Truth and Consequences: Treasurer Folwell’s decisions

Truth and Consequences:  Treasurer Folwell’s
Treasurer Folwell’s claims about his financial stewardship
simply aren’t accurate.  He inherited a pension that was in very
good shape, and he wants the public to believe he’s rescued the
pension and taxpayers from a troubling situation.  In fact the
Treasurer is undermining the pension plan’s financial condition
through his investment decisions and management practices.  This
post presents a series of incorrect claims, imprudent actions, and
even a couple of reasonable steps taken by Treasurer Folwell.  It
gets a bit technical for the casual reader, but the technical bits

Inherited Accolades: The Treasurer touts a recent
stress test that ranked the North Carolina pension #6 based on the
ratio of assets to liabilities (“funded ratio”) in 2017, his
first year in office.[1]  That’s not a sudden or great
accomplishment.  North Carolina ranked #5, #2 and #4 in 2010,
2012, and 2015[2]on this ratio when Janet Cowell was
Treasurer.  In fact, North Carolina has been near the top in this
ranking for decades.
The Treasurer has trumpeted the exciting news that Moody’s
recently rated North Carolina #1 based on the ratio of its pension
liability relative to total revenue.  In other words, North
Carolina’s pension is the least burdensome to the state’s
budgetary resources in the country.  It’s a nice accolade, but
it’s nothing new.  North Carolina has been #1 or #2 in this
metric for years according to Moody’s.[3]
Trends Inside the Pension:  If you dig inside the
pension’s actuarial reports, you’ll find that the Treasurer is
meeting his basic responsibility to get the legislature, local
government, and educational institutions to make their
contributions to fund the plan and slowly eliminate the deficit.
 He’s following the path laid out by Treasurer Cowell.[4]However, his stewardship is not
particularly commendable. For example, the “funded ratio” is
declining and continues to decline. To be clear, the pension is
still reasonably well funded, but the latest actuarial reports for
the Teachers’ and State Employees’ pension released last
November show that the funded ratio has dropped from 95.6% to 86.4%
between 2014 and 2018 if asset values are smoothed out, and from
95.4% to 82.3% over the same period if the assets are simply based
on year-end values.[5]    The funded ratio will
probably rise a bit in 2019 given the sharp rise in stock prices. 
However, the funded ratio would rise even more if the Treasurer
hadn’t tried to time the stock market by selling equities and
putting the proceeds in cash.
Moreover, the burden on taxpayers in funding the pension is on
the rise and will continue to rise for a period of time.  These
contributions by employers (taxpayers) are reasonable, but they are
likely to head in the wrong direction for a while.  In large part
the payments are rising because the assets haven’t grown at the
assumed rate of 7% during considerable periods of time. They are
also rising because the Treasurer made the decision to lower the
assumed rate from 7.25% to 7.00%.[6]  Eventually his ill-considered
decision to try to time the equity market will push the employer
burden even higher; someone is going to have to make up for all
that capital that’s been sitting in cash.
To measure the rising burden on taxpayers we turn to the
Actuarially Determined Employer Contribution or “ADEC”. In 2017
this ratio, which measures the employer contribution as a
percentage of total payroll, was 9.96%.  In 2020 it will be 12.97%
and is projected to rise to 14.78% in 2021.[7]  The Treasurer has asserted that
these increases will not result in tax increases, which is probably
true.[8]  That’s because the legislature
will decide to cut other programs or limit salary increases, while
local government and school boards will also have to pare programs
in order to fund the required pension contributions.
Moving in and out of index funds:  Treasurer Folwell
also takes credit for moving some $16 billion in index funds from
external to internal management.  The decision saved the pension
some $700,000, but the real work occurred under Treasurer Cowell. 
She shepherded through two statutory changes to allow for internal
management[9], and the staff led by Rhonda
Smith, Director of Public Equities, put in place all the systems
and technology to make this possible.[10]  The move to internal
management occurred on Treasurer Folwell’s watch, and he deserves
credit for implementing the change. 
Having built up the internal indexes to the aforementioned $16
billion in 2018, he then ordered the staff to sell off $5.5 billion
of the index exposure in 2019.[11]  This is more evidence that the
State Treasurer is not taking the proper long-term perspective in
managing the pension.  Moreover, the Treasurer has incurred two
sets of transactions costs (initially funding the internal indexes
and then partially liquidating them) that should be subtracted from
his much touted fee savings.
Foreign equity exposure: There’s another odd
consequence of the State Treasurer’s decision to time the stock
market.  As he’s terminated equity managers and liquidated index
funds, he’s dramatically increased the pension’s exposure to
non-U.S. stocks and foreign currency.  Before he started paring
the equity portfolio, U.S. stocks were 55.7% of the public equity
allocation[12].  At the last report in
September the U.S. exposure was down to 44.6%.[13]The pension’s exposure to
foreign currency risk has increased significantly as a consequence
of the Treasurer’s rush in 2017 to fire managers and then repeat
the exercise in 2019 without proper analysis or thought.
Ignoring the asset-liability study As I’ve indicated
the Treasurer needs to achieve a 7% return over time in order to
keep the pension liability from growing. In very simple terms, if
the pension fails to meet the investment target, the liability will
grow and the legislature will have to appropriate more money to
fill the gap. An asset-liability (“A/L”) study is the accepted
method for mapping out the best strategy for meeting the target and
forecasting future contributions by employees and employers. 
Treasurer Folwell has totally ignored the pension’s A/L study or
commissioned a new one.  As a result, the pension is destined to
fall far short of the 7% target.
To see why the pension’s going to fall short, you just have
to look at the last A/L study, done in 2016[14], which has been reviewed and
accepted by Treasurer Folwell.  The study sets out the 10-year and
30-year predicted returns for every type of investment in the
pension. Equities are predicted to return 8.0% and 8.7% over
10-year and 30-year horizons.[15]Cash and investment grade bonds
are only projected to return 2.1% and 2.5% in the next 10 years and
3.5% and 5% over the next 30 years.[16]  Treasurer Folwell can’t get
to 7% return because he’s shifted over $15 billion from equity
that is likely to beat his investment target to cash and bonds that
are highly likely to fall far short of the target.
Conclusion: This is an election year, so the Treasurer
is going to be occupied with a campaign.  At the same time he has
an enormous health insurance program to run, a retirement system to
manage, and local government finance to oversee.   If he has a
spare moment, there’s also a $105 billion pension plan with a
sizable allocation to cash that deserves his thought and
attention.  Chances are he’ll maintain the pension’s cash
hoard[17]and let the General Assembly,
local governments, and school boards figure out how they’ll pay
for his error.

