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Bobby Bonilla Day just passed, an annual occurrence that lives in infamy for many Mets fans. Every July 1, from 2011 through 2035, the former outfielder gets a check for about $1.19 million, under the deal he made with the team in 2000—a year after he’d batted .160—to buy out his contract. That Bonilla will receive a total of $29.8 million for not playing, to satisfy the $5.9 million owed him two decades ago, is especially galling.
This story is annual fodder for the sports pages, but what’s it doing in Barron’s? It helps demonstrate the most basic concept of finance—the time value of money—and how the Bonilla deal relates to the nation’s public pensions.
To start off, the Mets faithful’s contempt for Bonilla’s deal isn’t entirely deserved. He’s also getting $500,000 a year from the Baltimore Orioles under a similar deal. But more basically, most baseball fans, for all their devotion to increasingly abstruse statistics, don’t understand the time value of money.
That term describes the difference between the value of a dollar today and a dollar in the future, based on the interest rate that can be earned on that money. Assuming a rate of 10%, $1.00 received in one year has a present value of 91 cents. A dollar in two years discounted at 10% has a present value of 83 cents, and so on.
Given this, it takes fewer dollars today to meet future obligations if they can be invested at a higher rate of return. In Bonilla’s case, at 8%, he was able to pocket more than five times as much by waiting, rather than getting paid upfront. That was reasonable in 2000, when 8% was what investment-grade corporate bonds were yielding.
In a current example of the magic conjured by the time value of money, Connecticut has begun to award $3,200 in “baby bonds” to children born to mothers covered by Medicaid, with the estimable aim of narrowing the generational wealth gap. When the kids turn 18, the bonds will be worth about $11,000, which can be used for education, buying a home, or starting a business in the state. The bonds’ yield will be the same assumed return as Connecticut’s pension fund, 6.9%.
But that 6.9% projection now far exceeds yields on corporate bonds, pension funds’ traditional mainstay investment. The
iShares iBoxx $ Investment Grade Corporate Bond
exchange-traded fund (ticker: LQD) yields 2.19%, while its counterpart, the
iShares iBoxx $ High Yield Corporate Bond
ETF (HYG), scarcely lives up to its name, with a mere 3.33% yield.
The good news is that the 100 largest public pension plans, boosted by last year’s huge stock market recovery, were 79% funded at the end of the first quarter, according to Milliman, a benefits consultancy. That was up from 78.6% on Dec. 31 and just 66% at the end of 2020’s second quarter, following the market’s pandemic plunge.
But those aggregate numbers include wide variances. According to data from the Center for Retirement Research at Boston College cited by the Municipal Market Analytics newsletter, the top one-third of public plans are 93% funded and improving, the middle third is 74% funded and holding steady, and the bottom third is at 54% and deteriorating.
Investment returns play a huge role for retirees, given that they account for about 61% of the revenue that the funds pay out, according to the National Association of State Retirement Administrators. “The investment return assumption is the single most consequential of all actuarial assumptions in terms of its effects on a pension plan’s finances. The sustained period of low interest rates since 2009, combined with lower projected returns for most asset classes, has caused many public pension plans to reduce their long-term expected investment returns,” a report by the group says.
The median assumed return currently is 7%, according to Nasra, which is above the median investment return of 6.70% over the 20 years ended 2020. With bond yields at historic lows and stock prices at record highs, the chances are that future returns will be lower. According to a report from the American Legislative Exchange Council, those unfunded liabilities for state-run pension plans total $5.82 trillion, an average of $17,748 per person across the nation. Lower returns would widen that huge gap.
As for Mets fans, all they have to worry about is their team once again blowing its lead in the National League East as it heads into the baseball season’s second half.
Write to Randall W. Forsyth at [email protected]