Environmental, social, and governance issues are commonly packaged together in investment discussions through the ESG acronym, but a closer examination of these components raises questions about the value of grouping these things together.

It is evident that the concept of ESG investing owes its existence to politics by simply looking at its components. Why else would environmental, social, and governance criteria be lumped together other than for political positioning? Why not past, present, and future?  Or animal, vegetable, or mineral? 

Some idealists with a political agenda made the determination that these separate elements, ESG, were, in total, critical for long-term investing success, as well as other broader goals. They were also successful in positioning these three elements as a singular, necessary approach to investing success. ESG opponents then emerged, and the debate commenced. Through years of engagement, even opponents contributed to the idea that these three elements should be treated as one. Their position then became one where absolutely no credence could be given to any ESG investing criteria.

A prudent person, on the other hand, can see elements in standalone environmental, social, and governance issues that should be considered when public pension systems are making investment decisions. That same prudent person would also see that not every one of these issues should be applied to each and every investment decision. In fact, it is just as foolish to eliminate all such criteria from investing as it is foolish to include all such criteria. 

Fortunately, public pension fund trustees must follow prudent fiduciary standards, which set boundaries on how investment decisions are to be made. Given this, public pension fund trustees are afforded a perfect path to avoid the purely political argument that ESG investing has become. Fiduciary standards require that pension fund trustees make investment decisions based on providing the best possible financial outcomes consistent with the pension plan’s objectives for the plan’s participants and for the plan itself. 

All-in or all-out ESG investing is not sound, prudent fiduciary policy.  Therefore, public pension fund trustees should make investment decisions based on practical and sound financial criteria, not based on political ESG classifications that prioritize other factors above returns and volatility. The likely outcome of prudent decision-making is that some decisions will be made that align with the ESG approach, and others will not. All of these decisions, however, must be made for the good of the pension plan’s members and not to satisfy political agendas. 

The practical approach to responsible public pension system governance is there, fiduciaries just need to follow it.

The post Public pension fund trustees have a perfect path to avoid the politics of ESG investing appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Designing an optimized retirement plan for today’s public workers
• North Dakota considers pension reforms
• How ESG policies impact institutional investors
• State pension systems expand high-risk, high-reward investments

News in Brief
Quotable Quotes
Data Highlight
Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Designing an Optimized Retirement Plan for Today’s State and Local Government Employees

The discourse about public retirement policy often revolves around a binary choice between defined benefit (DB) pension plans and 401(k)-style defined contribution (DC) plans. Each has its own unique advantages and drawbacks, but both lack the flexibility to match many unique personal situations. A new paper from Reason Foundation’s Pension Integrity Project proposes that public retirement benefits need not be limited to these two choices any longer. In the new report, public retirement benefit experts and senior fellows Richard Hiller and Rod Crane introduce the Personal Retirement Optimization Plan—or PRO Plan—for the public sector. The PRO Plan adds the element of a guaranteed retirement benefit to a DC foundation to build a more secure, customizable, and portable retirement for public workers. The PRO Plan is built around the objectives of risk-managed retirement income adequacy, and unlike traditional public pension plans, does not impose funding risks on government employers. Testing this newly proposed PRO Plan design, Hiller and Crane find that the costs of providing guaranteed annuitized benefits through the PRO Plan would be much lower than an individual purchasing these benefits on their own.

• Full Report—The Personal Retirement Optimization Plan: An Optimized Design for Government Employees
• FAQ: Frequently asked questions about the PRO Plan
• Webinar: Experts discuss the need for the Personal Retirement Optimization Plan

Evaluating North Dakota’s House Bill 1040

Facing $1.8 billion in unfunded pension liabilities, and projections that the pension fund will be depleted within 80 years, North Dakota policymakers are seeking comprehensive reform of the North Dakota Public Employees Retirement System (NDPERS). The newly introduced House Bill 1040 would address many of the issues that have been plaguing the system for decades. Firstly, it would fix the state’s systematic funding deficiencies by switching from a statutory to an actuarial contribution policy. This would ensure that state and local governments are making the payments needed to fulfill all pension promises by a predetermined date. Second, the reform would provide new hires, beginning in 2025, a defined contribution (DC) plan that meets a high standard of benefit design. Reason Foundation’s analysis of House Bill 1040 finds the proposed reforms would effectively halt the accrual of new unfunded liabilities with new hires, and would reduce long-term costs of the pension plan by responsibly paying down its legacy debt.

• Testimony to North Dakota House Government & Veterans Affairs Committee
• Examining the Benefits of House Bill 1040
• The Public Pension Gold Standard, North Dakota’s HB 1040, and the Status Quo
• Does HB 1040 Meet the Objectives of Good Pension Reforms?

The Mechanics of ESG-Driven Divestment, Engagement, and Proxy Voting

Environmental, social, and governance (ESG) policies can take many different forms and are applied by a wide variety of organizations, but the foundational goal is to influence investors’ and corporations’ decision-making. In this commentary, Jordan Campbell examines two main avenues used to leverage this influence and how groups are trying to reshape the market through divestment and corporate engagement. Although there is no clear impact of ESG divestment practices, there has been a noticeable rise in ESG engagement practices, namely proxy voting. Data indicates that public pension funds have outpaced other institutional investors—and even ESG-focused funds—in throwing support behind ESG resolutions.

In Search of Higher Returns, Public Pension Systems Dive Deeper into Alternative Investments

Public pension plans saw significant investment losses in 2022, and economic forecasts indicate that more market turbulence is in store for 2023. Facing this increasingly unpredictable and volatile investment environment, and under pressure to achieve often overly-optimistic investment return assumptions, many public pension plans continue to dive deeper into high-risk, high-reward strategies. Reporting on these trends, Reason’s Steve Vu highlights several states, including New York, California, Texas, Ohio, Iowa, and New Mexico, where policymakers are loosening up limits and increasing targeted allocation in alternative investments like private equity, private credit, and real estate.

News in Brief

End-of-Year Update Describes a Tough 2022 for Public Pensions

An update to the State of Pensions report by Equable Institute summarizes the funding status of 228 state and locally administered pension plans at the end of the 2022 calendar year. Their calculations indicate that the aggregate funded ratio of these plans dropped from 83.9% funded the previous year to 77.3% in 2022, marking a significant reversal of the investment gains gathered during a record-breaking year of returns in 2021. They estimate an average return of -6.14% for the last year, which falls dramatically below the average plan assumption of 6.9%. Analysis in the report finds that—facing ongoing challenges in 2023—most state retirement systems remain fragile to a volatile and increasingly unpredictable market. The full update is available here.

Brief Examines Pension Contribution Behaviors of Governments

A new brief by the National Association of State Retirement Administrators (NASRA) focuses on the contributions that state and local employers made to fund the pension benefits promised to public workers through 2021. They find that of the more than $10 trillion in pension revenue generated since 1992, $2.5 trillion came from employer contributions, $1.1 trillion came from employee payments, and $6.5 trillion (64%) came from investment returns on those gathered funds. The brief recognizes the efforts of governments to reach actuarially determined contribution rates, finding that the average percentage of actual to actuarial contributions to be 99.3% in 2021, the best rate since 2001 and a major improvement from the below 80% paid in 2012. The brief attributes much of this improvement to reforms of contribution policies and supplemental payments from general government funds. The full brief is available here.

Quotable Quotes on Pension Reform

“There’s going to be acute fiscal pain and pressure the more you ignore the cost…If you’re not paying it down, you’re chasing it.”

—Leonard Gilroy, managing director of Reason Foundation’s Pension Integrity Project, on unfunded pension liabilities in “State Pension Plans Were Hammered in 2022. Next Year Will be Worse,” Politico, Dec. 28, 2022.

“Chicago government-worker pensions are massively underfunded. So in typical Chicago-land fashion, the City Council is betting on casino revenue to plug the pension gap. Do taxpayers and workers feel lucky?… The police and firefighter pension funds are only about 20% funded—among the worst in the country—even though 80% of city property tax dollars go toward pensions. The city’s annual pension payments have risen by $1 billion over the past three years.”

—The Wall Street Journal Editorial Board on the move to build a casino to generate tax revenue dedicated to the police and fire pension funds in “Chicago’s Big Pension Gamble,” The Wall Street Journal, Jan. 2, 2023.

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell, using Morningstar data, created a visualization comparing how public pensions and other institutional investors voted on ESG shareholder proposals. You can access the graph here.

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Modernizing public sector retirement plans, North Dakota reforms, and more appeared first on Reason Foundation.

While these ESG policies are often subjective and political, proponents tend to claim that they are an objective lens to value firms and allocate investments. The evidence for this claim is weak, however.

For many activist investors and politically-motivated institutional investors, investment performance may not be the main priority. ESG can be used to provide activist investors a framework to reshape how finance and investing relate to business into something that better conforms with their visions of the world. There are generally two approaches for these groups: divestment and/or engagement. 

Divestment 

The theory behind divestment is that by selling or avoiding the purchase of so-called ‘bad’ companies and industries, these firms and industries will be punished with a higher cost of capital. The cost of capital is the required rate of return or profit a firm must earn on capital investments to satisfy its owners and creditors. Companies can raise capital from equity by selling ownership or debt by taking a loan from a creditor. A higher cost of capital reduces the number of new investment opportunities available to a business.  

The latest Global Sustainable Investment Alliance report put ESG investments at 36% of all managed assets. According to the Global Fossil Fuel Divestment Commitments Database, 1,556 institutions have now divested from fossil fuels. These institutions include Harvard and Oxford Universities, several New York City pension funds, and the Norwegian Sovereign Wealth Fund. 

The actual impact of these divestment strategies is not clear. The cost of capital in the oil and gas industry has declined over the past decade, which is in line with the general decline in the total market. Conversely, the cost of capital did jump considerably in the green and renewable energy industry in 2021, but there is a fair amount of volatility across all sectors year-to-year. 

Examining the impact of divestment, Jonathan Berk and Jules H. van Binsbergen, professors from Stanford's Graduate School of Business and the University of Pennsylvania's Wharton School, respectively, were not able to find a meaningful impact of ESG investing on capital costs within the energy markets. "When calibrated to current data, we demonstrate that the impact on the cost of capital is too small to meaningfully affect real investment decisions," Berk and Binsbergen write. Instead, the authors suggest socially conscious investors should focus on changing corporate policy. 

Engagement 

Changing corporate policy through shareholder influence and proposals is the engagement side of environmental, social, and governance strategies. Publicly traded companies hold annual shareholder meetings in which shareholders can vote on various proposals in proxy voting. ESG proposals in proxy votes are increasingly common and supported by large asset managers. 

One of the better-known examples of engagement occurred in 2021 in association with the oil company Exxon Mobil. A green activist hedge fund, Engine No. 1, which says it seeks "to create value by helping companies transform their businesses to be sustainable," gained support from asset managers, including BlackRock, Vanguard, and State Street, and elected three supported directors to Exxon's board. Four directors were nominated by Engine No. 1.  

However, this election was not an isolated occurrence. According to Morningstar, an investment research and management services firm, there were 273 ESG shareholder proposals in 2022. Notably, the number of proposals that pass has steadily increased over the last three years. Twenty resolutions passed in 2020, 36 passed in 2021, and 40 passed in 2022.  

The support for these resolutions is highest with institutional investors, particularly public pension funds. While general shareholders supported 63% of ESG resolutions, according to Morningstar, public pension funds supported 90%—which was even higher than the rate of ESG-focused funds. The Teachers Insurance and Annuity Association of America (TIAA) supported 92%, BlackRock supported 74%, and State Street supported 66%. Vanguard was the only asset manager of the "big three" to support ESG shareholder resolutions less than the general shareholder, voting in favor of 51% of proposals, Morningstar found.  

