States study pension assumptions

By   /   August 20, 2010  /   News  /   No Comments

States are considering lowering assumptions on how much their pension funds will earn in the future, which would increase unfunded liability and require billions of dollars more in taxpayer contributions.

By Jonathan Miltimore
Pension boards in states around the country are considering recommending lower anticipated returns on investments, a move that could further pinch revenues in states struggling to balance yearly budgets. 
Prompted by a decade of weak stock performance and growing concerns in financial markets, many actuaries and government officials said more restrained expectations may be needed to avoid a future swell in unfunded obligations.
“At this point, I think it’s safe to say New York is one of the states out there considering changes,” said Robert Whalen, spokesman for the Office of the New York State Comptroller.
New York likely will be dropping its 8 percent anticipated rate by either one-half or one-quarter on its $132 billion retirement system, state officials reportedly announced Friday, and representatives for retirement systems in Massachusetts, Minnesota, and Colorado also indicated lower rates of return could be forthcoming.
Because public pension funds often contain tens of billions of dollars in assets, even nominal adjustments to anticipated rates of return result in changes that require hundreds of millions of dollars in state revenues to fund the future obligations.
The decision to lower anticipated returns comes on the heels of a “Lost Decade” that saw the Standard & Poor’s 500-Index post a negative return for the first time ever over a single decade.
Officials in Minnesota said a retirement board would be determining over the coming months whether to make a change.
“We are currently at 8.5 percent; we are considering lowering that,” said Dave Bergstrom, Executive Director of the Minnesota State Retirement System, who estimated any change would likely be one-half or one-quarter of a percent.
Jim Lamenzo, actuary for the public employee retirement administration commission in Massachusetts, said he generally advises a rate of return between 7.5 and 8 percent, lower than the 8.25 percent used in many of the state’s 106 plans.
“I would like to see that lowered to make it equal with the other systems,” Lamenzo said.
Colorado lowered its rate from 8.5 percent to 8 percent last year and officials said another adjustment could be on the way.
“We are completing an asset liability study,” said Katie Kaufmanis, director of communications for Colorado Public Employees' Retirement System.
Kaufmanis said the trustee board would be making a recommendation to the legislature based on the findings, but noted the state has a sensitivity analysis of 1.5 percent to reflect underperformance.  
“You can see what that does to our ARC (Annual Required Contribution),” Kaufmanis said. “We are very up front about that.”
But some economists contend lowering anticipated returns on investment by fractions of a percent does not go nearly far enough.
“I think that states have been living in fantasy land with how they have been funding their pension funds,” said Jonathan Williams, director of the Tax and Fiscal Policy Task Force for the American Legislative Exchange Council.
Williams said a four or five percent assumed rate of return is a far more realistic figure.
But some actuaries say the recent market collapse has resulted in an overreaction.
Lamenzo balked at the notion a 7.5 percent rate of return was Quixotic.
“We’ve done it for 25 years,” Lamenzo said. “You have a year like 2008 and everyone is panicking.”
Halving anticipated return rates, as Williams and others suggest, would essentially double pension liabilities at a time when the vast majority of state pension funds are already underfunded by billions and even tens of billions of dollars.
But advocates say this is preferable to stacking future obligations on future pension contributors and taxpayers.
“Yes, short term obligations would balloon; but if we want a clear understanding where our states stand … we need more realistic assumptions,” Williams said. Lamenzo said he believes much of the attention pensions are receiving is from interests seeking to move public employees out of defined benefit plans.
“Six percent seems fairly conservative to me,” Lamenzo said, “Certainly the last 10 years has not beaten that assumption, but we are funding long term.”
Williams said only 10 percent of private workers have defined benefit plans because they are costly and inefficient. 
“Even Warren Buffet has said it’s an extremely inefficient method,” Williams said. “If states don’t get this under control, they won’t be getting their heads above water any time soon.”