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Maryland's Retirement Costs Time Bomb

Governor O'Malley's proposal to shift $240 million in pension costs now shouldered by the state to the counties is among the many contentious issues facing the current Maryland state legislative session.   The back and forth between local and state officials has taken on a Punch and Judy Show quality.  State officials criticize county leaders for agreeing unaffordable labor agreements.  County officials reply that the change will result in draconian local services cutbacks.

Too often public employee retirement costs do not receive the attention appropriate to its growing impact on state finances.  More scrutiny is required as these expenses absorb an increasing share of budgets.

Nationally the Pew Center on the States estimates that the gap between the promises states have made for public employees' retirement benefits and the money set aside to pay has grown to at least $1.26 trillion.  Maryland is one the bigger offenders, with $19 billion in unfunded pension liabilities.  For many years our state's contributions to the pension fund has fallen short the level necessary to fund it.  Yet in 2006 Maryland raised pension benefits by 29%, retroactive to 1998, but failed to provide sufficient funding.

As badly underfunded as our state pensions are, Maryland has set aside only 1% of our health and other non-pension retiree benefits obligations.  This represents another $16 billion liability for the state, adding up to a total $35 billion retirement fund  shortfall.

Earlier this week Jeff Hooke of the Maryland Tax Education Foundation testified before the Senate Budget and Taxation Committee on the pension management system's investment failures.   Hooke estimates that pension fund has paid over $1.5 billion over the past decade to investment managers, with $200 million just in 2011.  Yet Maryland's pension investment performance trails others states.

Hooke compared Maryland's rate of return with other states in the last five years and in the last 10 years.  He found that our average rate of return is about 1% lower than its peers in six nearby states and other large public pension funds by almost 1% annually.  The difference may not seem great, but it costs the state $300 million in lost income annually or $3 billion over the last 10 years.

Comparative Investment Performance - State Pension Funds

Compound Annual Returns

June 30, 2011 Year End Only

2011

5 Yrs.

10Yrs.

Maryland

 20.0%

4.0%

5.0%

Delaware

24.3

6.6

6.7

Virginia

19.1

4.3

5.7

North Carolina

18.5

5.1

5.7

New Jersey

18.0

5.2

5.2

Kentucky

19.0

4.7

5.5

West Virginia

20.7

5.4

6.3

Six State Average

19.9

5.2

5.9

Large Public Funds

21.7

4.7

5.9

Compiled: Maryland Tax Education Foundation; Source.  State fund websites, annual reports and interviews. Public funds are state, county and city funds over $1 billion in assets, as reported by Callan Associates.

In order to improve performance and lower investment costs, Hooke recommends cutting back on Wall Street money managers and indexing the portfolio for a fraction of the cost of current management fees. He notes that indexing guarantees average investment performance because the portfolio will track the equity and bond markets exactly. Already about one third of all U.S. institutional portfolios are now indexed.

Improvement to "average returns" would only partially offset Maryland's $35 billion unfunded obligation for public employee retirement works out to over $15,000 per household.   A sustained practice of adequate contribution over many years and more realistic adjustment of future benefits are essential reforms.

However our $300 million investment return shortfall, not to mention savings on the $200 million in management fees paying for substandard performance is more than the $240 million that the Governor is proposing shifting to Maryland's counties

Mark Uncapher is Montgomery County Republican Chairman. Email: This email address is being protected from spambots. You need JavaScript enabled to view it.

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