Friday, December 20, 2019

"State Pensions Lower Their Return Assumptions"

Politicians make promises to government employees that are backstopped by taxpayers,
the least they can do is be straight with the the people who are ultimately on the hook for those promises.
From Pension Pulse, December 19:
Pew Charitable Trusts just released an issue brief stating state pension funds are lowering their assumed rates of return:

State and local public employee retirement systems in the United States manage over $4.3 trillion in public pension fund investments, with returns on these assets accounting for more than 60 cents of every dollar available to pay promised benefits. About three-quarters of these assets are held in what are often called risky assets—stocks and alternative investments, including private equities, hedge funds, real estate, and commodities. These investments offer potentially higher long-term returns, but their values fluctuate with ups and downs in financial markets in the short term and the broader economy over the long run.

Financial analysts now expect public pension fund returns over the next two decades to be more than a full percentage point lower than those of the past, based on forecasts for lower-than-historical interest rates and economic growth. Research by The Pew Charitable Trusts shows that since the Great Recession—which started in late 2007 and officially ended in mid-2009—public pension plans have lowered return targets in response to changes in the long-term outlook for financial markets. (See Figure 1.)

Pew’s database includes the 73 largest state-sponsored pension funds, which collectively manage 95 percent of all investments for state retirement systems. The average assumed return for these funds was 7.3 percent in 2017, down from over 7.5 percent in 2016 and 8 percent in 2007 just before the downturn began.

More than half of the funds in Pew’s database lowered their assumed rates of return in 2017. Following the steep swings during the recession and in the years immediately afterward, these changes reflect a new normal in which forward-looking projections of expected economic growth and yields on bonds are lower than those that state pension funds have historically enjoyed. Reducing the assumed rate of return leads to increases in reported plan liabilities on fund balance sheets, which in turn increases the actuarially required employer contributions. Still, making such changes can ultimately strengthen plans’ financial sustainability by reducing the risk of earnings shortfalls, and thus limiting unexpected costs.

Recently, many plans have worked to mitigate the higher required contributions that have been prompted by increased liabilities linked to more conservative investment assumptions. The present value of future liabilities is typically calculated using the assumed rate of return as the discount rate, which is used to express future liabilities in today’s dollars; lower return assumptions yield higher calculated liabilities. Some state pension funds have phased in discount rate reductions—effectively altering how they compute future liabilities. That allows them to spread out increases in contributions over time.

For example, in 2016, the California Public Employees Retirement System (CalPERS)—the nation’s largest public pension plan—announced it would decrease its assumed rate of return incrementally from 7.5 percent in 2017 to 7 percent by 2021. Even such an incremental change can have a significant impact over time: a 1 percentage point drop in the discount rate would increase reported liabilities across U.S. plans by over $500 billion, a 12 percent rise.

As assumed returns have gone down, asset mixes have remained largely unchanged. For example, average allocations to stocks and alternative investments—which can provide higher yields but with greater risk, complexity, and cost—have remained relatively stable in recent years at around 50 percent and 25 percent of assets, respectively. This indicates that most fund managers and policymakers are adjusting their assumed rates of return in response to external economic and market forecasts, not based on shifts in internal investment policies.

This brief updates research published by Pew in 2017 and 2018 that provided data on asset allocation, performance, and reporting practices for funds in all 50 states. It explores the impact of continued slow economic growth on investment performance, as well as potential management and policy responses to lower returns. Finally, the brief highlights policies and solutions employed by well-funded plans, including the adoption of lower return assumptions, that have helped insulate the plans from economic volatility.

Slow economic growth projected for the next decade....