Josh Elliott-Traficante

January 16, 2015

Today the New Hampshire Supreme Court issued a ruling in the case of American Federation of Teachers –New Hampshire et al v State of New Hampshire, which upheld pension reforms made in 2007 and 2008.


This suit, brought in 2009 by most of the state’s public sector unions, was against two particular changes made to the system. The first dealt with changing the definition of ‘earnable compensation’, by removing ‘other compensation’. In effect, it meant that special duty pay, for example, could not be used in calculating the pension payout. The second dealt with the method of funding cost of living adjustments (COLAs), specifically the move of $250 million from the Special Account into the rest of the trust fund and the elimination of annual COLAs. Both were efforts to shore up the financial stability of the New Hampshire Retirement System (NHRS).

The Unions’ Arguments

The unions argued that these moves impaired the rights of their members, which they were vested in upon full time employment. Changing the terms of how benefits were accrued and the effective halting of granting COLAs was a breach of contract. Likewise, these moves also constituted illegal taking by the government depriving members of the monetary gain these provisions would grant them.

The State’s Arguments:

The state argued that the statutes changed by the law did not constitute a contract. If they did not constitute a contract, then there could be nothing that could be illegally taken from union members. The employees were only vested in their retirement benefit once they retired. In addition, the plaintiffs did not show either the changes constituted a substantial impairment, or did they prove it was retroactive.  In regards to the COLA question, that by its very nature the COLA was based on a contingency, and not a contract. Even if it was a contract, the changes were reasonable and necessary (established as a key consideration by legal precedent for contract modification ) because without the change, the plan’s tax exempt status was jeopardized.

The Lower Court:

Like in the other pension reform cases, the lower court found that both the state and the unions were wrong in their arguments. Relying on the statutes governing the NHRS the court found that vesting both occurred at 10 years and that created a contract. As such, the changing the definition of earnable compensation did constituted breaking a contract, but only for vested employees. The changes to the COLA, though also breaking a contract, were necessary and reasonable to preserve tax exempt status with the IRS.

The Supreme Court:

When ruling in this case, the Supreme Court relied on the Unmistakability Doctrine’, just as it did in its pension ruling last December. Under the ‘unmistakability doctrine’, the court, in determining if a law constitutes a contract or not, must find evidence that the legislature meant to create a contract. “(A)bsent some clear indication that the legislature intends to bind itself contractually, the presumption is that a law is not intended to create private contractual or vested rights.”

Unlike the ruling on contribution rates, the Court had to deal with the issue of the word ‘vesting’. Rather than using the 10 year mark as the lower courts had done, the Supreme Court on the relied on the precedent set by the First Appellate Court, which had found that “when used in the context of a pension plan, the terms ‘vesting’ and ‘contractual’ are not synonymous and references to ‘vesting’ do not necessarily create a contract.” Looking the language that concerns vesting, the Court found “no unmistakable language that the legislature intended that once a member ‘vests’ that a contractual commitment has been established.” ‘Vesting’ in the sense that it is used by the NHRS does not create a contract.

With the vesting question dispatched, the Court then looked at the statutory language for the definition earnable compensation, and found, again, no unmistakable intent by the legislature to bind itself contractually. In looking at the statues concerning COLAs, the Court came to the same conclusion.

Going Forward:

There is still one pension case left outstanding; it had been stayed pending the outcome of these two cases. With this ruling firmly establishing that the use of the term ‘vesting’ does not in and of itself create a contract, and the application of the ‘unmistakability doctrine’ in both this case and in December’s ruling, all of the recent pension reforms are here to stay.

Josh Elliott-Traficante

 December 11, 2014

Yesterday the New Hampshire Supreme Court handed down a ruling in the case of Professional Firefighters of New Hampshire, et al v State of New Hampshire; representing the culmination of nearly three and a half years of legal proceedings that sought to answer the question: how far can the state go in reforming pensions? The answer: pretty far. The Supreme Court unanimously ruled that increases can be made in employee contribution rates for all employees, regardless of how long they have been working. The increase in employee contribution rates were a key component of the package of pension reform measures that passed in 2011.