Unfortunately, there are no standardized disclosures or reporting for public pension proxy votes. Morningstar looked at 65 public pensions but could only locate records for 34 (29 were included in its analysis). Only one-third of these public pension plans had their records available online. Six percent charged a fee to provide their proxy-voting records, and five percent declined to give them. The lack of reporting on proxy votes among public pension systems should be viewed as a red flag suggesting these funds may be avoiding transparency and accountability.  

While the actual impact of divestment strategies appears tenuous, there are an increasing number of ESG shareholder resolutions with considerable support from institutional investors, particularly public pension funds.  

It is inappropriate for public entities to engage in political, non-pecuniary investment activities, regardless of whether it occurs through divestment or shareholder proposals. Public pension plans have a duty to base their investment decisions on pecuniary factors, such as investment performance and financial risk. Reason Foundation's Pension Integrity Project recommends that policymakers help prevent politically-driven investing and proxy voting by public pension systems by allowing the public to view all of the system's proxy votes well in advance of them being cast, as well as by requiring an annual report showing all of a public pension plan's proxy votes.

To serve the public workers relying on public pensions and to protect taxpayers, who are ultimately liable for paying for them, there must be complete transparency and appropriate rationales for proxy votes and divestment decisions made by public pension systems.  

The post The mechanics of ESG-driven divestment, engagement and proxy voting  appeared first on Reason Foundation.

According to Department of Labor (DOL) statements, the rule “removed barriers to considering [ESG] factors in plan investments” and will provide more flexibility in “exercising shareholder rights.”

But those critical of using ESG factors to make public pension systems’ investment decisions believe this move exposes retiree savings to oftentimes unexpected or counterproductive social and political agendas when risks and returns should be the sole investment factors. This new rule sets the stage for state governments to establish their own standards, which could prompt state legislatures to set up guardrails against political investing.   

Institutional investors, corporations, credit rating agencies, and governments are increasingly adopting an ESG framework into their investment decision-making. The idea behind ESG is to create a more accurate accounting of the negative externalities—be they environmental or social caused by industries, businesses, and individuals and to use this knowledge to positively influence the future. This ESG framework is implemented in a variety of ways.  

ESG investment policies typically seek to avoid assets that are deemed to be harmful to the environment. Some institutional investors adopt and promote ESG principles in hopes of influencing the companies they invest in. ESG ratings are applied to companies to measure—albeit arbitrarily—the negative impact they may impose on various environmental and social areas. All of this is increasingly present in both the public and private sectors. 

Traditionally, those who are tasked with managing collective retirement funds, including either a 401(k) plan or a pension plan, have what is called a fiduciary responsibility to the members of those plans. Fiduciary responsibility is the focused objective of managing and growing investment funds at acceptable levels of risk. Any other interest or objective is supposed to fall outside of the fiduciary’s purview, making it out of bounds for any consideration in investment decisions.  

For privately-run retirement plans, these standards are set by the Department of Labor through ERISA. In the waning months of the Trump administration, the Labor Department issued a rule that reinforced the traditional understanding of what a plan sponsor can consider when making investment choices for its members, specifying that making choices based on ESG factors would be out of bounds. The department also released a proposal that would significantly restrict retirement plan administrators from directly influencing equities through stockholder voting—a process called proxy voting—on ESG-related issues. 

In response to these protections from 2020, the Biden administration’s DOL has reversed course. Through the implementation of this latest rule, specific restrictions on making ESG considerations a part of investment decisions have been removed, allowing 401(k) plans under ERISA to insert ESG metrics into their risk and return evaluations. The rule also reverses the restrictions on proxy voting that were applied in 2020, opening up possibilities for retirement plans to use stakeholder positions to shape the decisions of the companies they are investing in, even if the matter is unrelated to economic outcomes. 

According to a statement on by United States Secretary of Labor Marty Walsh, the rule will “end the chilling effect created by the prior administration on considering environmental, social, and governance factors in investments.”

Walsh added, “Today’s rulemaking is an important step toward a more secure financial future for America’s workers and their families.”

However, his position remains politically polarizing, most evident in the response from Republican senators who have submitted a resolution to reverse the rule. 

What will these latest developments mean for employees and retirees who are counting on their pension plans to act on their behalf as fiduciaries? It indicates that the federal government is not going to get in the way of retirement plan managers who choose to insert political, inconsistent, and often controversial ESG factors into their decision-making. Those looking for protection from politically motivated shirking of fiduciary responsibility will have to turn to state governments. 

With a lot still to be determined in the world of retirement plans and fiduciary responsibility, the full impact of the DOL’s latest rule remains unclear. At the very least, it sets the stage for more debate on the matter, which will ultimately take place at the state level. State policymakers have already begun to set strong definitions of what a fiduciary can consider in making investment decisions.  

For public pension funds, which are not bound by ERISA and therefore largely unaffected by the Labor Department’s recent rule, state policymakers should consider legislation to keep activist campaigns away from taxpayers’ money in keeping apolitical funds from politicization. Setting clear boundaries for what a public pension can consider when making investment decisions—the approach taken by Florida’s State Board of Administration and proposed in a piece of legislation in Michigan—is the optimal way to protect these funds from activism from any political side. 

The post The Department of Labor’s new ESG rule puts the onus on states  appeared first on Reason Foundation.

In This Issue: 

Articles, Research & Spotlights  

• A blueprint for protecting public funds from ESG and politicization 
• Arizona’s innovation for multi-employer pension plans 
• Challenges in inflation protection for Texas teachers 
• Retention trends in the public workforce suggest the need for portability 
• What U.S. pensions can learn from the U.K. margin call 

News in Brief 
Quotable Quotes on Pension Reform  

Articles, Research & Spotlights 

Reason’s New Blueprint for ESG-related Legislation

Reason Foundation’s Pension Integrity Project has developed an ESG Blueprint to help policymakers seeking sound and effective policies for managing public funds, particularly public pension funds. The website provides an overview of what ESG is, its potential impacts on public pension systems, and model legislation to strengthen the boundaries of fiduciary responsibility, ensuring that policymakers keep public funds out of political influence campaigns. Reason’s ESG blueprint is available here, and our full archive of ESG-related analysis is here. Recent pieces include:

Arizona Creates Prefunding Program for State Retirement System

Many state-run public pensions are multi-employer plans, meaning local cities and counties participate and contribute to a single fund and share liabilities. This allows smaller governments to reap the investment benefits of a larger asset-pooled plan, but it can also mean less flexibility in paying down the unfunded pension liabilities that are impacting annual budgets. State legislators in Arizona recently passed a bill that aims to improve this flexibility for employers participating in the Arizona State Retirement System (ASRS). As outlined by Reason’s Ryan Frost and Truong Bui, Senate Bill 1082 offers a vehicle for local governments to apply extra payments to a separate account, which can be used to offset rising contributions at a later time. This is an innovation that other state-run multi-employer plans should consider employing. 

Is Texas’ Definition of an “Actuarially Sound” Public Pension System Outdated?

With high inflation continuing to degrade the value of fixed pension benefits, there is significant attention being placed on the cost-of-living adjustment policies that are supposed to cushion the blow from retirees’ losses of purchasing power. In Texas, there is a strict hurdle set in law that must be achieved before giving retired public workers a so-called “13th check.” The state must be able to demonstrate that it is “actuarially sound.” Reason’s Steven Gassenberger explains the current understanding of this hurdle, noting that it would be prudent to adjust this standard with shorter debt-payment requirements. 

More Portable Retirement Plans Would Help Public Employers Attract and Keep Workers 

Increased rates of resignation in the post-pandemic world are a continuation of a decades-long evolution in the modern workforce, with the current generation of workers switching jobs at much higher rates. This phenomenon is even more pronounced among public workers and teachers. Examining some of the latest shifts in public employee retention, Reason’s Jen Sidorova offers ways that policymakers can shape retirement benefits to better fit today’s workers, including shorter vesting requirements and increased portability. 

The U.K.’s Margin Call Offers Warning Signs for Public Pension Funds in the U.S.

A sharp increase in bond yields recently put United Kingdom pensions in a difficult position where they needed to sell off assets, resulting in what was called a ‘doom loop’ scenario that prompted intervention from the Bank of England. Reason’s Swaroop Bhagavatula looks at how this market scare was associated with liability-driven investing (LDI), which is a strategy not often used by pensions in the United States. Still, there are some valuable lessons that can be applied, namely avoiding over-leveraging and maintaining adequate levels of cash to manage any major market shocks. 

News in Brief 

Paper Rediscounts Public Pension Liabilities 

A paper from economics professors Oliver Giesecke and Joshua Rauh of Stanford University asserts that public pension liabilities should be discounted in a way that reflects the guaranteed nature of these promised benefits, which would mean using zero-risk rates based on treasury yields. Their analysis of 647 state and local pension plans in 2021 finds that, while these plans report unfunded liabilities of just over $1 trillion and an aggregated funded ratio of 82.5%, rediscounting the same plans to the proposed specifications would mean unfunded liabilities of $6.5 trillion and a funded ratio of 43.8%. The full paper is available here, and an interactive dashboard of its results is available here. 

New Survey Asks Public Employees How The Current Market Has Impacted Their Retirement 

MissionSquare Research Institute has published results from a survey of 1,003 state and local government workers focusing on how current market turbulence has impacted the perception of retirement security as well as saving behavior. The survey indicates that most (84%) of respondents feel anxious about their personal financial security. Nearly half (48%) have reduced the amount they save for retirement, naming high inflation as the cause. Over half (58%) of the polled public workers indicated that the retirement plan offered to them was a factor in their decision to stay in the job, while 33% said that this made no difference. The full report is available here. 

Quotable Quotes on Pension Reform  

“In some cases, the [midterm election] campaign rhetoric not only dismissed the danger of climate change, it went so far as to mischaracterize a strategy we believe in strongly: examining the risk factors of the environment, of social inequality, and of good governance […] But let’s be clear: Applying the lens of ESG is not a mandate for how to invest. Nor is it an endorsement of a political position or ideology. Those who say otherwise are actually advocating for investors like CalPERS to put on blinders…to ignore information and data that might otherwise help build on the retirement security of our 2 million members.” 

—CalPERS CEO Marcie Frost quoted in “CalPERS CEO Pushes Back Against Politicization ESG Investing,” Pensions & Investments, Nov. 16, 2022 

“Regardless of your view on climate change or inclusion or human rights, Mississippi’s pension system, taxpayer dollars, and college savings programs are the wrong place to experiment with investment strategies that push balance sheets to the side. Moreover, many of the policies ESG promotes tie directly to higher costs for consumers, a weaker Mississippi job market, increased inflation, and smaller investment returns – all while undermining the free market and our economic liberty.” 

—Mississippi Treasurer David McRae in “Guest Column: Protecting Mississippi’s Finances,” The Vicksburg Post, Nov. 2, 2022 

“It does limit us…We, I believe, have been successful in trying to minimize any kind of cost that might bring to you, but eventually, it’s going to bite us in the butt if we continue. So we just have to be careful and prudent about it…Our bank list is getting short.” 

—Lamont Financial Services Founder Bob Lamb on Louisiana Treasurer John Schroder pulling the state’s investments from BlackRock over their ESG approach in “Pulling Louisiana’s Investments Could ‘Bite Us in the Butt,’ Adviser Tells Treasurer,” Louisiana Illuminator, Oct. 18, 2022 

Contact the Pension Reform Help Desk 

Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.  

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org. 

The post Pension Reform News: ESG blueprint, Arizona’s pre-funding, and more appeared first on Reason Foundation.