[1] Public Pension Stress Testing: North
Carolina, Pew Charitable Trust,
p. 11
[2] The trillion dollar Underfunded state
retirement systems and the roads to reform, February 2010, Pew
Center on the States, Pew Charitable Trusts,
p. 56
The State Pension Funding Gap: 2014, Pew Charitable
The State Pension Funding Gap: 2015, Pew Charitable
p. 6
[3] Medians – Adjusted net pension
liabilities decline; OPEB liabilities vary widely, Moody’s
Investors Services, September 17, 2019,
[4] See for example, TSERS Asset –
Liability and Investment Strategy Project describing efforts to
stabilize employer contributions, p. 5,
[5] Teachers’ and State Employees’
Retirement System of North Carolina
Teachers’ and State Employees’ Retirement System Principal
Results of Actuarial Valuation as of December 31, 2018 Actuarial
Valuation, presented to Board of Trustees on October 31, 2019, p.
See also Local Governmental Employees’ Retirement System
Principal Results of Actuarial Valuation as of December 31, 2018
presented to the Board of Trustees on October 31, 2019, p. 87
which shows similar trends in the other large public pension in
[6] When the assumed rate goes down the
size of the liability goes up because the assumed rate is also used
as a discount rate in calculating the present value of the
liability.  As a result the pension will require greater
contributions from employer’s in order to eliminate the deficit
between assets and liabilities over time (usually about 20
[7] Ibid, page 87
[9] Session Law 2009-98 (S.B. 703)
authorizing direct investment by the Treasurer in the S&P 500
index and Session Law 2016-55, House Bill 1137 broadening the
Treasurer’s authority to make direct investments.
[15] Ibid, p. 18 sets out all the
expected returns by asset class and strategies. 
[16] I have had to estimate the expected
return for investment grade fixed income based on the A/L studies
estimates for Treasuries, Corporate Bonds and Mortgage Backed
[17] Even if the Treasurer reinvested
the cash, the $2.6 billion of lost opportunity, will not be


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