Hawaii lawmakers are close to approving changes to public employees’ retirement benefits — a move to save money. But one proposal has us scratching our heads.

The state wants to downgrade the average rate of return the pension fund is expected to achieve each year. The Employees’ Retirement System board invests the fund’s roughly $10 billion worth of assets with the goal of an 8 percent annual return. House Bill 1038 would lower that assumed return rate to 7.75 percent.

It may seem like a prudent move on the surface, but keep in mind the fund has averaged only a 3 percent return over the last decade. (The ERS faces a $9 billion unfunded liability.)

What’s more, according to an actuarial study of the ERS obtained by Civil Beat, downgrading the yield from 8 percent to 7.75 percent would only improve the odds of hitting that target from 39 percent to 44 percent.

Would you gamble with those odds? For every percentage point investments fail to hit the target, state taxpayers will have to kick in more dollars to cover the cost of pensions.

The ERS’s board chairman called the move prudent. And Rep. Karl Rhoads, chairman of the House Committee on Labor, said it’s a step in the right direction.

“It’s definitely a step in the right direction, and I think it’s important to work with realistic assumptions,” Rhoads told Civil Beat regarding the 7.75 percent return goal. “Is 44 percent good enough? I’m relying on the professional judgment of the ERS personnel to figure out the right rate.”

The actuarial study, which was done by the firm Gabriel Roeder Smith & Co. Consultants and Actuaries, recommended the 7.75 rate in a report titled: “Actuarial Experience Investigation Study for the Five-Year Period Ending June 30, 2010.”

In it, the company wrote:

(Gabriel Roeder Smith & Co.) recommend the Board consider lowering the annual net investment return assumption to 7.75%.

  • Current expected return is 8.01% (arithmetic).

  • Range of a reasonable assumption runs from 6.03% to 8.80% with a median of 7.40%.

  • Average annual return over last 20 year has been less than 8%.

  • Currently, a 39% probability of achieving an 8% average return over next 30 years versus a 44% probability of 7.75%.

  • Due to current funded status of ERS, any bias should be toward a conservative assumption set.

Rhoads said the Legislature doesn’t want to overact by changing the return rate too drastically.

“It probably doesn’t make sense to make large changes, especially in times of financial instability,” he said. “The bottom-line goal is to be sure the fund is funded over the 30 year time frame, so while it’s important to do something, we’re not trying to pay off the $7.2 billion in two months or anything like that. Although, I’ve been tempted to try that approach, we obviously can’t do it,” he said with a chuckle.

Colbert Matsumoto, chairman of the ERS board of trustees, similarly said the board was being cautious when it recommended the 7.75 percent return.

Here’s what Matsumoto had to say: “If we measured our return like a treasury note as opposed to an investment portfolio, that would be a more reliable rate of return, but also a very low return. Because we have a diverse portfolio of assets, we need to evaluate expectations based on how the portfolio is comprised.”

He said the ERS’s portfolio includes fixed income investments, equities, private equity investments and real estate assets.

Other proposals within HB 1038, which is being considered in conference committee, would alter retirement benefits only for new employees. That would include raising the retirement age, increasing how much employees contribute to their plans, and counting an employee’s highest five year’s of compensation when calculating their pensions (versus the highest three now.)

Rhoads said if all portions of the bill become law, the measure would save the state $440 million in the first five years.

“There are downsides too,” he said. “It could make it harder to recruit because the benefits package will be stingier than they are now … But I think we have to do it because otherwise, what would happen is the ERS would get to a point of pay-as-you-go on a cash basis, and that would be very hard to do.”

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