• Clarify Fiduciary Rules and Responsibilities

Require pension and state trust fiduciaries only base investment decisions on pecuniary factors like investment performance and risk, not nonpecuniary factors like politics, ESG, etc.

• Require Advance Proxy Vote Notice and Annual Reporting

Surface activism in proxy voting by allowing the public to view proxy votes well in advance of being cast, as well as requiring a compiled annual report of all proxy votes annually. 

• Require Limited Partner Status Reporting

Help mitigate activism through alternative asset managers like private equity and hedge funds by requiring the annual reporting of limited partners and all committed and allocated capital.

• Require Investment Fee Reporting

Reporting of investment fees will allow for more transparency around the cost and benefit of generally higher-risk alternative investments like private equity and hedge funds.

• Require Pension/Trust Board Meeting Transparency

Ensure taxpayers and stakeholders have access to major planning and investment decisions by requiring materials and meetings are broadcast, published and granted open access to all stakeholders.

Step #2: Set Up Systemic Oversight

• Institute a Pension Oversight Board

Creating a dedicated agency or center of excellence to oversee all public retirement systems in your state, both state and local, regarding their actuarial soundness and compliance with state reporting requirements.

• Require XBRL Reporting Standards

Because government financial reports are mostly published in PDF format and are hard to analyze, compare and aggregate, transitioning to a more data-friendly XBRL format would make government finance more transparent.

• Require Public Trustees to be Insured

Unlike in the private sector, public pension trustees are not required to carry liability insurance. Requiring coverage against claims brought alleging a wrongful act in relation to their role as fiduciaries ensures the appropriate amount of accountability.

Step #3 – Install Protective Policies

• Remove Investment and Actuarial Management Privileges

Return important fund management duties to taxpayers by suspending management privileges until sound funding policies and metrics are achieved.

• Mandate “Excess Value” Consultant Compensation

Pioneered by the Public Employees Retirement Association of New Mexico, this limited partnership compensation method replaces the widely used carried interest compensation formula with one based on absolute returns, completely removing any consideration of the risk associated with such an asset.

Steps to protect public finance from ESG activism

The post Steps to protect public finance from ESG activism appeared first on Reason Foundation.

Greenwashing and Marketing

Both Goldman Sachs and Deutsche Bank’s DWS are currently facing U.S. Securities and Exchange Commission (SEC) probes over the alleged “greenwashing” of their investment funds, according to The New York Times. Greenwashing is a term used to describe firms or investment funds that make unsubstantiated or misleading claims to appear more environmentally and ESG-friendly. The Times reports:

ESG reporting has emerged as a top priority for the SEC under the agency’s chair, Gary Gensler. Earlier this year, the commission proposed changes that would require more disclosure from companies to investors about the risk that climate change and new government policies on it might pose to their operations. And last year, the regulator set up a special ESG task force to focus on whether Wall Street firms and companies were misleading investors about their investment and business criteria in the environmental, social and governance area.

The investigation into Goldman’s mutual funds appears to be related to the new enforcement initiative. Last month, the investment advisory arm of Bank of New York Mellon paid $1.5 million to settle an investigation by the SEC. into allegations it had omitted or misled investors about its ESG criteria for assessing investments. The SEC is also looking into Deutsche Bank.

The Deutsche Bank/DWS investigation may be related to whistleblower Desiree Fixler’s claims that ESG assets under management were inflated. Fixler told the Financial Times, “I still believe in sustainable investing, but the bureaucrats and marketers took over ESG and now it’s been diluted to a state of meaninglessness.”

Last year, Tariq Fancy, the former head of sustainable investing at BlackRock, questioned the legitimacy of ESG investments in an op-ed for USA Today:

I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.

Consistent with Fancy’s claim that ESG is little more than “PR spin,” many other critics contend the ESG signaling and actions from some of the largest asset managers are partly attempt to attract younger investors—who may be attracted by the idea of “socially conscious” investing. A Southern California Law Review paper by Michal Barzuza, Quinn Curtis, and David Webber in 2019 argues that:

…index funds must seek out differentiation in the market where they can find it. Using their voting power to promote their investor’s social values, and doing so publicly and loudly, is a way for these funds, which otherwise risk becoming commodities, to give millennial investors a reason to choose them.

Higher Fees For ESG-Related Funds

The asset management industry has experienced declining management fees since the 1990s, in what is commonly referred to as “fee compression.” A July 2022 analysis from Morningstar showed that for asset-weighted passive funds, fees have “declined 66% since 1990.”

But in many cases, ESG investments are proving to be an opportunity for funds to charge higher fees. The Economist looked at three very similar exchange-traded funds (ETFs) managed by BlackRock: Core S&P 500 (IVV), ESG Screened S&P (XVV), and ESG Aware MSCI USA (ESGU). Despite very similar composition and synchronized performance in 2022, the ESG ETFs had 2.7 to 5-times higher expense ratios, the percentage of a fund’s assets used to cover operating expenses.

Whether this difference is due to the relative size of these funds and the back-end work involved in constructing the index, it is a persistent pattern. In 2021, Morningstar found a significant so-called “greenium” upcharge for ESG funds. While Morningstar found fees were at record lows in 2021, the asset-weighted average expense ratio was 0.55% for sustainable funds—significantly higher than 0.39% for traditional funds.

Politicizing Public Pensions and Taxpayers’ Dollars

Higher fees and marketing strategies are not parts of the environmental, social, and governance-related sales pitches made to investors. Instead, ESG advocates and asset managers make the case that environmental, social, and corporate governance considerations are in the best interest of investors. BlackRock CEO Larry Fink, for example, wrote in his 2022 letter to “CEOs and chairs of the companies our clients are invested in”:

Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘woke.’ It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper.

Despite Fink’s framing, ESG policies often take sides on some of the most contentious contemporary political issues, including energy, environmental policy and climate change, foreign policy, abortion, guns, workplace issues, and more. ESG often moves these issues from legislative, judicial, and political spheres into financial markets and corporate boards, increasingly politicizing what might previously have been non-political organizations and institutions focused on their core missions and products.

To claim otherwise presupposes that ESG considerations are an objectively better way to operate and evaluate firms. Thorough analyses, like research by the University of California-Los Angeles Professor Bardford Cornell and Aswath Damodaran, a professor at New York University, concluded: “evidence that investors can generate positive excess returns with ESG-focused investing is weak.”

Still, to be clear, private individuals and institutions are free to allocate their assets in whatever ways they see fit. Public sector financial assets are a different story. Public pension funds have a fiduciary duty to manage assets in ways that ensure the funds can meet the retirement needs of their members. For public pension systems, political activism of any stripe, as my Reason Foundation colleague Richard Hiller notes, is “inconsistent with these fiduciary responsibilities and retirement plan objectives.”

The over $5 trillion in state and local public pension investment assets should not be treated as money that is up for grabs or that can be leveraged for political causes by politicians, system administrators, and subgroups of plan participants. Unfortunately, however, government entities across the board are increasingly becoming activists on political issues.

On ESG, two major groups in climate activism are the Ceres Investor Network and Climate Action 100+. Eleven public pension plans, eight state treasurer offices, and three state investment boards have signed on as members of Ceres, which describes itself as “a nonprofit organization transforming the economy to build a just and sustainable future for people and the planet.”

Similarly, 16 public pension plans, three state treasurer offices, and four state investment boards are members of Climate Action 100+, which says it “is an investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change.

A report from Morningstar found that public pension funds supported ESG shareholder resolutions at a greater rate than ESG-focused funds in 2021. Among key ESG shareholder resolutions in 2021, the report found:

Perhaps not surprisingly, public pensions based in Democratic-leaning states tended to vote in favor of ESG resolutions more often than those based in Republican-leaning states—the former had an average 98% support rate across public pension funds compared with the latter's 80%. Public pensions located in split states landed in between, at 85%. The less predictable outcome may be that all three groups came out well ahead of general shareholders' average 63% rate of support across key shareholder resolutions and didn't look too different from the 85% rate of support seen from ESG-focused funds.

The report also found that policymakers and taxpayers should: “Insist that public pension funds provide better transparency on their voting policy, votes, and voting rationale.”

As the financial industry receives increased scrutiny related to its ESG practices and likely inflated claims, the involvement of public pension systems becomes better known, and some politicians push to make ESG-related investments and issues mainstream public issues, there could be a reckoning ahead. Given the size of the ESG asset management industry, ESG investments and practices are likely to continue to be a significant part of financial markets and the business world for the foreseeable future. However, all parties involved should embrace a serious review of existing approaches and increased transparency, especially when it comes to public pension systems and taxpayers' dollars.

The post Scrutinizing high ESG fees, greenwashing and the politicization of public pension funds appeared first on Reason Foundation.

In This Issue: 

Articles, Research & Spotlights  

• What ESG policies mean for public pension systems 
• 2022 investment results for state pension plans so far
• Using hybrid retirement plans to balance risk 
• Examining effective amortization policies 
• Preparing public pension systems for a recession 

News in Brief 
Quotable Quotes on Pension Reform  
Data Highlight

Articles, Research & Spotlights 

Webinar: ESG Trends and Impacts on Public Pensions 

The emergence of environmental, social, and governance (ESG) strategies has elicited several responses from state lawmakers, some of whom are concerned with outside interests overcoming the primary fiduciary obligations of the governments managing public pensions. In this webinar hosted by the Pension Integrity Project, former U.S. Securities and Exchange Commission Commissioner Paul Atkins, former CKE Restaurants Chief Executive Officer Andy Puzder, and Reason’s Leonard Gilroy discussed how ESG strategies impact taxpayers and public pensions. They also evaluated the types of anti-ESG laws that are emerging in various states. 

You can watch the webinar here and read coverage of it at Institutional Investor and The Bond Buyer, amongst others.  Here is some of Reason Foundation’s recent ESG-related analysis:

• Politics can endanger public workers’ retirement 
• Democratic treasurers defend ESG investing 
• The differences between individual and institutional investors considering ESG factors 
• The public pension systems signing on to politicized ESG investment efforts 
• The difficulties of assigning ESG ratings 

The Investment Results State Pension Plans Are Reporting for the 2022 Fiscal Year 

After breaking investment return records last year, most state-run pension plans are reporting significant investment losses for 2022. These losses will negatively impact unfunded liabilities and the costs of public pension plans in the coming years. The Pension Integrity Project has compiled all of the 2022 state plan investment results reported thus far, along with estimates of what these returns will mean for each plan. While there is a wide range of investment returns so far, the overall results show the median investment return for state pension systems in 2022 is -5.4%, with nearly all plans reporting returns well below what they were assuming to earn. 

Best Practices in Hybrid Retirement Plan Design 

A hybrid retirement plan combines the defined benefit structure commonly offered to public workers with a 401(k)-style individual account. While this is a novel concept to some, splitting retirement benefits between the two different types of plans has been a valuable way for public employers to balance the risks involved in retirement saving between the employer and employee. This policy brief by Reason’s Ryan Frost details the policies that will ensure a public hybrid plan achieves the goal of adequate retirement savings while appropriately allocating risks between all participating parties. Using examples of the federal government and states like Washington and Tennessee, policymakers can better understand the long-standing value and effectiveness of hybrid plans. 

Best Practices for Pension Debt Amortization 

With unfunded liabilities growing beyond $1 trillion for state and local pensions, U.S. governments have a steep hill to climb and a limited timeframe to raise the funding needed to fulfill the retirement benefits promised to public workers. Every pension plan has an amortization policy, which details how they intend to close whatever funding shortfall arises. These policies not only have a major impact on annual debt payments, they also determine how long a plan will hold expensive pension debt and how resilient it will be amidst unpredictable market outcomes. This new policy brief from the Pension Integrity Project outlines a few of the major decisions policymakers must make when it comes to the amortization of public pension plans, including the way that payments are calculated and acceptable timelines for eliminating debts. 

