business Affairs

2018 End of Session Wrap-Up: Disparity Grants

2018 End of Session Wrap-up: Economic Development Tax Credits

2018 End of Session Wrap-Up: Education

2018 End of Session Wrap-Up: Elections

2018 End of Session Wrap-Up: Employee Benefits & Relations

2018 End of Session Wrap-Up: Environmental Legislation

2018 End of Session Wrap-Up: Finance and Procurement

2018 End of Session Wrap-Up: Government Liability & Courts

2018 End of Session Wrap-Up: Health & Human Services

2018 End of Session Wrap-Up: Housing & Community Development

2018 End of Session Wrap-Up: Intergovernmental Relations *MACo Initiative Area*

2018 End of Session Wrap-Up: Parks & Recreation

2018 End of Session Wrap-Up: Pensions

2018 End of Session Wrap-Up: Planning & Zoning

2018 End of Session Wrap-Up: Property Taxes

2018 End of Session Wrap-Up: Public Information & Ethics * MACo Initiative Area *

2018 End of Session Wrap-Up: Public Safety and Corrections

2018 End of Session Wrap-Up: Road Funding * MACo Initiative Area *

2018 End of Session Wrap-Up: School Construction * MACo Initiative Area *

2018 End of Session Wrap-Up: State Budget & Fiscal Affairs

2018 End of Session Wrap-Up: Tax Sale Bills

2018 End of Session Wrap-Up: Transportation and Public Works

2018 End of Session Wrap-up: Wynne Tax Bills

2018 End of Session Wrap-Up: County Tax Revenues

2018 End of Session Wrap-Up: Other Tax Bills

2018 End of Session Wrap-Up: County Pensions

An overview of MACo’s advocacy on legislation affecting county pension systems in the 2018 General Assembly. 

Follow links for more coverage on Conduit Street and MACo’s Legislative Database

Push Icons-DEFEATED

MACo successfully opposed a bill that would have imposed
several mandates on county and municipal pension systems, upsetting the structure of benefits and programs available to public safety officers injured on the job. The retroactive and finely prescriptive nature of the bill would have overturned a wide range of reasonable local decisions, and could have created legal and tax issues in implementation. House Bill 971 proceeded through the House of Delegates with amendments recommended by MACo, but the bill did not advance in the Senate. Bill Information | MACo Coverage: Disability Pension Bill Advances, With Major Amendments

Push Icons-NOT IDEAL

MACo opposed a bill that increases the limit for a normal service allowance for a member of the Law Enforcement Officers’
Pension System from 60% to 65% of the member’s average final compensation. While House Bill 1042 has a very minor anticipated fiscal effect on county governments, MACo requested an opt-out for county governments that participate in the State Pension System, a courtesy that has been extended before by the State for plan changes. Unfortunately, the legislation passed the General Assembly on the final day of the legislative session without MACo’s amendment and now awaits the Governor’s signature. Bill Information | MACo Coverage: Pension Benefits Increase Would Create an Unbalanced System

 

For more information on pensions legislation tracked by MACo during the 2018 legislative session, click here.

In Search of a Window of “Opt-outunity”

MACo seeks options for county government members of the State Pension System with regard to legislation to increase the maximum benefit allowance under the Law Enforcement Officers’ Pension System (LEOPS).

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Senator Eckardt spoke in support of county budget security at the hearing on HB 1042.

Legislation has passed the House of Delegates to increase the maximum benefit allowance that law enforcement officers might attain in the State’s Law Enforcement Officers’ Pension System. On March 22, the bill, HB 1042, which does not have a Senate companion, had a hearing before the Senate Budget and Taxation Pensions Subcommittee.

Seven Maryland county governments participate in the State’s Law Enforcement Officers’ Pension System. These include Allegany, Caroline, Dorchester, Harford, Kent, Queen Anne’s, and Worcester Counties.

At the hearing, MACo Research Director Robin Eilenberg presented an argument for adding an opt-out provision to the bill. Such an amendment would provide county government participants in the Law Enforcement Officers’ Pension System with a choice as to whether or not to sign-on to the new benefit levels.

From MACo’s testimony:

An amendment could resolve this county mandate. There is precedent for providing county members of the state system with an option to join the benefit enhancement, too. Such an option could provide a discrete amount of time, for example 12 months, for a county government to determine whether they would join the enhancement.

There is precedent for allowing county governments an option like this. When the State enacted broad enhancements to several of its pension systems in the early 2000s, county participants were given a certain amount of months to opt-in or out of the changes. Those county participants had joined the pension system under a certain benefit structure, and enhancements to benefits increase pension contributions and pension liabilities for county government participants.

Cost estimates for this particular benefit change are not high. However, those costs will only increase with increases to officer salaries. In addition, the enhancement change creates a deeper divide between retirement benefits for local law enforcement and other county employees.

Senator Eckardt is a member of the Senate Budget and Taxation Pensions Subcommittee, and spoke at the hearing about the need to protect county budgets. Senator Eckardt represents Caroline, Dorchester, Talbot, and Wicomico Counties.

MACo will continue to advocate for an amendment to allow counties to opt-out of this pension enhancement.

For more information, see Pension Benefits Increase Would Create an Unbalanced System

Investments Come In-House with Pensions Bill

Legislation to create an investment division within the State Retirement Agency has proceeded smoothly through the Maryland Senate. The change would bring Maryland’s System into line with many other state pension systems of similar size, and could save costs in the long term.