The pension reforms measures passed in 2011 took a number of steps to shore up what was, and still is, among the worst funded state pension systems in the country. Reforms included changing the way pension payouts were tabulated, such as extending the number of years used to calculate the final average salary from the last three to last five, how much overtime could be counted, and increasing employee contribution rates.

Additional suits had been filed (and are still pending) regarding other facets of reform measures, but this ruling on this case, commonly referred to as ‘Firefighters I’ only dealt with the changes made to the contribution rates for employees. Those changes increased rates for employees and teachers from 5% to 7% of salary, firefighters from 9.3% to 11.55% and police from 9.3% to 11.8%. However, the key point in each of these suits is the determination of when ‘vesting’ occurs. Once a person is vested, it means they have property rights that cannot be violated.

The Unions’ Arguments:

In June 2011, shortly after the increase in contribution rates took effect, a group of unions filed a petition in Merrimack County Court, arguing that these changes were unconstitutional. They argued that ‘members become vested in their NHRS benefits upon commencement of permanent employee status” In short, as soon as an employee makes it through their probationary period, how his or her pension benefits are accrued or contributed to on that day can never be changed.

This claim rested heavily on the precedent set in State Employees’ Association v Belknap County. In that case, a number of county employees were not enrolled in the New Hampshire Retirement system, despite several long standing orders from the State Treasury to do so. In that ruling, the court stated that “(retirement)benefits constitute a substantial part of an employee’s compensation and become vested upon the commencement of permanent employee status.” The use of the word ‘compensation’ was critical to the union’s case, as there is substantial judicial precedent in regarding compensation as contractual. With the Belknap ruling using the word ‘compensation’ in describing retirement benefits, the unions argued that retirement benefits were in fact a contract, and therefore changes made by the legislature were in violation of the Contract Clauses both in the U.S. and New Hampshire Constitutions.

The State’s Arguments:

The state argued that the legislation was not a binding contract, and that the only contract formed is the one once the employee retires and begins collecting his or her pension. If that is the case, then changes could be made to the pension system, such as increasing the amount of money an employee must contribute toward it, right up until the moment an employee retires.

The Lower Court Ruling:

Judge McNamara, of Merrimack Superior Court ruled that vesting occurred at ten years; not as some sort of Solomonic decision, but by looking at the letter of the laws governing the New Hampshire Retirement System itself. The RSA in question, 100-A, states that vesting occurs after 10 years, but crucially does not make mention of retirement benefits being considered as part of compensation.

In his ruling McNamara disagreed with the unions’ arguments on the basis of the Belknap County case. McNamara noted the Belknap decision found that RSA100-A only “(E)ntitles government employees to receive benefits in addition to salary, and that both wages and benefits are a substantial part of the employees’ compensation.” He went on to state that the issue at the heart of the case, the ability of the state to alter those benefits, was not presented in any of the case law cited by the unions.

The Supreme Court Ruling:

Both the State and the Unions appealed the decision to the Supreme Court. Leaving the issue of when vesting occurs aside, the Justices went to the heart of the matter: does language of the law concerning pensions constitute a contract?

Relying on previous case law, the Justices relied on the “Unmistakability Doctrine”, which requires the court to determination whether a challenged law has evidence of “the clear intent of the state to be bound to particular contractual obligations.” After review of the language of the statute that establishes the contribution rates, the court found that “the legislature did not unmistakably intend to establish NHRS contributions rates as a contractual right that cannot be modified.” As such, the Court ruled unanimously in favor of the state. With no contractual rights established in the law, the state can change the contribution rates for all employees.

What Does this Mean?

In short, the reforms of the past few years will remain in place. Though the Court only ruled on one narrow piece of the reform package, the impact of the ruling extends to the two other unsettled legal challenges. It its conclusion, the Court found “(T)here is no indication that … the legislature unmistakably intended to bind itself from prospectively changing the rate of NHRS member contributions to the retirement system.” Taking that as a guidepost, a reading of the legal language of the other contested reform measures, turns up nothing that would ‘unmistakably’ establish a contract.

In addition, the bulk of the other reforms made in 2011 were made to those who had not yet hit that critical 10 year mark. Those changes are currently being litigated in the ‘Firefighters II’ lawsuit. Firefighters II is currently stayed, pending the outcome of this weeks ruling and a third suit made against the reforms made to the system in 2008. That third suit, the HB1645 case, which deals with many of the same questions that Firefighters I and II does, was heard before the Supreme Court last month, with no timeline for when a ruling will be handed down.