Most State Pension Plans Are not Adequately Prepared for a Recession 

The warning signs of a major recession continue to rise, which ought to be a significant concern to public pension plans. With significant levels of underfunding reported among state and local retirement plans, and too little progress made to reduce these shortfalls since the Great Recession, another economic recession would mean significant challenges for public pensions and potentially huge costs to taxpayers. Reason Foundation’s Anil Niraula and Zachary Christensen use the Teacher Retirement System of Texas to illustrate what a major recession could mean for many other public pension systems around the country. Unless policymakers make significant changes to the way governments contribute to these plans, they’ll remain especially vulnerable to periods of market turbulence. 

News in Brief 

New Report Indexes National Retirement Systems 

Mercer and Chartered Financial Analyst (CFA) Institute’s 2022 Global Pension Index ranks retirement systems globally in terms of adequacy, sustainability, and integrity. Adequacy is evaluated by the plan design and overall benefit levels. Sustainability examines the funding levels of the plan. Integrity is understood as the regulations and protections around the plan. According to this analysis, the highest-ranking countries were Iceland, Netherlands, and Denmark. The U.S. graded around the middle of the pack, with below-average marks in “integrity.” The report acknowledges a significant drop in “adequacy” from previous years for nearly all countries, likely due to the high inflation experienced across the world. The full report is available here. 

Study Finds Difference in Spending Habits from Supplemental DC Participants 

A new study from the Public Retirement Research Lab examines the spending and saving habits of public employees, finding some notable differences in how those with a primary defined benefit (DB) plan and a supplementary defined contribution (DC) plan spend compared to others with standalone DB or DC plans. According to the analysis, employees who have a primary DB plan with a flexible DC supplemental option tend to spend more and save less, which could indicate a misguided level of confidence among these members. The authors suggest that this phenomenon highlights a need for better education for new members of these types of plans. The study is available here. 

Quotable Quotes on Pension Reform  

“The majority of investment experience for people managing money, be it asset management firms or pensions, endowments, and foundations, has been with tailwinds in the last 40 years…I would say now, the environment is that tailwind may become a headwind and is likely more challenging.” 

—Los Angeles County Employees Retirement Association Chief Investment Officer Jonathan Grabel in “Are California’s Public Pension Funds Headed for Another Crisis?,” Los Angeles Times, Sept. 29, 2022 

“The state will have to pay those pensions regardless if we make that return on our investments or not. If we don’t make a return on those investments, it means higher taxes for the business community and all of us. For that reason alone, we should not be doing this” 

—New Jersey Business and Industry Association’s Ray Cantor on legislation to divest state pension funds from the fossil fuel industry in “N.J. Pension Fund Would Stop Investing in Fossil Fuels Under Bill Advanced Thursday,” New Jersey Monitor, Oct. 6, 2022 

Data Highlight 

Each month, we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analysts Anil Niraula and Jordan Campbell created an interactive distribution of the 2022 market returns from state-run pensions reported so far. You can access the map and data here. 

Contact the Pension Reform Help Desk 

Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.  

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org. 

The post Pension Reform News: ESG debates, public pension plans’ worrying investment results, and more appeared first on Reason Foundation.

These trends are becoming more prevalent, both in the choices individuals make with their own investments and the policies implemented by institutional investors and public pension systems.

Since ESG debates and activist investing look to be a significant subject of contention for the foreseeable future, it is essential to draw clear lines of when it is and is not appropriate to implement investment strategies that overstep the usual purpose of meeting specific financial objectives, especially in the case of retirement savings.

It is entirely appropriate for individuals to make whatever investment decisions they like with their assets. Giving individuals a choice in where to place their assets is healthy and consistent with long-standing American investment tradition. Look to the long history of specialized or sector funds for examples. Of paramount importance with these investments is that their objectives and methods are made clear to potential investors through the prospectus and other communications materials. Individuals having the ability to invest with their conscience in a way consistent with their beliefs and objectives is laudable and is consistent with a free society.

Recently, however, activist investing has been pushing in a more dangerous direction. There are serious concerns when activism is involved with pooled retirement investments, like public pension systems. Public pension plans should not engage in political activism. Unfortunately, lawmakers and officials on all extremes of the political landscape are increasingly attempting to dictate how investment funds maintained for various governmental functions must be invested.  The trends, both promoting ESG and anti-ESG, are being directed at state and local government-run pension funds for public employees.

Pension fund investment managers have a fiduciary responsibility to manage their funds exclusively to best meet the financial needs of plan participants. In the case of retirement plans, those needs are for long-term income stability and sustainability within closely managed risk guardrails. It is also clear that activist investment mandates are inconsistent with these fiduciary responsibilities and retirement plan objectives.

To be clear, this is happening on both the left and right across the country’s political spectrum. For example, those that want to exclude oil company investments in public pension funds as well as those that want to mandate the inclusion of oil company investments in public funds. Neither of these positions is directed at improving public employee retirement incomes.

The demand for investments that match certain political or policy beliefs and the increasing pressure on state and local government-run pension systems to ignore their fiduciary responsibilities in favor of politically-motivated investing present more reasons for governments to examine alternative retirement plan designs immediately. It has become more widely understood that the traditional public sector defined benefit (DB) pension plan no longer meets the needs of many of today’s public employees and other impacted groups. Employees are increasingly mobile in their careers, and traditional defined benefit pension plans cannot effectively meet workers’ portability needs.

Traditional DB plans also fail to meet many employers’ needs, impacting their ability to recruit and retain qualified employees. Additionally, in many cases, traditional DB plans’ funding status continues to deteriorate, putting increasing pressure on taxpayers and on state and local government budgets.

From public pension debt to failing to serve today’s workers to misguided politically-motivated investment pressures, it is clear that the public retirement space is due for some recalibration.

Retirement plan designs that are built on a defined contribution (DC) foundation and have objectives focused on lifetime income and risk management can be the leading-edge answer to many of today’s public pension dilemmas.  Sophisticated design structures incorporating defined benefit-like features into a defined contribution construct, uncomplicated from an employee perspective, are available and in use today.

With these plans, sponsors can make available many employee-selected investment options that do not force the employee into heavy-handed, politically-motivated investments or ones they oppose morally. With the help of an independent financial advisor, if desired, individual employees can build a portfolio that best meets their personal goals and objectives.

It should seem obvious that retirement plans must focus on meeting the objectives of several interested parties, most notably the public employee participants. Attempting to impose politically-motivated investment controls of any kind on public pension plans violates core fiduciary standards and is a gross over-reach by governments. Instead, lawmakers and workers should seek to modernize public retirement plan designs in ways that give individuals the flexibility to vote with their feet, have plan portability when they change jobs, and invest as they see fit.

The post Politics and ESG endanger public pension plans and workers’ retirements appeared first on Reason Foundation.

The letter was issued by a new nonprofit organization called For The Long Term, which says it “supports state, city, county, and tribal Treasurers in managing the unique challenges they have in interfacing with each other and nonprofit organizations to support the long-term well-being of their beneficiaries.” The letter begins:

Several states in our country have started blacklisting financial firms that don’t agree with their political views. West Virginia, Idaho, Oklahoma, Texas, and Florida have created new policies and laws that restrict who they will do business with, reducing competition and restricting access to many high quality managers. This strategy has real costs that ultimately impact their taxpayers.

These blacklists are a backlash response on behalf of political and corporate interests seeking to interfere with the progress made by those of us who believe in collaboration and engagement. We work towards developing common goals, along with other investors and enlightened companies throughout the world. Our joint efforts have resulted in increased corporate responsibility, transparency, disclosure, and long term positive outcomes for the funds that we oversee, with greater benefits to employees and customers alike.    

Oregon State Treasurer Tobias Read, who signed on to the letter, also recently wrote an op-ed in The New York Times elaborating on it. Read specifically called out the implementation of a Texas law, Senate Bill (SB) 13 (2021), that prohibits the state’s pension funds from investing in firms the government deems hostile to the fossil fuel industry. As previously argued at Reason.org, this legislation may end up costing taxpayers and retirees because it limits Texas pension plans’ ability to invest in Blackrock and nine other publicly-listed companies, as well as 348 mutual funds that Texas claims “boycott energy companies.”

Texas’ actions have also caused some investment banks to stop doing business with state and local governments in the state. Another Texas law, SB 19 (2021), prohibits state agencies from doing business with companies that oppose the firearms industry. 

The combined impact of Texas’ fossil fuel and firearms legislation appears to have deterred some financial firms from participating in the state’s municipal bond market. According to a working paper by the University of Pennsylvania’s Daniel Garrett and Ivan Ivanov of the Federal Reserve Bank of Chicago that was cited by Oregon Treasurer Read, Texas’ governments incurred between $303 million and $532 million in extra borrowing costs over the eight months following the effective date of SB 13 and SB 19—Sept. 1, 2021.

Garrett and Ivanov determined that five major banks exited the market for underwriting state and municipal bond offerings in Texas after that date. Those institutions are Bank of America, Citigroup, Fidelity, Goldman Sachs, and JP Morgan Chase.

Using a difference-in-differences model comparing underwriting results in Texas before and after the new laws came into effect, the researchers estimate that the reduced competition caused interest rates paid by Texas municipal bond issuers to rise 15.4 basis points (0.0154%) above what they otherwise would have been. 

With $31.7 billion of Texas municipal bond issuance in the eight months ending April 30, 2022, Garrett and Ivanov estimate that issuers will pay $532 million in extra interest over the life of the bonds, assuming they are not paid off until maturity. If instead, issuers prepay (or call) the bonds at the earliest allowable date, the extra interest would total $303 million.

Although this is not a public pension issue, this finding appears to support the contention made in the letter by the Democratic state treasurers that “new policies and laws that restrict who they will do business with” is a “strategy [that] has real costs that ultimately impact their taxpayers.”

Less convincing is the treasurers’ assertion that buying the stocks of ESG-oriented companies will produce better long-term investment returns. They claim:

Today stakeholders, customers and employees are more diverse and informed. Companies that acknowledge these changes, and incorporate strategies to capture this reality are more innovative, creative and more financially successful, consequently better investments for long term investors. Organizations that recognize the threat of climate change are already working toward reducing their carbon footprint, while the automobile manufacturers have begun rapid movement to electric vehicles. Engaged investors are working with the fossil fuel companies to help them effectively manage the energy transition, supporting their efforts to seize new opportunities in renewable energies. Doing otherwise would be a huge risk to them and their investors.

But market outcomes thus far do not appear to validate this claim. The largest US ESG Exchange Traded Fund, iShares ESG Aware MSCI USA ETF (ESGU), underperformed the S&P 500 for the 12 months ending August 31, 2022. During that one-year period, EGSU returned -13.96% compared to –11.23% for the S&P 500. 

Similarly, Bloomberg reports:

Global ESG funds have underperformed the broader market in the past five years, returning an average of 6.3% per year, compared with 8.9% for broader funds, according to data compiled by Bloomberg. An investor who put $10,000 into an average global ESG fund in 2017 would have $13,573 today, roughly $1,720 less than if they’d put it into a non-ESG portfolio.

In a 2019 paper, the Pacific Research Institute’s Wayne Weingarden found that the vast majority of ESG funds returned less than an S&P 500 ETF for the 10-year period ending April 2019.