On Thursday, March 15, a bill to create an internal investment division within the State Retirement Agency passed the Maryland Senate on what is called “second reader.” After a quiet hearing in the House, the bill passed that chamber with only a few technical amendments, and all signs now indicate that the bill will pass the General Assembly this year.

Additional amendments were described on the floor of the Senate on Thursday by Senator Guy Guzzone, Co-Chair of the Joint Committee on Pensions. The Senate’s amendments would establish an objective criteria committee to assist the State Pension Board in setting compensation for the Chief Investment Officer and positions in the investment division created by the bill.

As described in the fiscal note on the bill, compensation and operating expenses of the investment division are subject to appropriation from the accumulation fund of each system and are not paid by participating employers. Administrative fees, including those paid by county governments who participate in the State system, will continue to be used to support other divisions of the State Retirement Agency.

This legislation marks a major change in the State Retirement Agency, and one that could be prudent financially, resulting in better returns for the System. As described by Senator Guzzone,

“What we are trying to do is help the division perform better in each asset class. So we are giving them some authority to hire and raise salaries, commensurate with the industry. Hopefully that will lead to some success in those areas.”

For more information, see: SB 899 State Retirement and Pension System – Investment Division

Broad Unfunded Disability Allowance Would Disrupt County Systems

MACo Research Director Robin Eilenberg testified in opposition to House Bill 971, Local Pension Systems – Special Disability Retirement Allowance”, before the House Appropriations Committee on March 6, 2018. The bill would mandate and establish a new structure of pension benefits in county and local governments for special classes of public safety employees.

Counties that already negotiate benefits for these special classes would potentially have current systems undermined. Additionally, participating counties generally already engage in practices regarding finding other work for public safety employees who has an on-the-job injury who can no longer perform their duties. Counties also generally ensure retirement benefits at 60% of final compensation for injuries that are severe enough that the individual can no long work at all.

As an unfunded mandate that also applies retroactively to individuals that would be eligible for this allowance, the disruption of current systems and the costs to counties could be significant.

From MACo Testimony:

In the case of a public safety employee who suffers an on-the-job injury, county governments seek to get that employee back to work as quickly as possible. When the injury will not allow for a return to a duty post, the county’s first objective is to find another position for that employee. When an injury is so severe that work is not an option, the county governments MACo consulted generally ensure that a former employee is provided with retirement benefits and other income that equal 60% or more of the employee’s average final compensation. In some counties, the benefits may be greater than that amount (and greater than the amounts provided in the legislation), subject to union negotiations.

Under this legislation, those provisions might be inadequate. For example, finding an injured employee a new county government position and providing appropriate training and re-training would not be sufficient, unless the new position includes substantially similar pay, benefits, and advancement opportunities as the employee’s former post. Even in counties with large public safety departments, fulfilling these standards while seeking to place an employee in a vacant post would pose challenges, and in smaller departments, it may not be possible.

If it is not possible, then the county would be required to provide an injured employee with a permanent retirement allowance equal to 100% of his or her final pay, or an annuity of the employee’s retirement contributions and a permanent retirement allowance equal to 2/3 of his or her final pay. A former employee in such a scenario would likely find employment elsewhere, while still earning a level of retirement benefit typically reserved for employees who are unable to work at all.

In addition to these issues, the bill’s provisions would also apply retroactively – to anyone injured on the job in a law enforcement, public safety, or emergency response position since July 1, 2015. Opening the door to new benefits for cases already settled creates administrative and cost concerns, in addition to creating fiscal unpredictability in a county’s debt profile.

As an unfunded mandate that interferes with the local ability to provide coverage for special circumstances while sustaining retirement support for a broad spectrum of county government employees, MACo requests an UNFAVORABLE report on HB 971.”

Follow MACo’s advocacy efforts during the 2018 legislative session here.

Pension Benefits Increase Would Create an Unbalanced System

MACo Research Director Robin Clark Eilenberg testified in opposition to House Bill 1042, “Law Enforcement Officers’ Pension System – Benefit Cap Increase”, before the House Appropriations Committee on February 22, 2018. This legislation increases the limit for a normal service allowance for a member of the Law Enforcement Officers’ Pension System from 60% to 65% of the member’s average final compensation.

Seven counties currently participate in the Law Enforcement Officers’ Pension System (LEOPS), and this would require an automatic increase in the benefits provided to eligible law enforcement officers in those jurisdictions. This change would possibly change pension schedules and create an imbalance between law enforcement officers and other county employees.

From MACo Testimony:

For county governments that participated in the Law Enforcement Officers’ Pension System, this legislation effects an automatic increase in county law enforcement pension benefits, and a new variable in county government pension contributions. The changes in this legislation could widen the gap between retirement options for one portion of the county workforce—law enforcement—and all other county employees. It also could create costs, although the fiscal effects are difficult to predict alongside other law enforcement benefits, such as early retirement options.

An amendment could resolve this county mandate. There is precedent for providing county members of the state system with an option to join the benefit enhancement, too. Such an option could provide a discrete amount of time, for example 12 months, for a county government to determine whether they would join the enhancement.”

Follow MACo’s advocacy efforts during the 2018 legislative session here.