Josh Elliott-Traficante

September 2013

The New Hampshire Retirement System announced that for fiscal year 2013, the state’s retirement fund saw a 14.5% return on its investments. Broken out by the different investment classes, domestic stocks saw a 23.2% return, foreign stocks 13.8%, bonds 2.8%, real estate 12.3% and alternatives assets[i] 8.7%.

While 14.5% return makes for a great year, being 6.75 percentage points above the assumed rate of return of 7.75%, that number alone does not really speak to how well the fund did in relative terms. For example, 14.5% looks quite paltry if other state pension systems uniformly saw 24.5%. Likewise, 14.5% looks like a fantastic return if the fund benchmarks saw only 6%.

How well did the New Hampshire Retirement System really do? There are two good comparisons to make that give a better sense of investment performance: the fund’s own benchmarks and the experience of other public sector pension funds. Measured against both internal benchmarks and the performance of other pension funds, New Hampshire did slightly better than average.


The New Hampshire Retirement System has a series of internal benchmarks, which are derived from stock indices blended with historical investment decisions. Each asset class has their own benchmark, which are then combined into a total fund benchmark.

Looking at the individual asset classes, nearly all of them met, or exceeded their respective benchmarks. Domestic stocks beat their benchmark by 170 basis points[ii], foreign stocks by 20 basis points, bonds by 240, real estate by 100, while 91 Day Treasury Bills hit their benchmark.

The one laggard was alternative investments, which fell 1240 basis points short of its benchmark. Over the long term, alternative investments have consistently fallen short of their benchmarks. In the last 10 years, this investment class has seen an average yearly return of 0.6%, while the benchmark has seen 9.1% on average.

For the year, the fund as a whole beat its benchmark by 100 basis points.

Other States:

Another useful measure is to look at the returns of other public sector pension funds. While each fund has its own investment strategy, risk tolerance, and portfolios, they are all operating in the same markets.


Among a sample of 28 public sector pension systems from 26 states that have released investment return data, New Hampshire’s returns are above average. For the returns sampled, the average return was 13.05%, with New Hampshire’s returns being 145 basis points higher.

What Good Returns Do Not Mean:

While there is little to criticize about a 14.5% return, the fact that the New Hampshire

Retirement System did well on the asset side this year does not mean all of the problems of the pension system are solved, just as last year’s returns of .9% did not mean that the System was in trouble.[iii]

Assets only account for one half of the ledger and to cite one year’s returns as a sign of the System’s financial strength (or weakness for that matter) is short sighted at best. It would be akin to highlighting the fact you got a $2000 raise, while not mentioning you took on more credit card debt at the same time. If you added 2500 in credit card debt in the same time, you are actually worse off. For a pension system, liabilities is that credit card debt. It remains to be seen is how much liabilities went up in 2013. If they increased more than assets did, then the system’s funding ratio goes down. If they increased less than assets did, then the ratio goes up.

While looking at asset growth and liability growth separately is valuable, to assess the health of the System, both asset and liability growth must be looked at together.

[i] Alternative Investments is a catch all for non-traditional investments, such as venture capital, stakes in privately held companies and distressed assets (think Bain Capital)

[ii] 100 Basis Points = 1.00 percentage point

Josh Elliott-Traficante

With Illinois preparing to go to market with $500 million in general obligation bonds, the big three bond rating agencies, Moody’s, Fitch, and S&P have all issued their ratings of the new debt. Moody’s ranked the bonds as A2, Fitch at A and S&P at A- with all three agencies rating the outlook on the state as negative. This downgrade put Illinois’ bond rating as the lowest in the country. In comparison, the ratings on New Hampshire’s last bond issue were Aa1, AA+ and AA respectively, each 5 notches higher than their Illinois counterpart.

While seemingly archaic financial scores, bond ratings have a large impact on how much the state has to spend in interest payments over the life of the loan. Illinois State Treasurer Dan Rutherford has estimated that Illinois’ poor rating on the latest tranche of bonds will cost the state nearly $95 million.