The Democratic treasurers who signed the letter are right to highlight the potentially negative financial impacts of narrowing the eligibility for contractors vying to provide financial services to public entities. What remains unclear after reading both the FTLT letter and Mr. Read’s supplemental opinion, however, is how these Democratic financial officials and financial institutions can prove their preferred ESG strategies directing capital away from firearms or fossil fuels are any better for their own taxpayers and retirees.

The post Democratic treasurers defend ESG investing appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Webinar: Former SEC Commissioner Paul Atkins, former CKE Restaurants CEO Andy Puzder, and Reason Foundation on the impact of ESG policies
• Best practices for pension COLA design
• Which states and pension systems have adopted ESG policies?
• Cash flow challenges and solutions for public pensions
• Evaluating Alaska’s defined contribution and annuity plans
• Texas counters politicized ESG efforts with more politics
• Participation, not equity, should be the focus of retirement plans

News in Brief
Quotable Quotes on Pension Reform   
Data Highlight
Contact the Pension Reform Help Desk     

Articles, Research & Spotlights

Webinar: What Does ESG Mean for Public Pension Systems and Taxpayers?

Environmental, social, and governance (ESG) trends are impacting public pension systems, retirees, and taxpayers. Join former SEC Commissioner Paul Atkins, former CKE Restaurants CEO Andy Puzder, and Reason Foundation’s Leonard Gilroy for a webinar on September 20 at 1 pm ET to discuss how ESG policies and politicized public investments may impact investment returns and saddle taxpayers with additional costs. The panel discussion will also examine if legislators pushing broad anti-ESG laws could unleash unintended negative consequences and will explore potential reforms that would help keep politics out of public pensions.

Best Practices for Cost-of-Living Adjustment Designs in Public Pension Systems

Extended periods of high inflation can be particularly challenging for pensioners, whose promised benefits usually come in the form of fixed payments. To protect retirees from losing too much purchasing power, many public employers provide a cost-of-living adjustment (COLA) benefit. Like any other retirement benefit, this brings additional costs and requires appropriate funding and limitations. A new report from the Pension Integrity Project identifies a set of best practices that policymakers should consider when structuring or reforming the COLA benefits offered to public retirees. Among those principles are the recommendations that COLAs should be pre-funded and aligned with explicit retirement plan objectives.

The Public Pension Systems Signing on to Politicized ESG Investment Efforts

Several state and local public pension systems have signed on to global climate change accords and/or formally joined activist investment groups focused on reducing climate change. This interactive map by Reason’s Jordan Campbell shows the state and local pension plans, treasurers, and investment boards taking such actions to date.

Policy Brief: The Impact of Cash Flow on Public Pensions

Because public pension plans are designed to combine annual contributions with investment returns to fulfill retirement promises, it is crucial to monitor the money flowing in and out—also known as the cash flow—of public systems. In this new policy brief, Reason’s Truong Bui uses the Montana Public Employee Retirement System (PERS) as a case study to examine the impact of cash flow, both historically and in long-term forecasts. The analysis demonstrates some of the risks that can arise when a plan has more money leaving its fund than going in.

How Alaska’s Defined Contribution Plan and Supplemental Annuity Plan Compare to the Gold Standard

Alaska’s defined contribution and supplemental annuity plans are the primary retirement offerings to the state’s public workers. In this analysis, Reason’s Richard Hiller and Rod Crane partner with the Alaska Policy Forum to evaluate these plans according to best practices for defined contribution plans. They find that the plans fulfill some of the best practices of well-structured retirement plans, while also finding that there is still room for improvement in areas such as a formal statement of plan objectives and contribution adequacy for both teachers and public safety workers.

Texas Dangerously Inserts Politics into Pension Investing

In accordance with Senate Bill 13 from the 2021 legislative session, the Texas Comptroller of Public Accounts recently released a new list identifying 10 financial firms and 348 investment funds that Texas claims are boycotting the fossil fuel industry. This means the state’s public pension funds must remove them from their investment portfolios. Reason’s Marc Joffe highlights some of the implications of this new policy and considers how this reaction to ESG investing also elevates politicized investments over core fiduciary decision-making and risks higher costs for taxpayers.

Policymakers Should Focus on Improving Participation Rates in Retirement Plans

Recent reporting from the National Institute on Retirement Security (NIRS) identifies economic inequities caused by tax incentives in retirement savings, but this analysis overlooks some key facets of how the laws promoting savings operate. Reason’s Rod Crane asserts that tax incentives are working exactly as they are meant to by benefiting those who are closer to retirement. Instead of focusing on retirement benefit inequities between the upper- and middle-classes, policymakers should simply seek to maximize the number of employees that are participating in retirement saving programs.

News in Brief

New Report Underscores Volatility for State Pensions

A new paper published by the Center for Retirement Research looks at the impact of declining stock market returns and rising inflation on pension funds. The paper shows that, despite the market drop, pension funds have still seen a net increase in funded ratios by one percentage point between 2020 and 2022. The paper goes into more depth as to how this affects amortization payments and overall contribution rates. Regarding inflation, the only types of COLA plan offered by pension plans affected by inflation are CPI (Consumer Price Index) linked. Other types, such as ad-hoc and invested-based COLAs, are unaffected. CPI-linked COLAs typically have caps of around 3.5%. Due to these caps, increases in amortization payments from inflation will be relatively limited (estimated to be between 0.4% to 1.6% of payroll). The full brief is available here.

Paper Examines Purpose and Effectiveness of ESG ratings

A new working paper from the Rock Center for Corporate Governance at Stanford University reviews the stated purpose of ESG ratings and how effective they are at achieving these goals. The paper identifies the shortcomings that exist in both the objectives and execution of current methods in grading the nonfinancial impact of companies. It also asks if the motivations of fund managers are aligned to produce accurate and reliable reports, which are crucial for calibrating ESG ratings that the market can confidently apply to decision-making. The working paper is available here.

Quotable Quotes on Pension Reform

“Starting in FY 2024, the budget will start reflecting the impact of adverse financial market conditions on pension returns.”

—New York City Comptroller Brad Lander cited in “NYC Will Need to Chip in an Extra $6 Billion to Shore up Pension Funds — Comptroller” in Pensions & Investments, September 7, 2022

“For a while, ESG looked like a good bet, and values seemed cheap. In a down market, though, ESG’s true cost is starting to reveal itself—and in a more volatile, energy-scarce market, it will only get more expensive. Politics aside, few people or fund managers will tolerate funds that underperform, and this may be the real reason ESG funds have peaked.”

—Manhattan Institute Senior Fellow Allison Schrager in “The ESG Bubble Is Bursting” in City Journal, August 30, 2022

“The concern for most investors now is ‘how do I find exposures that are going to help me stabilize the portfolio vs. investing with my values?’”

—Managing Director at FLX Networks Jill DelSignore cited in “The ESG Crown Is Slipping, and It’s Mostly the Fund Industry’s Own Fault” in Bloomberg, September 2, 2022

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell created an interactive map showing the state and local government pension plans that have signed on with the Ceres Investor Network on Climate Risk and Sustainability and Climate Action 100+. You can access the map here.

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Join our ESG webinar, best practices for addressing inflation, and more appeared first on Reason Foundation.

But before expanding on this criticism, ESG deserves its due. Individual investors have, for decades, considered factors other than maximizing risk-adjusted returns. Personally, I never wanted to buy stocks in tobacco companies from the time I first had money to invest forty years ago. To the extent that ESG analysis assists individual investors (as opposed to fiduciaries) in selecting financial products that assist them in meeting their non-pecuniary goals, it is not all that worrisome.

Further, it is possible that insights derived from ESG orientation could lead to more prudent investments. For example, if we believe that climate change is going to cause sea-level rise that, if unmitigated, will inundate coastal real estate within a period that is relevant for investment purposes, it would be prudent to avoid Real Estate Investment Trusts that are heavily weighted toward oceanside properties. Whether environmental projections constitute useful news for investors depends on the reliability of climate and sea-level models, as well as the success or failure of mitigation measures that property managers and local governments might implement in response.

However, ESG proponents often cite such examples to justify moving away from conventional investment analysis. One must wonder how frequently or rigorously institutional investors model the impacts of ESG considerations on future cash flows. And it is this potential lack of rigor that makes the growing influence of ESG in modern investing troubling.

Predicting earnings before interest, taxes, depreciation, and amortization (EBITDA) and earnings multiples for equity investors, or default probabilities and recovery rates for fixed-income investors is already very difficult. Investors and the analysts they rely on often get these numbers very wrong. An example is when rating agencies messed up their projections of mortgage risk prior to the Great Recession of 2007-2009.

Now rating agencies, other analytical firms, and investors themselves are weighing in on a much wider set of metrics that often lack precise definitions, let alone clean data. Across third-party ESG-score providers, there are varying criteria for determining scores.

For example, Moody’s and S&P list the following elements of their “social” scores:

Some of these concepts appear to overlap: For example, Moody’s lists “labor relations” while S&P mentions “labor practice indicators.” Other elements, such as Moody’s “demographic change” indicator or S&P’s “asset closure management,” do not appear to have a parallel in the rival’s rating scheme.

Under the circumstances, it should not be surprising to see a lot of divergence among ESG-score providers. In the chart below, I list ESG scores for Pfizer from Moody’s, S&P, and three other firms. The assessments range from dire (in the case of finance company MSCI) to celebratory (in the case of CSRHub, a web-based rating tool).

Complicating the comparison is the divergent scales different agencies use. Moody’s, for example, has ESG Credit Impact Scores (CIS) ranging from 1 (Positive) to 5 (Very Highly Negative). It also provides individual sub-scores on the E (environmental), S (social), and G (governance) components, respectively.

But even if analysts could all get on the same page, large-scale ESG investing poses an even greater concern: misdirection of capital. As aforementioned, it is difficult to determine the future profitability of any given firm. As a result, capital is often allocated to firms or projects that fail to produce the type of return that might reasonably be expected. For every successful company, there are often many competitors with skilled management teams attempting to serve a similar market that fail. 

While critics of capitalism might dismiss this circumstance as a market failure, it is more properly understood as an experimentation process necessary for economic advancement. Or, in the words of Joseph Schumpeter, a process of “creative destruction.” No one can predict with certainty which businesses and product plans will succeed; we must learn through trial and error.

But if investable funds are not even chasing profitability, many more dollars are likely to be invested in companies pursuing product plans that do not gain support from the market or suffer from ineffective execution.

Meanwhile, startup founders and management of existing companies will likely receive market signals that steer them away from the task of efficiently meeting customer needs and toward other priorities. They may conclude, for example, that it is better to focus on diversity, equity, and inclusion than to make product improvements, causing them to expend more of their scarce resources on the former than the latter.

Individual investors should be free to consider ESG when deploying their own capital, even though it may not be economically efficient for them to do so. But this idea should not scale to the activities of large investment fund managers with billions of dollars in assets. Not only do their decisions have a much greater impact than those of virtually all individual investors, but they have a fiduciary responsibility to manage the funds with which they have been entrusted in the best financial interests of those whose money it is or, in the case of retirement funds, will be.

Like many movements in America’s past, the ESG investment movement has taken a reasonable idea and stretched it beyond reason. If institutional investors continue to deploy funds according to shifting criteria other than long-term profitability and rely on imprecise metrics while doing so, they will likely undermine the ability of the U.S. economy to grow and thereby improve our standard of living.

A version of this commentary was first published in National Review.

The post The differences between individual and institutional investors considering ESG factors appeared first on Reason Foundation.

While private investors are free to utilize whatever assessments they deem most valuable, ESG assessments are rightly seen by many as out-of-scope for public pension systems and other investments of taxpayer-sourced funds. Public pension trustees, for example, are required by state laws to exercise their fiduciary responsibilities to maximize public pension systems’ investment returns at acceptable levels of risk for retirees and future beneficiaries.  

