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PA pension fund bets $250M on sunny days with high risks

By   /   April 12, 2012  /   1 Comment

PSERS catastrophe bond investment carries promises of rewards, but high risks for taxpayers
By Eric Boehm | PA Independent
HARRISBURG — Driven by years of lackluster investments and ballooning retirement costs, one of Pennsylvania’s major public pensions systems is investing in a high-risk fund essentially betting on the weather.

The state’s Public School Employees Retirement System, or PSERS, has invested $250 million in so-called catastrophe bonds, which back insurance companies in parts of the world at high risk for costly natural disasters.
So when “the big one” hits, insurers have somewhere to turn for additional capital to pay off the losses incurred by their clients. The bonds, also known as insurance-related securities, are a form of financial insurance for insurance companies and have been offered since the mid-1990s. 
“Over the past few years, PSERS has focused on reducing the overall risk profile of the portfolio by looking for uncorrelated return streams,” said Evelyn Tatkovski, spokeswoman for PSERS.  “The reinsurance market is one new area where we have found the risk (and) return profile to be attractive.”
PSERS has a total investment portfolio of $51 billion and an unfunded liability of about $27 billion – though by some calculations the liability is $100 billion – and is one of two pension systems in the nation to invest in these bonds.
As long as there are no major losses, PSERS can expect an 8 percent to 10 percent annual return on the investment on the catastrophe bonds, according to Nephila Capital, the Bermuda-based firm that runs the funds PSERS invested in. But in 2005, this fund saw a 14 percent loss due to three major hurricanes — including Katrina — striking the U.S.
Like any other investment, it’s a balance of risk and reward. 
“At the end of the day, no one can predict the future,” said John Thompson, senior vice president at Emerald Advisors Inc., a Lancaster-based investment firm. “People can make calls in the short term, but longer term and consistently, no way.”
Good investors can read and react to changes in the market but not so to Mother Nature.
The Nephila fund has the greatest exposure in Florida, Texas and New York, which are vulnerable to hurricanes. Other risks are in California and Missouri, where earthquakes are the biggest threat.
The promised returns of 8 percent and higher probably make the fund attractive to PSERS, since the pension plan has an assumed annual rate of return of 7.5 percent. Failing to meet that target — which is higher than most private-sector pension funds — means taxpayers or employee contributions have to make up the difference.
If the fund continues to assume a higher rate of return, it will be forced to take riskier investments to meet that obligation, said Rick Dreyfuss, a retired actuary and pension expert for the Commonwealth Foundation, a free market think tank here.
Dreyfuss said individuals usually invest by starting with a time period and an acceptable level of risk, and then try to maximize returns within those parameters, but public-sector plans are doing it backward.
“In public-sector defined benefit plans, the expected rate of return really is locked-in due to political purposes,” said Dreyfuss. “As a result, these plans determine the nature of the portfolio necessary to achieve this return assumption.”
Frank Keegan, a pension fund expert with State Budget Solutions, a nonpartisan national policy center that advocates for budgeting reforms, said it was still too much of a risk.
“With a state pension system more than $100 billion in the hole, why are they risking $250 million of pension money on a deal like this? These investments are tricky and risky,” Keegan said. “If the pension fund managers think this is such a good idea, why don't they put their houses on the line instead of taxpayers?”