Saturday, February 4, 2012

MPSERS Unfunded Pension Liabilities Grow to $45.3 Billion, or $53.9 Billion?

Looks like things are getting worse, while we’re told they’re getting better. The just released Michigan Public School Employees’ Retirement System (MPSERS) annual financial statement should dispel any notion of a School Aid Surplus. Remember, most of the unfunded liability (+$45.3 BILLION) has to be paid for by annual transfers from the yearly operating budgets of local schools and colleges that participate in MPSERS. This year that transfer will represent an added cost of 27.4% on top of all employee salaries.  Salaries and benefits are 80% to 90% of a typical school budget so this is significant impact to operating budgets.
The MPSERS unfunded liability is significantly worse than the reported number. Consider, the fund uses an accounting rule (trick, gimmick, game) to “smooth” the data over a five year period. Without smoothing the unfunded liability approaches $53.9 BILLION (current year assets total $34.7 billion, down from $35.9 billion in 2010).
It gets worse. The fund makes some aggressive assumptions about its expected future earnings. The fund assumes it will earn 7% to 8% annually depending on the obligations. Actual performance over the last 5 years has been 2.3% annually, nearly 3.5 times below plan (and 5.1% annually over 10 years, nearly 1.6 times below plan). On a current basis, aggregate assets FELL between 2010 and 2011 by $1.2 BILLION (the second time this has happened in the last three years) making the true unfunded liability hole deeper. 
The fund notes that it had a good year realizing returns of 6.6%  That return sounds good but there are two problems: 1) 6.6% is far below the 8% required in the plan assumptions, and 2) Digging into the details much of the that performance was realized in segments of the portfolio classified as ALTERNATIVE INVESTMENTS and REAL ESTATE which saw returns of 29.9% and 16.9% respectively. 
The ALTERNATIVE INVESTMENTS and REAL ESATE investment pool include limited partnerships and investments in the private equity market. Funds should have these types of assets in their portfolio, that’s not the issue. The problem is measuring returns; who values these investments? Are the assumptions used realistic? When were the values established? By nature these investments are private, so there is no traditional clearing market, there is no public venue to check prices. As such there is significant latitude in how any individual asset is valued; caution should be exercised when these asset class significantly boost total returns as they have in this case. 
This problem has been brewing for years despite my repeated attempts to sound the alarm. It’s been allowed to fester and the price of the problem has exploded. It’s time to fix it.