In what appears to be a contradiction of these fiduciary standards, many public pension plans, along with some state treasurers, comptrollers, and state investment boards, have become signatories to global climate accords and members of climate activist groups.  

One commonly used set of ESG investment standards originates from the Paris Aligned Investment Initiative (PAII) created in 2019 by the Institutional Investors Group on Climate Change to provide “a member-led forum to explore how investors can align portfolios to the goals of the Paris Agreement.”   

The North American group involved in PAII, the Ceres Investor Network on Climate Risk and Sustainability, says it works “with our members to advance sustainable investment practices, engage with corporate leaders, and advocate for key policy and regulatory solutions to accelerate the transition to a just, sustainable, net zero emissions economy.” 

And another group related to Ceres is Climate Action 100+, which says it “is an investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change.” 

Regardless of how one feels about environmental policy, it involves overtly political questions that must be adjudicated via a legislative process. It is inappropriate for public pension funds to leverage their assets for political purposes rather than serving their duty to fully fund the pension benefits that have been promised to public workers.   

The map below identifies the US state and local public entities signed on to Ceres and/or Climate Action 100+. You can click (or select on mobile) on individual states to see the public entities that have joined these groups.

The post The public pension systems signing on to politicized ESG investment efforts appeared first on Reason Foundation.

It is understandable for state policymakers to want to push back against an environmental governance social investment (ESG) movement that they view as threatening to Texas’ oil and gas industry, but just as some progressive states are wrongly telling their public pension funds not to invest in specific sectors, Texas Senate Bill 13 threatens the cost-effective stewardship of taxpayer funds.

Texas SB 13 instructs the Comptroller to identify financial firms that are:

“…refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalize, inflict economic harm on, or limit commercial relations with a company because the company … engages in the exploration, production, utilization, transportation, sale, or manufacturing of fossil fuel-based energy and does not commit or pledge to meet environmental standards beyond applicable federal and state law.”

The Comptroller’s list includes nine European companies and BlackRock, the world’s largest asset management firm. Disinvesting in BlackRock could impose special challenges for Texas pension funds because it is included in the Standard & Poor’s 500 stock index. Thus, in simple terms, any exchange-traded fund (ETF) or index fund that is based on the S&P 500 holds some shares in BlackRock.

Fortunately, SB 13 appears to provide some flexibility for state agencies that have exposure to blacklisted firms through indirect means—like holding them through mutual funds or ETFs. Specifically, SB 13 states:

A state governmental entity is not required to divest from any indirect holdings in actively or passively managed investment funds or private equity funds. The state governmental entity shall submit letters to the managers of each investment fund containing listed financial companies requesting that they remove those financial companies from the fund or create a similar actively or passively managed fund with indirect holdings devoid of listed financial companies.

So, according to the law’s text, a Texas pension fund or government agency can continue to hold an S&P 500 fund—as long as it asks the fund manager to drop BlackRock from its portfolio. It is doubtful that an S&P 500 fund would follow through and eject BlackRock for various reasons, including because it would introduce a tracking error—a divergence between the index fund’s performance and its underlying index.

Among the mutual funds on the Comptroller’s blocked list are six vehicles that invest in most S&P 500 stocks. Texas is targeting them because the state claims they explicitly exclude companies in the fossil fuel industry and those with low ESG scores. These blocked funds would also diverge from the S&P 500’s performance, but it is possible that ESG-focused investors holding these funds may be more likely to accept any discrepancy. It remains to be seen whether a fund provider could attract sufficient interest in an investment product that mostly tracks the S&P 500 while excluding ESG-oriented firms such as BlackRock.

The European firms on Texas’ blacklist include three institutions—BNP Paribas, Credit Suisse, and UBS—that rank among the 50 largest banks worldwide. The Texas Employees Retirement System or the Texas Teacher Retirement System may hold securities issued by these entities, but this cannot be readily confirmed because neither system publishes a detailed list of investments on their respective websites.

Although SB 13 is relatively clear that pension funds do not need to liquidate mutual funds that include the blacklisted companies, it is less clear whether the Texas pension funds can invest additional, new money in such vehicles going forward.

Most importantly, while the law includes provisions that try to reduce its impact on the state’s pension funds, Texas Senate Bill 13 sets a dangerous precedent for inserting politics and legislating into investment decisions.

It’s also part of a troubling bipartisan trend. In 2021, Maine passed a law requiring the state’s pension system to divest from fossil fuel investments.  And similar divestment bills have been proposed in Massachusetts, New York, and New Jersey.

State policymakers and legislators should not limit the flexibility of pension fund managers to maximize risk-adjusted returns. Public pension fund managers should focus on optimizing their portfolios on a risk/return basis, so the pension systems have funding to pay for pension benefits promised to workers.

The post Texas dangerously inserts politics into pension investing appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Who benefits most from defined benefit and defined contribution plans?
• California’s public pension losses will impact local governments.
• A new survey suggests retirement plans are poor tools for recruitment and retention.
• More transparency is needed on public pensions’ private equity investments.

News in Brief

Quotable Quotes on Pension Reform

Data Highlight

Articles, Research & Spotlights

Examining the Populations Best Served by Defined Benefit and Defined Contribution Plans

Research by some pension advocacy groups suggests that defined benefit pension plans enjoy a cost efficiency advantage over defined contribution plans (e.g., they generate a greater value for the same cost), but this conclusion is based on too narrow of a perspective. In a new analysis, Reason Foundation’s Swaroop Bhagavatula, Rod Crane, and Richard Hiller posit that there are many more factors that need to be considered to evaluate the efficiency of a public retirement plan. They introduce the concept of benefit efficiency, which measures how well a plan distributes its benefits to all of its members. Using hypothetical pension plans, their analysis shows that a standard defined benefit plan maximizes “efficiency” for only a narrow group of plan members, making it a less optimal option for the vast majority of public workers.

California’s Unfunded Pension Liabilities Will Burden State and Local Governments

Reporting a -6.1% return for its 2022 fiscal year, California’s pension system serving most state and local public workers—CalPERS—is bracing for growth in its unfunded liability and the inevitable hike in annual costs. Reason Foundation’s Marc Joffe notes that while CalPERS may have outperformed some institutional investors, the nation’s largest pension system’s losses in the last quarter may not have been fully captured in this figure due to the standard lag in reporting on private equity assets. Either way, Joffe notes the growth in California’s public pension debt will impose higher costs on already cash-strapped local governments and taxpayers in the state.

Retirement Plans’ Impact on Recruiting and Retention in the Public Market

A new survey of 319 government respondents by the MissionSquare Research Institute sheds some light on a common question in the sphere of public employment: Does the quality or type of a retirement plan impact a government’s ability to recruit or retain workers? Reason’s Richard Hiller argues the survey results suggest pension plans have little to no impact on a public employer’s ability to attract or keep their employees. The survey results do suggest, however, that employees respond to their perceived wellness and overall happiness. Hiller says public employers should focus on providing effective retirement plans that are optimal for as many employees as possible to improve their perceived well-being.

As Public Pension Plans Take Risks, SEC Wants More Transparency from Private Equity Funds

With economic uncertainty and shifting investment strategies, many public pension systems are now relying heavily on alternative investments to help secure the investment returns they need to fund promised retirement benefits. Reason’s Jen Sidorova outlines some of the key challenges that arise from alternative investing, including a lack of transparency and predictability. She also notes how the Security Exchange Commission’s newly proposed reporting requirements could help public pension investors better evaluate the risks involved in this opaque asset class.

News in Brief

New Report Underscores Volatility for State Pensions

A new report from S&P Global Ratings highlights the impact volatile markets are having on the funded ratios of public pension plans across the country. On average, after last year’s excellent returns, pension plans went from 69% funded in 2020 to 81% funded in 2021. According to this report, however, pension plans will likely drop back to 2020’s funded levels after this year. The report also highlights the states that used 2021 to shore up their unfunded liabilities. Thirty-eight states met their minimum contribution requirements, and 16 states exceeded them, the report finds. States like Washington, Indiana, and Utah had some of the highest contributions above what was required in 2021. The report concludes that with an economic recession likely looming, many state-level public pension reform efforts have been put on the back burner. The full brief is available here.

Quotable Quotes on Pension Reform

“Larger public pension funds fared better than smaller ones over the past year, with those managing more than $1 billion returning a median minus 6.6% and plans over $5 billion returning a median minus 5.1%, the data showed.”

—Heather Gillers, citing data from Wilshire Trust Universe Comparison Services in “Market Rout Sends State and City Pension Funds to Worst Year Since 2009,” The Wall Street Journal, August 9, 2022

“Implementing programs that enhance corporate profits is the age-old guiding principle for corporate management and no new ESG [environmental, social, and corporate governance] management principles are required to achieve these ends. Therefore, ESG as a management paradigm is only necessary when the proposed ESG programs are financially harmful to the company—the company would not adopt the program without explicit pressure from ESG advocates. Implementing programs that reduce profitability is a serious violation of management’s fiduciary responsibility.”

—Wayne Winegarden, in “Proxy Advisory Firms and The ESG Risk,” Forbes, July 25, 2022

Data Highlight

Each month, we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell created an updated interactive map showing aggregated state pension funding levels from 2001 to 2022. You can access the map here.

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by email at pensionhelpdesk@reason.org.

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Comparing different pension plans, CalPERs reports negative returns and more appeared first on Reason Foundation.

CalPERS reported a -6.1% return for its fiscal year ending June 30, 2022. Even though it lost billions, the -6% loss compares favorably to the change in broad stock market indices. For example, the S&P 500 index experienced a total return, including dividends, of -10.6% during the 12 months ending June 30. Because CalPERS invests in other asset classes that outperformed stocks, it did not face the full impact of the stock market decline.

But at least some of the outperformance may be illusory. CalPERS’ two best-performing asset classes—private equity and real assets— are reported on a one-quarter lag. So, CalPERS’ reported results do not reflect valuation changes from April through June when the values of many types of risky assets were falling. While CalPERS investment policies led to outperformance in the most recent fiscal year, they resulted in serious underperformance during the prior year. In its 2021 fiscal year, CalPERS reported returns of 21.3%—typically great news, but well below the S&P 500 return of 40.8% for the same period and lower than all other major US pension funds with the same fiscal year-end date.

Going forward, there is some concern that CalPERS management could lose focus on maximizing risk-adjusted returns for retirees as its investment team potentially becomes preoccupied with environmental, social, and governance (ESG) issues. The CalPERS board has received presentations on Sustainable Investing, the organization’s “Diversity, Equity, and Inclusion Framework,” and the “Racial Impacts of Financial Market Operations.” Although we might wish this was not the case, there can be tension between optimizing investments and prioritizing social goals in investment strategies.

To CalPERS’ credit, it used some of its good investment performance last year to lower its discount rate and assumed rate of return from 7% to 6.8%, which is more conservative than most other large public employee pension funds. This change slightly cushions the impact of 2022’s -6% results.

Ultimately, the impact of this year’s negative returns and unfunded public pension liabilities affect contributions required to be made by the state government and any local government that participates in CalPERS, including most Southern California cities.

Employer contribution rates—ultimately paid by taxpayers— are determined on a roughly 14-month lag from the end of the fiscal year. So, this summer, government employers will be receiving good news about lower contribution requirements arising from 2021’s results. But these benefits will be almost fully reversed when governments receive their updated actuarial reports from CalPERS next summer.