Much has been made in the past few years over the dysfunction of Illinois’ finances and the legislature’s inability to get the state’s fiscal house in order; however, rating agencies are taking a closer look at another factor that weighs heavily on state finances: pensions.

All three of the rating reports of Illinois latest bond issue underscore the desperate need for pension reform.

From Fitch:

The rating watch negative reflects the ongoing inability of the state to address its large and growing unfunded pension   liability…Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable. This large unfunded pension liability is despite the issuance of pension obligation bonds and passage of bipartisan comprehensive pension reform affecting new employees.

Moody’s also highlights the issue in their rating:

Illinois’ rating and negative outlook are consistent with our view that the state’s pension funding pressures are likely to persist and perhaps worsen in the near term. Lawmakers’ repeated inability to reach consensus on retiree benefit measures last year underscored the task’s extreme difficulty…Illinois is heading towards an unsustainable combination of higher pension contribution needs and reduced tax revenues.

S&P pointedly states that:

(t)he downgrade reflects what we view as the state’s weakened pension funded ratios and lack of action on reform measures intended to improve funding levels and diminish cost pressures associated with annual contributions

So while this does not bode well for Illinois, what impact does this have on New Hampshire? No question, Illinois is in much worse financial shape than New Hampshire when it comes to both state finances and pension funding ratio. In New Hampshire’s last bond issue however, while all three agencies affirmed top ratings for the debt, they also highlighted the size of the pension unfunded liability as a concern going forward. (Fitch & Moody’s)

However, state pension systems that have higher funding ratios than New Hampshire, such as Pennsylvania, have seen debt downgraded in part due to pension liabilities. In Pennsylvania’s case, a combination of high debt and modest unfunded pension liabilities contributed to its downgrade. New Hampshire’s relatively light debt load so far has allowed the state to avoid costly downgrades despite a large unfunded pension liability.

To prevent New Hampshire from going down the path of Illinois or Pennsylvania, the state policy makers must keep bonding in check and not only hold the line on past pension reforms, but reform the system further by taking steps to spread the risk more equitably between the public employees and the taxpayers of the state.

[UPDATE: Illinois has postponed the bond issue mentioned below, citing “unfavorable market conditions”]

The New Hampshire Retirement System announced Friday that the pension fund posted a 0.9% gain for Fiscal Year 2012.

Preliminary estimates had projected a 0.7% gain, but upon the final calculation for the fund’s real estate and alternative assets, the rate of return was revised upward.

In the quarterly investment highlights, the system also published the performance of each of the asset classes’ benchmarks. In benchmarks are used as a standard to see how well the fund has performed. Sometimes they are broad; such using an entire index, or they can be more specialized. In the case of the NHRS, the benchmarks are a mix of both, using indices as well as taking into account historical investment strategy decisions.

Below is a chart showing how well the NHRS matched the benchmarks for each asset class.[i]


Given the market volatility over the past year, the fact that the NHRS has lagged behind its benchmarks is no surprise. Generally speaking, volatility favors passive management over active management.

Market volatility however, is not the cause of the spread between the realized return and the benchmark for alternative assets. By definition, these types of holdings do not trade on the open market and are made up of stakes in privately held companies, non-publicly traded debt and distressed assets. These types of holdings are on the higher end of the risk spectrum, meaning big losses when things go poorly, or big gains should they do well.

The level of risk in Alternative Assets has split the public pension fund community, with some embracing it and others shunning it entirely. The NHRS currently has roughly 2.5% of assets in this type of holding, with plans to expand up to 10%.


Joshua Elliott-Traficante

September 2012

The New Hampshire Retirement System’s 0.7% investment return for fiscal year 2012 was jumped on by some as a sign the system had failed because it had not met the assumed rate of return of 7.75%. As pointed out in an earlier piece[1], for FY12, the System’s returns were about par for the course in comparison to other state pension systems.

Taking a wider historical view, this is true both in comparison to the stock market as a whole and in comparison to other pension systems.


The NHRS and the S&P 500: A Historical Look[2]

Below is a comparison of the rates of return, by fiscal year, for the NHRS and the S&P 500. It is not a perfect fit for the NHRS, since the System’s assets also include fixed income, foreign stocks and real estate, among other financial instruments. However, domestic equities make up roughly 40% of the portfolio.



