Fixed COLA Rate is NOT Required

Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Fri Nov 04, 2016 9:18 am

Fixed COLA rate is NOT Required--Sixth Circuit Affirms Chattanooga Ruling

A fixed COLA rate is not required for the city's pension system.

Yesterday, the Sixth Circuit Court of Appeals affirmed the trial court's decision in Frazier v Chattanooga--the city was entitled to change its COLA for pensioners, which it did in 2014. COLA is not an accrued or vested benefit nor is there a contractual right to such an annually applied boost to an employee's vested pension benefit. A city legislature (council) is free to change such a provision under both constitutional and Tennessee law. The court specifically said nothing in old/unrelated Blackwell case holds to the contrary.

A COLA benefit helps an employee or pensioner to keep up with inflation. So far, so good. But a fixed rate of 3% has not been needed in recent years, rather it significantly exceeds the actual 1.5 to 2% inflation rate experienced in this economy. It is nothing more than unearned and unneeded pay raise to pensioners at the expense of the already over-burdened taxpayers. And unfortunately it increases the ever growing pension deficit this city must fund annually.

In case you haven't looked lately, the pension fund earned less than 1/2% last fiscal year, and less than 2% the prior year. Projections of fund growth and the resultant short-fall make-up cost to the city based on a roughly 7 3/8% earnings projection is out of line and unwarranted (regardless of accounting conventions like the so-called smoothing). We haven't hit that percentage growth in three years. The real gap is widening.

As stewards of the public fisc, it is time to stop hiding from reality using assumed projections that lack real world facts. Actual COLA up to a cap of 3% should be implemented now. We can respond fairly to inflation without giving away the store.

PS. In 2014, Chattanooga cut it annual pension contributions by $5 million, by taking several bold steps: increasing employee contributions to the plan, reducing COLA from 3% to 1.5%, and not starting COLA for new retirees in the 1st three years.
Nick Della Volpe
 
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Fri Nov 04, 2016 2:28 pm

Note that the CPI has been below 3% annually in 8 out of the last 10 years.

2006 =2.5%
2007 =4.1%
2008 =0.1%
2009 =2.7%
2010 =1.5%
2011 =3.0%
2012 =1.7%
2013 =1.5%
2014 =0.8%
2015 =0.7%
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Sat Nov 05, 2016 8:03 am

Pension System Funding Shortfall--A Derived Figure of $713M

Pension Figures are often complex, as they are expressed as a part of an actuary's estimated analysis of the future (considering average age, survival statistics, expected career wage earnings, assumed rate of return, etc).

Here is a current snapshot of the city pension fund's financial status, as of the most recent September 30, 2016 accounting report (accumulating such accounting data always lags a bit):
Net Assets = $541,639,480.
Liabilities = $714,658,239.

Hence the shortfall in funding is roughly $713M.
See clarifying note below.
__________________

Note: the $714M liability number shown above was derived mathematically: by dividing the current asset value (a financial market value number) by the plan's disclosed funding percentage of 75.79% (a pension fund assumed number, premised on the adopted average 7.375% rate of return--that latter percent figure is estimated by the pension's actuary and then adopted by city's pension board). It is an estimate.
If, in fact, the actual rate of return proved to be lower than the assumed 7.375 %, it would mean that the actual pension funding deficit would be greater than the calculated $713M shown above (i.e., you would be dividing the reported asset value by a smaller assumed number).

Such rate of turn figures are a matter of debate in the pension world. Realistically, a higher assumed rate of return makes the reported fund shortfall look better. So, the unexpressed bias tends to be to err on the high side.
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Sat Nov 05, 2016 12:40 pm

Illustration--A Small Change in the Assumed Rate of Return Makes a Big Difference

If I can attach it (I am admittedly technologically challenged), see the illustration provided by the Pension Plan Actuary, Allen Pennington, on October 13, 2016 based on July 1, 2016 data (i.e., fiscal year end) below. His projections also show that the city's $25M to $30M per year contribution level will drop to a more modest level in 2038 or about 22 years.
Attachments
CC_IMG_0108_rs.png
Screen shot from Actuary Report
CC_IMG_0108_rs.png (38.41 KiB) Viewed 16346 times
Last edited by CCAdmin on Mon Nov 07, 2016 9:36 am, edited 1 time in total.
Reason: Resized image
Nick Della Volpe
 
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Sat Nov 05, 2016 11:38 pm

The actual Rate of Return that the defined-benefit pension fund experiences in the financial market is significant. It affects the amount of funding needed to pay the pension plan's annual distributions to retirees.