Over the longer term, there may be some good news for these government employers, and taxpayers as the benefits from Brown-era pension reforms begin to take hold. These reforms lower the amount that governments need to contribute on behalf of public employees hired after Jan. 1, 2013. As these newer employees replace more senior staffers eligible for CalPERS “classic” benefit plans, the overall cost of public pensions will begin to drop for many employers. Actuaries at consulting firm GovInvest expect these savings to start kicking in for most government employers after the 2028-29 fiscal year, at which point employer contributions as a percentage of payroll will begin falling.

California’s local governments can expect to face continuing budgetary pressure from public employee pension benefits for the next several years. But thanks to more conservative investment assumptions and prior reforms, the impacts will not be as severe as those faced by governments in Illinois, New Jersey, and some other states. And, over the longer term, there may be light at the end of the tunnel as long as state and local tax bases hold up, market conditions improve, and CalPERS invests wisely.

This column originally ran in The Orange County Register.

The post California’s unfunded pension liabilities will burden state and local governments appeared first on Reason Foundation.

S&P acknowledges that “having a social mission and strong ESG characteristics does not necessarily correlate with strong creditworthiness and vice versa.” S&P’s ESG credit indicators politicize what should be a purely financial decision. This politicization has manifested itself in the capital markets where, for example, banks are pressured to cut off capital to the oil, gas, coal, and firearms industries. ESG is a political rating and should be characterized as such. This is clear when recognizing the two layers of indeterminacy that make ESG an exercise in servitude: 1) which “ESG factors” are chosen, and 2) the “correct” answer to any given factor. Whoever answers those questions has all the power in achieving a desired outcome.

These are not technocratic questions; they are normative questions. No financial firm should substitute its political judgments for objective financial analysis, especially on matters that are unrelated to the underlying businesses, assets, and cash flows it evaluates. This is especially true of a properly regulated independent entity like S&P that is charged with providing objective clarity and insight. The use of ESG-related quantitative metrics and analytical frameworks confounds the distinction between subjective normative judgments and objective financial assessments. It is therefore unconscionable for S&P to weigh in on indeterminate and normative questions. Moreover, the answers to the normative factors can and do change depending on circumstances. We believe this entire exercise in identifying, evaluating, and publishing ESG factors is highly intrusive and leads to manipulation, coercion, and misleading outcomes.

As the term environmental, social, and corporate governance suggests, ESG ratings attempt to assess the societal impact of a company across three broad dimensions: environmental impact, social impact, and corporate governance. These ratings and ESG-centered investing have gained significant traction among many major asset managers. BlackRock, Vanguard, and State Street (which, combined, are the largest shareholders in 88% of S&P listed companies, according to a 2017 study) all issued ESG commitments and guidance for their portfolio companies in 2022.

As evidenced by S&P’s ESG credit indicator for states, the reach of ESG is not limited to private companies and investors. State public pension systems in New York, California, Colorado, Maryland, and Maine have begun incorporating ESG principles in investment decisions. However, as the National Association of State Retirement Administrators (NASRA) notes, “ESG investing has been challenged by some who believe that this approach is contradictory to fiduciary duty.”

Pension trustees are required by state laws to exercise their fiduciary responsibilities to maximize public pension systems’ investment returns at acceptable levels of risk for retirees and future beneficiaries.

In response to fiduciary concerns, the environmental, social, and corporate governance model is commonly justified under the auspices that investors do well when companies do good. The evidence for this claim is not clear. A comprehensive analysis by Vanguard found:

This article sets out to empirically investigate the performance characteristics of investable ESG equity funds to assess whether support for a particular direction in performance impact can be found…After controlling for style factor exposures, the majority of funds in any of the tested ESG categories does not produce statistically significant positive or negative gross alpha. An industry-based performance contribution analysis reveals that systematic differences in allocations relative to the broad market exist. However, their median contribution to performance is close to zero over time. Overall, return and risk differences of ESG funds can be significant but appear to be mainly driven by fund-specific criteria rather than by a homogeneous ESG factor.

This suggests it would be prudent for both private and public investors to assess ESG scores with skepticism. Even beyond very real concerns about the politicization of investment decisions, there needs to be an assessment of the validity of ESG rating metrics. Is there any precision in ESG ratings? In other words, do they measure what they’re trying to measure?

One of the leading ESG rating agencies, Morningstar’s Sustainalytics, provides publicly-accessible ESG Risk Ratings for many publicly traded companies. Sustainalytics’ ESG Risk Rating is a measure of “the degree to which a company’s economic value (enterprise value) is at risk [given the] company’s unmanaged ESG risk.” Sustainalytics assigns a rating by determining the total exposure risk of a company. Sustainalytics says the risk rating given to a company is a combination of entirely unmanageable risk and manageable risk that is not being addressed.

Size

Looking at the available ESG scores from Morningstar’s Sustainalytics ESG Risk Ratings, we see a trend where large companies rate better than small companies. On a scale in which a lower score indicates a better ESG rating, the median value of S&P 500 (large capitalization index) companies is 21.1 and Russell 2000 (small capitalization index) companies is 29.3. The difference in ratings is not just for the overall capitalization index but results in similar scoring across every single sector (communication services, consumer staples, energy, health care, etc.).

Large companies may have some structural advantages that make their businesses more ESG friendly, but it is also clear that they have structural advantages that enable them to boost ESG scores. A report for Legg Mason, which found a similar preference for company size across three rating agencies, notes:

“Many companies have started documenting their policies in publicly available sustainability disclosures; however, producing such disclosures is resource-intensive and financially burdensome. As a result, larger companies rate better as they generally have increased transparency and resources to dedicate to such initiatives.”

In some respects, the interplay between market capitalization and ESG scores is analogous to how businesses of different scales respond to government regulations. While reporting requirements may be burdensome for the large players, their bigger accounting, legal, and human resources departments are better able to take on these burdens than their smaller competitors.

Sector

In addition to size, there is also a clear stratification by sector in Morningstar's Sustainalytics. To some extent, this is logical. We would not expect a communication services company to have the same environmental rating as an oil company. Still, businesses are not isolated entities operating independently of other sectors.

For example, looking at the materials and technology sectors, the median materials sector ESG score is 30.9 while information technology has a median score of 22.4. If a technology company sources critical inputs like cobalt and lithium for its products from the mining sector, where do the ESG boundary lines fall, and are these ratings objectively reflective of a company’s true ESG impact?

Coherence

Beyond sector and size, there are specific results in Sustainalytics’ ESG risk ratings that call into question the logical coherence of the ratings. Notable is the comparison of leading defense contractors with a pasture-raised egg and butter company, Vital Farms. Even putting aside concerns about the underbelly of defense contracting, all four defense contractors are heavily taxpayer-subsidized. Northrop Grumman, Raytheon, Lockheed Martin, and Boeing, with ESG risk ratings ranging from 28.4 to 35, all rate better than Vital Farms’ 42.8. Ostensibly, the food company checks a lot of ESG boxes. It partners with small family farms and the company website states:

“Our purpose is rooted in a commitment to Conscious Capitalism, which prioritizes the long-term benefits to each of our stakeholders (farmers and suppliers, customers and consumers, communities and the environment, crew members and stockholders)...We are mission-minded people working together to bring ethically produced food from family farms to families’ tables.”

There may be a lot more to this picture, but seeing results like defense companies ranking better than Vital Farms raises several questions about ESG ratings. No single score applied to a complex world is flawless. Still, with ESG ratings increasingly being considered by corporations, governments, and institutional investors, the potential problems with these metrics shouldn’t be ignored.

Broadly, environmental, social, and corporate governance policies should be examined under a precision and accuracy framework. Do the metrics measure what they purport to measure—and are the priorities baked into ESG ratings the proper priorities in the first place?

The post The difficulties of assigning ESG ratings appeared first on Reason Foundation.

In This Issue:

Articles, Research & Spotlights 

• Louisiana’s Hybrid Pension Proposal Falls Short
• Shortcomings of ESG Scores
• A Chance for New Hampshire to Reduce Pension Debt
• Texas Needs to Reform Teacher Pensions
• Past Pension Missteps Should Be a Warning to California

News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk

Articles, Research & Spotlights

Evaluating the Potential Impacts of Louisiana Senate Bill 438 

Recognizing the need to better accommodate an increasingly mobile workforce, Louisiana legislators are considering a proposal to create a hybrid pension plan for new workers in the Louisiana State Employees’ Retirement System (LASERS). Senate Bill 438 would place all new hires into a plan that combines a risk-reducing individual investment account with a defined benefit pension structure. Despite the bill’s intentions, Reason’s analysis and testimony find that the structure of the new plan would offer little risk mitigation, add costs, and be a poor fit for the modern worker. 

The Difficulties of Assigning ESG Ratings

Despite concerns with fiduciary priorities, an increasing number of public pension plans are applying environmental, social, and corporate governance (ESG) policies to their investment strategies. A major part of this trend is the emergence of ESG ratings that attempt to quantify the environmental impact of companies. In an examination of this scoring, Reason’s Jordan Campbell finds companies with a higher market capitalization tend to receive better ratings, raising some questions about the validity of ESG scoring. Do bigger companies truly have a lower impact on the environment, or are they just better equipped to comply with demanding reporting requirements?

Why Paying Down New Hampshire Pension Debt Faster Would Be a Win for Taxpayers 

New Hampshire’s state government holds over $800 million in unfunded pension obligations to public workers and retirees, but lawmakers have an opportunity to significantly reduce this costly debt. With state government revenues currently $382 million above expectations, policymakers should consider using this surplus to close the funding gap of its retirement system to reduce long-term costs and risks to taxpayers. The Pension Integrity Project’s new one-page explainer outlines the benefits of paying down New Hampshire’s pension debt sooner rather than later.

Teacher Retirement System of Texas Can Improve Funding Policies and Plan Design to Benefit Taxpayers, Employees 

Texas policymakers have adopted several major reforms to improve funding and reduce runaway costs associated with the state’s pension plans in recent years. Most notably, 2021 legislation adopted an improved funding policy and established a risk-managed retirement plan for all new workers in the Employee Retirement System (ERS). Now, as Reason’s Steven Gassenberger testified to the State Senate Committee on Finance, Texas policymakers need to make similar reforms to the Teacher Retirement System (TRS), which is still chronically underfunded and remains very vulnerable to overly optimistic market assumptions. TRS benefit offerings also need to expand to better serve the mobile nature of educators today.

California Should Learn from Past Mistakes Made with Unfunded Pension Benefit Increases 

California Senate Bill 868 would increase pension benefits for teachers who retired over 20 years ago. The bill aims to counteract the degrading effects that inflation has had on retirees’ pension benefits, but as Reason’s Marc Joffe warns, this benefit increase would come with a high price tag. The pension plan’s actuaries indicate that the move would cost the state $592 million, but this estimation could be too low because it depends on the plan achieving optimistic returns over the next few decades. The proposal would also add to California’s unfortunate history of giving out pension benefit increases without properly funding them, which has generated significant unexpected costs to public employers and taxpayers.

News in Brief

Forensic Analysis of Pension Funding: A tool for Policymakers

A new study conducted by Boston College’s Center for Retirement Research (CRR) looks at the role legacy debt plays in the solvency of pension plans in Illinois, Massachusetts, Pennsylvania, Ohio, and Rhode Island. The inception of many public pensions occurred in the early to mid 1900s and there were not the same established norms in funding practices that we see today. Many pension plans had a “pay-go” system where the funding for benefits was not saved in advance. Even those that used an actuarial funding method approached unfunded liabilities very differently, not always including legacy debt as part of the calculation for required contributions. These old funding policies, combined with underperforming investment returns and benefit increases during the 1980s and 1990s, have resulted in several plans holding significant unfunded liabilities that accrued more than half a century ago. On average, CRR reports that legacy debt is 40% of total unfunded liabilities for the five focus states, with some as high as 74% in the case of Ohio. The full brief is available here.