Generally speaking, investment returns follow market trends. Investment return data shows that the NHRS tends to outperform the S&P, particularly in the bad years. From 1990 to present, the S&P has averaged a return of 7.69%, where the NHRS has seen 9.29%. Put another way, the NHRS outperformed the S&P 500 in 13 of the last 22 years. Of the years that the NHRS underperformed, half were by less than 3 percentage points.


The NHRS Returns and other Public Sector Pension Systems:[3]

Another check on performance is to compare the NHRS to similar public sector pension systems. Below is a chart comparing the returns of the NHRS, to the returns of state and large local public sector pension systems across the United States.

In the chart, above, the horizontal bar indicates the returns of the New Hampshire Retirement System for the year. As the data shows, System returns have been in the middle of the pack. Returns have stayed well within the range of similar systems, usually near the average.

The vertical lines represent the range of investment returns from the sample systems. Surprisingly enough, returns vary greatly with more than 10 percentage points often separating the highest and lowest returns. This spread can be attributed to a number of factors, in particular asset allocation and the performance of private equities.


[2]Investment Return Data for the NHRS is taken from each year’s Comprehensive Annual Financial Report. Fiscal Year 1999 to date CAFRs are available online at Fiscal Year 1990 to 1998 are available at the New Hampshire State Library. S&P Returns are available online.

[3]NHRS Returns, see Footnote 1, National Pension Data Public Plans Database. 2001-2009. Center for Retirement Research at Boston College and Center for State and Local Government Excellence. FY10 and 11 data was unavailable so those years use a randomly selected set of 10 consisting of ME, NM, KY, ID, AK, RI, NJ, MD, CALPERS, and AZ, with the data compiled by the author.

Recently the New Hampshire Retirement System (NHRS) released its preliminary investment return figures for Fiscal Year 2012. Over the fiscal year, the NHRS saw .7% return on pension fund, falling well short of the assumed rate of return of 7.75%. While this shortfall will lead to a decline in the funding ratio, it is important to remember that pension funds do not function on a year to year basis. One really good year, or one really bad year does not mean that a system is healthy or sickly respectively.  Nor does the NHRS operate in a bubble, independent of global economic conditions.

The chart below shows a comparison of how the returns of the NHRS stand in relation to a handful of other state retirement systems that have reported preliminary figures so far. More or less, the NHRS’s returns were average when stacked against similar systems.

The research firm Wilshire Associates calculated the median gain to state and local pension funds for fiscal year 2012 at 1.15%, so though New Hampshire’s return was lower than the median, it was only by 0.4%.

So did the NHRS do badly this past year? While the system did poorly in terms of meeting the assumed rate of return for the year, comparatively speaking, the NHRS was firmly in the middle of the pack.

The recently released investment return figures from the third quarter show that while the New Hampshire Retirement System investment fund saw a 8.4% return in the corpus’s investments, beating the benchmark, the fund has only seen returns of just under 3% so far for the year, falling short of the 7.75% assumed rate of return.

The domestic equity portfolio, saw a 12.2% return, though falling short of the benchmark of 12.9%. Non-US equity saw 13.2%, which beat its benchmark by 2 points. Fixed income assets also did well, seeing a 2.5% return versus a .9% benchmark.

Due to the complex nature of the valuation of assets of Alternatives and Real Estate, the figures and benchmarks a lagged by one quarter, but the data is still valid. Real Estate saw 1.3% return, though the benchmark was 3.1%.

Lagging behind all other investment vehicles was Alternatives. Alternatives are private equities, essentially stakes in a company that does not have shares that are publicly traded. For example, Burger King and Toys R Us, fall into this category. Bain Capital, which was in the news as of late, as well as Berkshire Hathaway are both involved in these financial sector.

Alternatives saw a -.2% loss for the quarter, while the benchmark was 9.2%. So far this fiscal year and year to date, the NHRS has lost money on these investments. Annualized returns have also the System lagging far behind. Granted, the system had left the Alternatives portfolio go dormant, (i.e. new investments were not made, but money was not pulled either) until its revival in fiscal year 2011. For FY11, Alternatives saw a 13.9% return.