Discussion: Did you notice in the actuary's example (see the above post) that a 1% drop in the presently-assumed 7.375% earnings rate or rate of return (i.e., dropping it down to 6.375%) raised the expected pension liability by an additional $85 million! That's a huge change. One that directly affects the unfunded pension liability.

Q. What if the average rate of return actually experienced is lower? Like 5.375%, for example. There would be a resultant larger pension underfunding.*
_________
* The converse is true, of course. If the defined-benefit pension fund consistently earned more than the presently-assumed 7.375% rate, there would be a lower shortfall that the taxpayers would have to shoulder. In short, the market risk for the original defined-benefit plan falls on you, the taxpayer.
Note: For employees under the newer "hybrid plan", there is a sharing of market risk (or reward) by the employee once their annual salary exceeds $40k.

(Additional note: Under a typical 401k plan, the person's savings bear the entire market risk).
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Tue Nov 08, 2016 12:56 pm

PENSION FACTS
There is an Annual Report by Actuary Allan Pennington, as of July 1, 2016. It shows, among many things, the following facts pertinent to this discussion of the uncovered cost of the original or legacy pension plan:

Retirees (or Inactive plan participants inluding those under the DROP plan) = 2230 individuals
Annual retirement benefits paid = $44,717,303
That means (by my crude math) that the COLA expense portion = $1,341,522
(Note: Such COLA adds to the base amount for next years COLA--so any exaggeration is ultimately compounded)

City payroll (without benefits like ins, retirement, ...) = $71,481,768
Employees contribution to pension was $3,939,178 = i.e., roughly $4M
City's contribution to retirement was $23,180,275 (lowered in part by the remaining $2M of the $10M extra paid in 3 or 4 years ago)

Report also shows the following percentage average earnings, in typical 1 yr, 5yr, and 10 year broker disclosure fashion:
1 year = .01%
5 year = 6.73%
10 year = 5.897%

None of those return averages equal the assumed 7.375% assumed by the plan as estimated earnings used to meet the pension liability. By definition that understates future/ unfunded liability.
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Tue Nov 08, 2016 2:13 pm

Facts from Annual Report, cont'd

Active workers covered original plan = 1472
(recall Inactive or retired workers was 2230)
So total participants = 3702
_______________
Active workers under new Plan H (or hybrid plan) = 267
(Their COLA plan looks to actual cost of living adjustments under a formula)

_______________
The Actuary reports net pension liability, as of June 30, 2016, as $214,007,866
(That net represents total pension liability as $739,185,050, less fiduciary net positions of $525,177,184)
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Fri Nov 11, 2016 8:58 am

Correction: Cost of COLA 2017 = $1.25M

At the November 10, 2016 Pension Board meeting I learned from director Kristi Paczkowski (an accountant) that a better cost number for the upcoming COLA adjustment is $1.25 million (rather than my earlier $1.34M guesstimate). This is due in part because the varied ground rules for the half dozen or so legacy plans, which still have pensioners, and apparently an actuarial aspect to such calculations. $1.25M is the number.

Whatever the prescise amount, actual cost of living should govern the increase.
For our purpose, it means EACH big-hearted (or excess) COLA percentage point adds $417k to the annual pension cost, raises the base, and thereby compounds future cost increases over time.
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Re: Fixed COLA Rate is NOT Required

Postby Nick Della Volpe » Fri Nov 11, 2016 9:07 am

Major Math Correction: My calculated pension shortfall as of July1st should read: $173M.
Somehow I juxtaposed the first two numbers in typing that earlier, third entry.
Humble apologies. I did not mean to overstate it. (Measure twice, cut once...)
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