A recently passed bill designed to reform the failing state employee pension system will soon be waiting for Governor Henry McMaster's decision to sign it into law or to veto it.
The purpose of this bill is to eliminate the funding gap that was created by years of poor and ill-timed investments as well as soaring management fees and other costs in the plans.
Timeline, How we got here……..
A 1997 change to the state Constitution allowed up to 40% of the pension funds to be invested into the stock market. Prior to this, the funds were invested into bonds and cash. In 1999, the plan was considered 99% funded. This is the year the pension funding problems began; it was the year state pension funds were first invested in stocks.
Timing is everything! Buy low/Sell high! Don't risk what you can't afford to lose; retirement age isn't when you take risks!
All sound investment advice that went unheeded.
In the five years before the change to the SC Constitution, U.S. stock prices had nearly tripled. However, SC employee pension fund managers arrived just in time to invest for the dotcom bubble to burst. Beginning in 2000 and running into 2002 the stock market plummeted approximately 42%.
As the stock market began to sluggishly recover between 2003 and 2005, our legislature passed Act 153 which allowed an
additional 30% of pension funds to be invested in stocks. Fund managers were allowed to invest a whopping 70% of pension funds into the stock market. This was followed by another SC Constitutional amendment in 2006 which allowed pension funds to be invested in alternatives such as hedge funds.
Capitalizing on this investment freedom, pension fund managers invested in international stock markets. Again, money was invested when the markets were high and just in time for a crash.
As if poor investment strategies weren't enough, SC paid, and still pays, some of the highest management fees and other costs in the nation while coming up dead last in Return on Investment (ROI). Annual management fees and costs averaged $27 million in the five years prior to the alternatives investment strategies. In the past five years we have seen these costs skyrocket to more than $361 million each year.
1 in 9 South Carolinians are part of the state pension plan (active employees or retirees). The ratio of employees contributing to the retirement system versus the number of employees (retirees/inactives) collecting benefits also contributes to the shortfall.
In a 99% funded plan this wouldn't be an issue but in a 59.5% funded plan such as this there will be underfunded or unfunded liabilities.
Current employees already pay some of the highest pension contribution rates in the country. The current contribution rate is 8.66% of pay. Under this reform bill, employees will begin contributing 9% on July 1, 2017. Firemen and Law Enforcement will have to contribute 9.75% into the plan.
The plan also calls for an increase in employer contribution rates. The rates are scheduled to increase by 2% on July 1 and increase by another 1% of covered payroll each year through 2022. The state will fund 1% of the July 1 increase.
However, forecasted to 2022, a town would be responsible for paying $21.24 to the pension plan for every $100 paid to a law enforcement officer while $18.56 would be paid by a school district for every $100 paid to a teacher.
Did you catch that? The additional contributions will be paid by the employer; the town, the county, the school district, etc… through increased property taxes. In the final analysis these contributions come from us, the taxpayer, through increased millage rates on our real property.
It is understandable that there will be a period of financial hurt in trying to get the plan back into the black.
But what this bill has not addressed is the poor investment practices, the usurious management fees and other costs, the extensive leeway given to the fund managers in the investment strategies they choose and the percentage of fund monies that can be used in stocks and alternatives investments. All of these played a role in eviscerating the pension fund.
Should we even expect an investigation of the previous fund manager and try to find out where all that money went? There were so many violations of fundamental investing strategies that its difficult to believe that an investment professional could be that incompetent.
A 2014 Funston Advisory Services report on the pension systems suggested giving the Retirement System Investment Commission more control and flexibility in managing the fund. It also defended the management fees paid by RSIC and found “no red flag indicators of malfeasance or misfeasance.”
This pension legislation would also strip state Treasurer, Curtis Loftis, of his role on the RSIC and the role he plays in selecting and overseeing the custodial bank for the pension funds. Loftis has said that these provisions in the plan are an attempt to silence his criticism.
An amendment that would require closing the pension plans to future government employees once the plans were fully
funded was added late in the day by Sen. Tom Davis, R-Beaufort. 2040 is the expected year the funds would become fully funded.
Davis supports moving the funds from a defined benefit plan to a defined contribution plan. The difference being that the defined benefit plan provides a fixed, pre-established benefit for employees at retirement. A defined contribution plan is a plan where the employee and/or employer make contributions to the employee's individual retirement account (401(k), 403(b), stock ownership programs, profit sharing, etc…). The value of these accounts fluctuate with the market investments they are tied to and the contributions made into them. These type plans are the norm in the private sector.
Critics of the defined contribution plan alternative say that it makes the government less competitive in the jobs market. Public sector jobs typically pay much less than their private sector counterparts so having a defined benefit plan plays a pivotal role in recruiting and retaining skilled workers.
But The Club For Growth – South Carolina Chairman Dave Ellison, a financial advisor from Greenville, says it is necessary to move to a defined-contribution plan and away from the current defined-benefit plan. “Defined-benefit plans are unsustainable. Just look at the mess we are in now.”
Here is a screenshot from The SC Club for Growth Facebook page:
There is much debate on both sides of the isle. My debate begins and ends with my wallet!
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