All that being said, it is hard to gauge the success or shortcomings of an investment class over the time frame of less than two years and even more so for just a single quarter that this investment snapshot looked at.

In the world of pension funds, Alternatives are a mixed bag. Some systems embrace them, seeing them as a way to close unfunded liabilities without resorting to pension reform. Others shun them, viewing them as far too risky an investment. While the gains could be substantial, so could the losses they reason.

The New Hampshire Retirement System currently allocates roughly 2.1% of the fund for these kinds of investments, roughly $132 million. Their new target 10%, all things being equal would mean an investment of more than $650 million. While that in of itself is not a bad thing, investments in this area must be carefully placed and closely monitored. Big risks can mean big rewards, but we shouldn’t forget it can mean big losses as well.

Though the fund is currently falling short of the 7.75% goal, the books do not close until June 30th, so there is time to make up the difference. Only time will tell if we hit or miss the mark this year.

With growing funding shortfalls, exacerbated by the recent economic turmoil, many states are taking a hard look at reforming their state pension systems. We here at the Josiah Bartlett Center have been following this trend here in New Hampshire as well as in other states across the country. Below is some of our work done on pensions so far as well other informational resources.

New Hampshire Specific:

A JBC study that explains what an Unfunded Liability is and why it is important

Another JBC report on the current state of the New Hampshire Retirement System and why reform is desperately needed

The current legislation in the New Hampshire Senate, SB229, which would create a defined contribution plan for state employees

The most recent analysis of SB229 done by the NHRS actuary



A JBC study on defined contribution (401(k)) models that other states currently have in place

Research done by NCSL on the types of retirement systems used by various states across the US

Further research on the growing problem with unfunded liabilities in state pension systems

A recent US Senate report on the current pension funding crisis as well as a piece from Real Clear Markets on the issue

Joshua Elliott-Traficante

February 2012


Earlier this month, the New Hampshire Retirement System (NHRS or ‘the System’) released its Comprehensive Annual Financial Report (CAFR) revealing the current state of the System at the close of the last fiscal year. Fiscal Year 2011 saw assets grow by nearly $1 Billion, however the funding ratio dropped more than a percentage point to an unhealthy 57.4%. Though this seems counter intuitive, this shows the folly of judging the financial soundness of the System by looking at a single data point. Instead the following paper seeks to take apart the complex CAFR and explain the financial status of the pension portion of the System in layman’s terms, as well as look at the troubling historical trends.


Asset Growth


It is critical for any retirement system is to see solid returns on investments, and 2011 was certainly a stellar year for the NHRS. The System saw a 23% return on its investments; over $1 Billion, which added nearly $993 million in assets to the system. Under 5 year smoothing, the first 8.5% is recognized immediately, with all growth over that amount phased in over the following five years. However, it is important to recognize that for all the gains made in the past year, the system is still absorbing the losses of 2008 and 2009.


An Apples to Apple Comparison: Liabilities, Reforms and the Rate of Return:


While undoubtedly an investment return of nearly $1 Billion is excellent news for the financial health of the NHRS, it only tells half of the story. It is the liabilities that tell the crucial other half of the story. Put simply, the liabilities of any pension system is the sum of money needed today, given certain assumptions about payroll growth, the rate of return on investment and retirement age, among a litany of other metrics, to pay for future retirement benefits.


As is the nature of actuarial assumptions, these are regularly tweaked to fit a changing workforce as the need arises. For the most part, apart from a major unforeseen demographic change in the state, they are usually small adjustments. However, when it comes to the assumptions regarding the assumed rate of return on investments and how benefits are calculated, this can cause major changes in the value of the liabilities for the System.


The revision of the anticipated rate of return from 8.5% to 7.75%, on the advice of the Gabriel, Roeder and Smith (GRS) and approved by the Board of Trustees, increased the liabilities of the system by roughly $757 million. With the reforms in the calculations of benefits, which passed last year, decreased the unfunded liability by roughly $430 million for a net result of a $327 million increase in the unfunded liability due to these reforms.


In order to do an apples to apples comparison of the growth of liabilities over past years, these reforms must be taken into account. Doing so, by backing out these two changes, the liabilities of the System increased $717.3 million.


