As a Fellow of the Society of Actuaries, I know almost everything taxpayers are told about the Hawaii Government Employees' Retirement System is false.
 
One lie is that employee benefits depend on, or are affected by, the $10 billion of assets earmarked by the state for their payment. In truth,  the benefits are legally guaranteed by the taxpayers' full faith and credit. Losing the entire $10 billion would not cost any employee or retiree a single penny of benefits already earned, or a single penny of future retiree cost of living allowances (COLAs). The Unions even claim current employees would retain the right to earn more benefits under the current formula for life, and the Attorney General's silence blesses that claim. Instead, taxpayers would make up every lost dollar, continue annual contributions for new benefits as they are earned, and even make up any amount by which future earnings fall short of 8 percent thereafter.
 
Lie number two is that the purpose of earmarking assets is so their earnings can lower benefit costs relative to pay-as-you-go funding. In truth, taking earmarked assets out of prior budgets increased bond debt by an equal amount. So, earmarked assets earnings should be reduced by the bond interest they created. That still leaves some arbitrage gain between tax-exempt bond interest paid out and riskier taxable investment return earned by the tax-exempt earmarked fund. However Hawaii's earmarked assets averaged less than 6 percent from '00 – '07, and the excess of 6 percent over tax-exempt bond rates hardly compensates for '08's $1.8 billion (as of 9/30) loss.

The real reason for earmarking assets and using an accepted actuarial funding method is to keep politicians honest. It does so by showing taxpayers the cost of a proposed benefit increase today, instead of letting politicians hide the cost for decades as they can with pay-as-you-go funding, i.e. until many years hence after the employees earn the higher amount, retire, and start collecting it.

So in truth, while earmarking assets produces a theoretical arbitrage gain between borrowing at tax exempt bond rates and putting the proceeds into a tax-exempt fund that can invest in riskier, higher return taxable securities, the real difference is that pay-as-you-go funding would otherwise let politicians pass many benefit increases before taxpayers had a hint of what the first one cost.

Just a note... most accepted actuarial funding methods first calculate how much taxpayers already owe employees for benefits to which the service already rendered by employees will entitle them later—the accrued liability (AL). The required contribution is then the amount that must be added to the earmarked assets to get, and keep, them equal to the AL, i.e. fully funded.

Assets less than the AL means taxpayers are behind. The shortfall is called the unfunded liability (UL).
 
In 2000, the system was fully funded. By June '07 underperforming assets put taxpayers $5 billion behind. A $5 billion UL is the cost of rail, or it is $5,000 per infant, child, adolescent and adult. Then came '08. The June '08 report hasn't been released yet, but I'm certain the UL is at least $7 billion today. But even though taxpayers hold 100 percent of the investment risk, Hawaii state legislators gave investment control to a unionized teacher, a government retiree, two unionized employees, and three people appointed by the Governor, one of whom must be a banker. They are called "trustees," even though the assets are just legally earmarked public money. Their other duty is to maintain records and calculate benefits.

So, the third lie is one told by "trustees," and sworn to by the silence of the Attorney General', Governor,' and Legislators'. It is that the "trustees" owe a fiduciary duty to employees, but not to taxpayers. That's simply absurd! Fiduciary duty first requires discretionary authority, and then only flows to those whose interests are affected by the exercise of that discretion. Hence, the duty trustee's owe employees and taxpayers with respect to benefit calculation is ministerial, not fiduciary. It does not involve discretion, just an obligation to correctly apply the law. However, the duty owed by "trustees" with respect to setting investment risk is a fiduciary one, because they are granted broad discretion, and it's owed exclusively to taxpayers, because they are the only party whose interests are directly affected by the exercise of that discretion.

The fourth lie is that "skimming" system assets caused the under funding. Aside from the fact that system achieved full funding at the end of the alleged "skimming" years, the system sued the state for "skimming". I was the state's expert. The suit was dismissed.
 
In addition to investment return falling short of 8 percent, what is contributing to the post-skimming UL explosion is the Governor and Legislators repealing a 70-plus year old legal requirement that government contributions be calculated by an accepted actuarial funding method. Since '05, the contributions have been set by fiat to a lower number. It also increased the Governor's "surplus" that Legislators enjoyed spending.

So, it would be no surprise to find that "trustees" who claim no duty to taxpayers, who know their decisions held no risk to employees, and who worry someone might soon notice the $5 billion shortfall from underperformance (amplified by suppressed fiat-funding) were tempted to increase the taxpayers' bet on riskier equities in the hope of winning back their losses – which regardless of reason lost horribly for us in '08. And, it's not just the direct loss. A $7 billion UL means the System is barely 50 percent funded. Bond raters will notice the deterioration from 100 percent to 50 percent when the June '08 is released, so taxpayers may have a bond rating adjustment laid on our backs.
 
Now I worry another law change is being crafted to further suppress the increase in contributions actuarial funding would demand, i.e. to silence the warning bells of actuarial funding. I think taxpayers will be foolish to permit another law change without a full and fair public hearing at which taxpayers are represented by an actuary not someone on the "trustees'" payroll. Anyone agree?

- GIR -