By Len Lazarick
State Treasurer Nancy Kopp told lawmakers Thursday that she opposed Gov. Martin O’Malley’s proposed $100 million cut in the pension contribution, and said it would undermine trust by the state’s bond rating agencies.
“I think this is a very difficult thing to defend with the rating agencies,” Kopp told the House Appropriations Subcommittee on Public Safety and Administration.
Kopp was testifying as chairman of the State Retirement and Pension System Board of Trustees. As treasurer, she is also the top state official that handles Maryland’s bond issues and deals with the three New York firms that rate them.
In 2011, the legislature and governor made major reforms in pensions for state employees and teachers that included higher contributions and lower benefits. At that time, the state promised in law to set aside $300 million from those savings to beef up Maryland’s chronically underfunded pension fund.
O’Malley has proposed permanently reducing that to $200 million, but the legislature must agree to change the law.
“We set out a plan, and we were going to stick with that plan,” said Kopp, who served on the special commission that had recommended the changes.
A matter of trust for rating agencies
“It’s a question of trust, in all candor…. We trusted $300 million, and now we’re told to trust $200 million,” Kopp said.
“Making such reforms and remaining faithful to them is of great importance to the rating agencies,” Dean Kenderdine, executive director of the retirement agency, told the committee in written testimony emphasizing Kopp’s position. “It is fair to expect that any further reneging on the state’s reform plan will be dimly viewed.”
Maryland has been able to maintain its triple-A bond rating for five decades, but the rating agencies persistently point out that its pension system is currently covered for only 65% of promised benefits, a lower figure than the handful of other states with triple-A ratings. One rating agency, in fact, uses a different expected rate of investment return to calculate liabilities and says Maryland has even higher pension liabilities than reported.
The State Retirement Agency assures retirees that there’s plenty of money to cover current pension payments to 138,000 retirees, who were paid almost $3 billion in fiscal 2013.
Unfunded liabilities means the amount of money the state would owe all the plan participants — an additional 192,000 active participants — if the state went bankrupt.
Pension fund under-performs compared to peers
An essential component of the pension fund is the return on its $40 billion investment portfolio, which contributes more money than either the state or its employees to the pension fund.
At the same hearing Thursday on the budget for the retirement agency, legislative analyst Michael Rubinstein asked the agency to defend its poor performance compared to other states.
“The system’s investments returned 10.6% in fiscal 2013, which exceeded both the actuarial funding target and its own plan benchmark,” said Rubinstein’s report. “However, the fund performed poorly in comparison to other large public pension plans.”
“The fund’s movement away from public equity at a time when it is performing well continues to place it at a disadvantage relative to the performance of its peers, whose allocations to public equity tend to be greater,” Rubinstein said.
SRA Chief Investment Officer Melissa Moye defended the plan’s diversification, saying it was designed to reduce volatility — the up and down swings in the stock market. The Maryland fund has a lower percentage of its investments in stocks than some other pension systems, and stocks have been performing well recently.
Critic pushes for more stock index funds
“During periods of very strong stock returns, the system’s performance will likely lag more aggressive funds,” Kenderdine’s testimony said. “Conversely, the system would likely outperform those funds during time periods when public equity does not perform well.”
Investment banker Jeff Hooke, a persistent critic of the system’s investment strategy, told the legislators that the Maryland underperformance by 1.8% compared to funds comparable in size cost the system $720 million in earnings last year, and $3.5 billion over the last 10 years.
As he has in the past, Hooke again recommended that the system stop paying Wall Street managers $275 million in fees for active management, hedge funds and private equity by using stock index funds.
“Pension fund trustees and staff are no doubt trying to beat the averages, but their tactics aren’t working,” Hooke said.
“We do index a lot in the portfolio,” Moye responded, with 65% of U.S. stock holdings matching a broad portfolio of stocks.
“Indexing is not a panacea,” Moye said. “We’re actually big believers in indexing, but we don’t believe it is the only thing that should be done.”
This article and others on Maryland’s pension system have been supported with a grant from the Abell Foundation.
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