The Heavy Burden of Increasing Your COLA Base

A white paper has found an increase in unfunded liabilities in Massachusetts’s already underfunded public pension plans when raising their COLA base.

(October 24, 2013) — Raising the cost-of-living adjustments (COLA) base in state pension funds would massively increase unfunded liabilities and appropriations over the next 20 to 30 years, according to a paper.

A white paper by the Pioneer Institute for Public Policy Research found that due to a series of regulations passed that allowed Massachusetts pension funds to increase the COLA base in increments of $1,000 up to a maximum of $18,000, state and local pensions could face significant rise in liabilities, of more than $1 billion, which could be detrimental to already underfunded plans.

COLA bases were designed to ensure retirees’ benefits remained consistent to the rate of inflation over time, the authors said. However, the Massachusetts public pension system’s COLA does not adjust for inflation—instead, it allows each retirement board to increase up to a maximum of 3% annually, only to a $12,000 base.

This system made the real value of future benefits uncertain, according to the paper, depending on the rate of inflation and pension size. Most likely, Massachusetts’s pensioners found their purchasing power decreasing over time as the COLA failed to adapt to inflation—losing up to 50% during their lifetimes.

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“There is no clear answer about whether the [Massachusetts’s] COLA system is unfair to employees and retirees,” the report said. “However, it is clear that changing the COLA to track inflation more closely would cost state and local governments.”

Massachusetts’s retirement funds’ unfunded liability equaled more than $6 billion, or only 58% funded, research found.

The paper concluded that if every local system in Massachusetts increased the COLA base to $13,000, liabilities would increase by $2,300 per pensioner, resulting in a total rise of about $203 million. However, since most pension plans do not have enough money invested, they would result to spreading the payments over a 20-year duration, amounting to $470 million.

If every state retirement system in Massachusetts raised the COLA to $18,000, the paper calculated an estimate of $1 billion increase in liability—an appropriation of an extra $2.5 billion over the next 20 years.

Despite such exorbitant impact on plans’ liabilities, the study said 45% of local retirement boards have already raised the COLA base as of 2013.

These changes in Massachusetts’s legislature and movement in COLA base stood out among a sea of other American public pensions’ decisions to lower COLA.

aiCIO reported in August that Illinois’ legislators have proposed to cut the automatic 3% annual increases in COLA and instead link the raises to inflation, to settle its serious underfunding. The state also suffered a downgrading by the ratings agency Fitch from “A” to an “A-“.

Rhode Island pensions plans also made headlines when the state treasury identified COLA as “the most expensive aspects of the current pension system (continuing to pay out COLA may deplete the pension und if the 7.5% investment return assumption is not achieved).”

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“In a series of rapid-fire tweets posted earlier this year, Jay-Z held forth on his favorite cereal (Cap’n Crunch) and his greatest strength (‘my genius’). For her part Beyoncé revealed in GQ that, since 2005, she has employed a full-time videographer to document her every waking moment.”

That is not a made-up quote. It is an apparently straight-faced factoid about Shawn (“Jay-Z”) Carter and Beyoncé Knowles, the power-couple topping Vanity Fair’s list of the who’s who in Editor Graydon Carter’s world, “The New Establishment: The Powers That Be.” They are, in essence, the celebrity world’s equivalent to Henrik Gade Jepsen, the man who leads this year’s Power 100 listing of the world’s most influential asset-owner chief investment officers. And, while the rest of the Vanity Fair list has more gravitas—New York City Mayor Michael Bloomberg, publishing titan Rupert Murdoch, and New York Times Editor Jill Abramson all find themselves in a deserved top 10 position—the list prompted a question for me: Is this all absurd?

The answer? Kind of. The Power 100 is a decidedly unscientific compilation—and proudly so.

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We refuse to rely on one-year returns as a benchmark of influence, just as we equally refuse to use assets under control as a proxy. What we do is look for the large, positive trends in this industry—risk-factor approaches, infrastructure investments, novel advances in risk management—and then ask around (we’re journalists, after all). Who are the CIOs leading the charge in these areas? Who is taking the risks that other, more timid CIOs refuse to? Once we identify this select group, we ask them the obvious question: Who do you believe also belongs on a list of influencers? It’s a painstakingly qualitative approach.

The most enjoyable part of the whole process, however, is speaking to the members of the list. I have often said that this end of the financial system is by far the nicest. There are very few… how do I say this… [redacted] in CIO roles. There are egos, to be sure, but there are decidedly different egos populating downtown Manhattan and London’s Square Mile—and they’re most certainly different from the leading members of Vanity Fair’s effort. You won’t see Jepsen—or David Neal or Chris Ailman, who round out the medals—proclaiming their genius or demanding a video camera’s attention. But if they did, well, it would make for good copy…

“Henrik Gade Jepsen held forth on his Facebook fan page about his ‘exceptional’ portfolio construction skills, while David Neal sold bathing suit pictures of his manager lineup to The Telegraph in Sydney for AUS$2 million. Chris Ailman, meanwhile, revealed that he has had three assistants take an uninterrupted stream of monologue-like dictation since 2003.”