Net investment income, allowing for 5-year smoothing, was $993 million, leaving in a theoretical net gain $275.7 million under this scenario.


Current Liabilities


Revision of rate of return


Revision of payout calculations



Adjusted Liabilities




Even taking into account this reforms, liabilities still grew by 8.19%. This is where, in part, the problem lies with the pension system: the growth of liabilities.


Fiscal Year

Liability Increase

2011 (Adjusted)



Though this increase is below the old rate of return of assumed rate of return of 8.5%, it is now above the new rate of return of 7.75%. Taking a longer view of the system, we see this troubling trend more clearly:




Over the past 22 fiscal years, the compounded annual growth rate in the liabilities of the system was 8.93%, outstripping most of the projected rates of return for that time frame, as well as the 7.19% compounded growth rate in assets, leading to the growing unfunded liability.

Compounded Annual Growth Rate






Granted, this time frame covers two revisions in the rate of return (1992 from 9.5% to 9% and in 2005 from 9% to 8.5%. Figures for 2011 have adjusted to account for the recent change) as well as two changes in accounting methods in 1992 and 2007. While the CAFRs from the respective years do not detail the extent to which the changes affected the growth or decline in liabilities, below details the average yearly growth in liabilities for all of the 22 years analyzed as well as a the average yearly growth with the atypical years removed. The results are essentially the same.


Average Yearly Growth Rate of the Liabilities

All 22 Years


Atypical Years Removed



As mentioned in earlier works, one cannot judge the soundness of a financial institution by looking at one side of the ledger sheet. Below is the same liabilities data alongside the actuarial value of assets.




It should be stressed that the asset figures are not investment rate of return figures, rather they are the actuarial value of assets figures, which are used in calculating the unfunded liability of the system. Again however, we see the same trends: the rate of increase in the liabilities is outstripping the rate of growth of assets. As always there are years which are anomalous, in the case of assets, 2007, where due to legislative reforms, previously siphoned off funds were returned to the pension Trust Fund.


Average Yearly Growth Rate






So what does this all mean? Simply put, the retirement system is on less than stable long term financial footing. This is not to say that the system is going to collapse, but the trends over the past 22 years are not good ones and point to issues greater than just short term market cycles.


These trends stand for themselves. Years of record investment returns of the 1990s, which averaged nearly 14.5% a year from 1990 to 2000, played a role in masking the problem with the growth in liabilities. In those years the growth in liabilities were overshadowed by the investment returns, so there was no problem; as long as the investment returns were consistently in the double digits, year over year.


But this highlights the issues facing the current system, which without consistent double digit investment returns, it cannot keep up with the growth in liabilities. Again, this is not a problem with investment returns; this is a liability growth issue.


While the current amortization schedule will fix this problem over a 30 year period, we cannot keep in place a system that only works well for everyone when it realizes double digit return on investments.


Looking Towards the Future: A Defined Contribution Plan


One policy decision that could be made to prevent this from happening again is to switch all new employees to a defined contribution plan. Currently under consideration is SB229, which proposes to do just that.


Under such a plan, the state’s liabilities end once the employer contributions are deposited into the employee’s accounts. Thus, there can be no unfunded liability to the system. This gives the state, counties, cities and towns budget certainty because there is a set amount that goes into the employee’s accounts and that figure does not change based on what happens in the market. Such certainty is critical for local and state government to be able to hire more teachers, police officers and firefighters.


Such a system also protects the employees. Once those funds are deposited into their accounts, that money is theirs and only theirs, no legislative actions can change that.


An added benefit of a defined contribution system is that since the employees own the accounts, it travels with them when they change jobs. We live in an era where people typically do not work in the same industry for 30 years and a pension model does not fit the needs of these people as well as a defined contribution plan would.


Defined contribution plans have been adopted in several other states across the country, Michigan has had one in place since 1996. What this shows is that not only is it possible to create and implement a defined contribution plan for government employees, but that it works, and it can be done well.


Joshua Elliott-Traficante is a Policy Analyst at the Josiah Bartlett Center for Public Policy, a free-market think tank based in Concord, NH. He can be reached at [email protected]