House and Senate Miles Apart On Pension Reform
The House has taken up a strong position on fixing pension reform that more closely represents Governor Burgum's position, while the Senate wants the status quo with bailouts and almost no reform.
Audio Above: February 22nd, 2023 edition of Watchdog Wednesday with Daryl Lies on KFYR Radio’s afternoon show.
House Floor Debate Focused On The Involvement Of The Reason Foundation’s Analysis and Involvement
The debate over pension reform has been going on for over a decade.
In this latest fight, the libertarian think-tank Reason Foundation has taken center-stage by quantifying the data and math of what many people had already been telling the legislature needed to happen.
House Majority Leader Mike Lefor, in his role as chairman of the interim committee studying pensions, invited the Reason Foundation to help him and the committee to work on the pension problem.
(I’ve been very critical of Representative Lefor on other issues, but he as well as Governor Doug Burgum deserve massive credit for taking on this issue in a serious way - something both their predecessors have long been unwilling to do.)
In 2021, the Reason Foundation issued a broad analysis of North Dakota’s pension situation.
Pensions Were Intentionally Under-Funded
One slide that illustrates the problem is Slide #9 in their presentation, showing that the legislature has intentionally under-funded the pension fund by setting contribution rates based on statute rather than math that the investment fund requires.
The state’s contribution has been 7.16% when it should have been 12.94%, this has resulted in a funding shortfall of at least $585 million since 2003.
This is an example of what I call “being cheap and pretending it is conservative”.
Past legislatures failed to properly fund the pensions at the level the math was telling them to fund it at.
State Spending And Hiring Magnified Problem
It is important to remember that in these years, the state was on a spending and hiring binge. The number of Full Time Equivalent state employees not including higher ed went from 8,366 to 9,391 - a 12% increase in 12 years. This added more future liabilities and exasperated the under-funding problem per employee.
Chasing Market Returns To Make Up For Under-Funding Has Failed
Because the legislature wanted to under-fund their share of the pension fund, the fund management was forced to chase unrealistically high market returns to make up for the legislature’s cheapness.
Slide #16 of the Reason Foundation’s presentation illustrates just how badly chasing market returns has under-performed and made the under-funding and over-hiring problems even worse.
The fund has been chasing an 8% return.
This approach has not worked since the crash of the internet bubble at the end of the 90’s - but the philosophy was based on the old ways.
Back in 2012, I wrote an Op-Ed for the Grand Forks Herald where I pointed out that this 8% target figure was way too high and part of the problem. At that time, I recommended a 6% target return rate.
Reason Foundation: Even A 6% Return Is Too Optimistic
One of the major debate points during the House Floor debate on HB 1040 was what the pension fund should target as a rate of return.
Oddly, the representatives could not agree on what the Reason Foundation Report actually said. But Slide #19 says it in plain english: even 6% is too optimistic.
This disagreement resulted in an argument between the Republicans supporting the overall reform saying that the return target did not need to be reduced - while Democrats like Corey Mock saying it needed to be reduced, possibly to 4.5%.
As you can read in this slide: “McKinsey & Co. forecast the returns on equities will be 20% to 50% lower over the next two decades compared to the previous three decades. • Using their forecasts, the best-case scenario for a 70/30 portfolio of equities and bonds is likely to earn around 5% return.”
Representative Corey Mock (D-Grand Forks) was right - the Reason Foundation’s own data says that the even a 6% return rate is too optimistic.
Now, that should not be a reason to not pass the overall changes - it does mean that if even after moving new hires to a Defined Contribution system, if the old Defined Benefits plan continues to chase a rate of return higher than realistic, it will only increase the need for future taxpayer bailouts.
Slide #38 shows just how vulnerable the pension fund and future taxpayer bailouts are to minor changes to the return target rate:
It is unfortunate that the House members who are in favor of the needed reforms don’t seem to understand the very numbers in the report being used to justify the changes. But that does not negate the need for changes.
It is becoming more and more clear that the fiscal mismanagement of the pension fund by the legislature since the year 2000 has set the state up for long-term financial pain. In fact, a significant amount of the “surpluses” bragged about by previous governors and legislatures has actually been created on the back of the underfunding and underperforming of the pension funds.
Even those of us who were trying to get the attention of the public and lawmakers on this issue did not realize just how bad it was.
This problem is way worse than we thought.
Meanwhile, the Senate’s approach in SB 2239 is to just throw $200 million at the problem and go about business as usual and hope things work out.
It’s unclear why the Senate is unwilling to admit the mistakes of the last two-decades like the House is, but that seems to be their position.
This will be one of the big fights between the House and the Senate in the second-half of the session.
Governor Burgum will have to throw his weight around on this issue to swing the Senate his way.
Otherwise, they will kick the can down the road like Congress does, and the problem will only get worse and worse.