Quotable Quotes on Pension Reform 

“We have a lot of counties and cities that are struggling right now with inflationary costs, and every time the plan doesn’t perform, they have to put in more money.”

— North Carolina Treasurer Dale Folwell in “Pensions’ Bad Year Poised to Get Worse,” The Wall Street Journal, May 10, 2022

“Ultimately at a fiduciary level, if a pension fund’s total worst-case exposure to all earnings and income derived from autocratic nations is an insignificant fraction of its total portfolio, the composite risk is probably not worth losing sleep over, on purely financial grounds. But politics could still enter the theater stage for pension boards that ignore this issue”

– Former GASB board member and ICMA Retirement Corp. President Girard Miller in “Public Pensions’ New Quandary: Coping With Geopolitical Turmoil,” Governing, May 10, 2022

Data Highlight

Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell created a visualization of ESG risk ratings for the nation’s largest companies, showing the difference between the S&P 500 and the Russel 2000. 

Contact the Pension Reform Help Desk

Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org. 

Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.

The post Pension Reform News: Hybrid pension proposal falls short in Louisiana, shortcomings of ESG scores, and more appeared first on Reason Foundation.

Chair Huffman and members of the committee:

Thank you for the opportunity to offer our brief perspective on the three interim charges before you today as they pertain to the state’s public pensions.

My name is Steven Gassenberger, and I serve as a policy analyst for the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way. Our work in Texas includes actuarial modeling and technical analysis related to the state’s most recent and impactful reforms, Senate Bill 12 of 2019 and SB 321 of 2021. These public pension reforms represent critical initial steps toward making the state’s pension systems as strong and effective as possible.

Increasing contributions to the Teacher Retirement System of Texas (TRS) and modernizing the Employees Retirement System of Texas (ERS) benefit have taken two public pension systems that were on a financially unsustainable path and have redirected them toward long-term solvency. However, the interim charges being discussed today show us there is still an opportunity to improve on how the state and taxpayers offer retirement security to public employees. These improvements can be secured without taking on the risks of unfunded liabilities and surprise cost overruns borne by taxpayers.

Between 2000 and 2019, ERS went from having an $867 million surplus to having $14.7 billion in unfunded pension obligations. By 2019, 64% of new hires under 35 were expected to leave public employment within five years, forfeiting their contributions made on their behalf by their ERS employer. Only 14% were expected to reach a full-career, un-reduced retirement benefit. For many years the state contributed a fixed percentage of payroll toward ERS that fell far short of what actuaries calculated was necessary every year to properly fund the plan. Worse, investment markets also shifted away from high-yielding fixed assets over that period, with many public pension systems opting to increasingly rely on less transparent—and generally higher risk—alternative asset investments to achieve expected returns.

In short, Texas was structurally underfunding a retirement plan designed to address a shrinking cohort of public employees’ needs while taking on more investment risk in an unsuccessful effort to stop the problem.

During the 2021 regular session, Senate Bill 321 tackled these problems head-on. It established a debt payoff plan and a date for when all ERS’ unfunded liabilities must be fully funded. It also provided a new, risk-managed retirement option for new hires that will help ensure that state workers of the past, present, and future can rely on a strong and sustainable ERS system. These solutions also minimize taxpayer exposure to severe long-term financial risks.

Unfortunately, many of the elements that plagued ERS at that time continue to plague TRS today. Although additional state contributions and historic market returns have improved the fiscal posture of TRS on paper, outdated assumptions, funding policies, and benefit offerings make it less likely that the increased contribution levels set by SB 12 in 2019 will ever fully fund all earned benefits going forward or meet the needs of modern educators.

Actuaries advising the TRS board recently warned members about a critical element underpinning the future solvency of the system that needs updating: the current 7.25% investment return assumption. By showing how TRS uses one of the highest investment return assumptions among major public systems—the national average has fallen to 7% over the years, with major plans like CalPERS now lowering assumptions into the 6-7% range—plan actuaries offered legislators a hint of what is in store for the retirement system over the next two decades. Investment revenue is expected to underperform in the next decade relative to expectations, which combined with contribution rates being artificially capped through statute creates the conditions for unfunded liabilities to steadily accrue over the next decade—just as it has done over the last two. 

Obviously, lowering investment revenue expectations will mean actuarial cost projections will reveal previously unrecognized costs. Other states have used surplus funds or large investment gains to cover the actuarial cost of using a lower investment return assumption to avoid accruing debt. That method of minimizing risk may be particularly interesting to lawmakers looking for ways to effectively use supplemental surplus revenue without growing government, as well as retirees who depend on the plan being on the path to full funding in order to receive a cost-of-living adjustment (COLA).

Our team will be sharing actuarial modeling throughout the legislative interim that covers both ERS and TRS, highlighting areas of opportunity from a technical perspective. We hope this will help facilitate productive dialogue among stakeholders.

Finally, nearly every lawmaker has heard at least one call for Texas to invest in or divest from one particular asset or another. Sometimes—like the recent calls by some pension systems to divest from Russian companies in the wake of the Ukraine invasion—geopolitics and other national security concerns may dictate certain shifts in investment strategy. Most investment or divestment calls, however, do not involve national security, but rather narrow political interests of various factions.

The impact investment returns have on both the cost and effectiveness of retirement benefits makes placing political constraints on pension fund investments a dangerous proposition. Not only does it make the goal of fully funding earned pension benefits harder for administrators, but it rarely achieves the intended political impact. Instead of preferential treatment for certain industries, an across-the-board update of the rules and expectations set for public pension fiduciaries and enhanced reporting requirements would improve governance and give stakeholders even more confidence in their system for future generations.

The Texas state legislature has been a national leader in updating public retirement design options that empower public employees to choose the best retirement path for themselves and their families. But there is more work to do. We look forward to following up with more technical analysis and exploring these issues in greater detail throughout the interim.

The post Testimony: Teacher Retirement System of Texas can improve funding policies to benefit taxpayers, employees appeared first on Reason Foundation.

The most notable measures being considered align closely with three national public retirement plan trends dealing with the current rise in the cost of goods, states’ difficulty retaining public workers, and the politicization of public pension fund investments. Here’s the Pension Integrity Project’s overview of these trends and the public retirement-related legislation currently being considered in Louisiana.  

Cost-of-Living Increases

The United States is experiencing the highest rate of inflation in 40 years, making everything more expensive, and several state bills under consideration in Baton Rouge grapple with how inflation impacts public pensions and retirees. Without Social Security, many retired from Louisiana’s public workforce have only their fixed public pension benefit through their golden years, leading retirees to be especially vulnerable to inflation. To address this issue, Louisiana public retirees depend on a complicated set of rules tying market returns to their pension systems’ ability to grant a cost-of-living adjustment (COLA). The result over the last decade has been “confusion surrounding when a COLA is likely to be granted as well as how much the ultimate cost to employers will be,” according to state actuaries. 

In an effort to address retirees’ inflation concerns, State Sen. Edward Price, chairman of the Louisiana Senate Retirement Committee, introduced a suite of bills granting retirees of the three largest state-sponsored retirement systems a supplemental retirement benefit. For public employees, House Bill 5 would issue a supplemental benefit in the form of a one-time bonus—commonly referred to as a 13^th check—that does not increase the base pension benefit for retirees in any future year. 

The additional pension check is expected to cost the state approximately $85 million for retirees in the Louisiana State Employees’ Retirement System (LASERS). This cost is expected to be limited to the one-time check being issued and would not carry over to subsequent years. 

The 13^th check concept is not unique to Louisiana. In 2021, Texas lawmakers issued a 13^th check to retired teachers, who hadn’t seen a cost-of-living adjustment for over a decade at the time. The mechanism for adjusting benefits to accommodate inflation built into the Texas system failed to trigger a payment. This was due to decades of inadequate funding into the pension system, stemming from a combination of outdated funding policies and underperforming investments. Texas lawmakers decided to issue a supplemental, one-time benefit payment from the state’s budget surplus to retirees. This differs from Louisiana’s proposal for an additional check, which would be funded with part of LASERS’ investment gains. 

If lawmakers feel a 13^th check is needed, the Texas approach would be better for Louisianans because it ensures the cost associated with this bonus is limited to one-time appropriations. In contrast, the cost of the proposed LASERS 13^th check would extend beyond the initially reported price because the pension system would be paying for the bonus check by reducing its assets that should be generating investment returns over time.

Louisiana’s House Bill 6 and House Bill 7 would permanently increase public pension benefits, with state taxpayers as underwriters. Expected to initially cost the Teachers’ Retirement System of Louisiana (TRSL) $369 million and the Louisiana State Police Retirement System (LSPRS) $9.5 million, both TRSL and LSPRS permanent benefit increases bump retiree benefits indefinitely. This means the accuracy of each plans’ assumptions would dictate the ongoing costs of the benefit increase. If investment returns for either pension plan perform below expectations, the difference would either increase the systems’ unfunded liabilities or employer costs. 

These bills use funds from each systems’ respective experience account to issue the one-time payment. Louisiana’s public pension experience accounts—created in 1992—use returns on pension investments above a set threshold to fund cost-of-living adjustments. The problem with this policy is that actuaries and plan administrators depend on good investment years to make up for any funding ground lost in the years that investments don’t meet expectations. Each plan’s experience account skims and redirects investment returns from each fund to pay for permanent benefit increases and this way of funding cost-of-living adjustments, Louisiana’s legislative auditor warns, empties each pension system’s experience account resulting “in an increase in expected future employer contributions.” 

State Rep. Tony Bacala introduced a cost of living measure relating to the Municipal Police Employees’ Retirement System (MPERS). But instead of issuing an immediate, one-time 13^th check or a permanent benefit increase, the measure would create a deposit account to hold employer contributions in anticipation of issuing a COLA. The measure differs from the LASER 13^th check and other bills that include permanent benefit increases in that the bill funds COLAs by prefunding a separate account through employer contributions rather than excess investment returns. 

Labor Market Challenges

A second major trend impacting the 2022 regular session is the growing challenge of retaining teachers, first responders, and other public workers amid a dramatic post-COVID-19 rise in retirements. Like many of their private sector counterparts, public employers are struggling to recruit and retain effective workforces in the wake of the pandemic’s economic impacts and a highly competitive labor market. Although there is scant evidence to support claims that retirement benefits a playing any factor whatsoever in worker retention decisions, especially for workers early in their professional careers, policymakers often try to influence employee decisions via retirement benefit policy because they may view it as the easiest carrot, in part due to the deferred cost of retirement benefits.

One example of the clearest examples of using retirement benefits as a carrot this session is State Sen. Jay Morris’ idea to give members of the TRSL Optional Retirement Plan (ORP), who previously made an irrevocable election to join the ORP, the right to revoke that irrevocable election and become participants in the TRSL defined benefit plan. Although ORP members would be responsible for the initial cost of TRSL credits, state actuaries warn that “comparatively generous assumptions” will undercalculate the final cost of each transfer.  

Claims that the bill is cost neutral with respect to changes in TRSL’s unfunded accrued liability were also debunked by state actuaries. In the actual note, actuaries said the passage of Senate Bill 10 “results in an ORP member being able to purchase guaranteed benefits (e.g. a retirement annuity, disability, and death benefits, all guaranteed by TRSL and backed by the State of Louisiana) at a price that is significantly less than the cost of similar benefits on the open market.” 

Similar bills have popped up around the country using similar arguments. For example, the Alaska State House recently passed a measure allowing  transferees to move from their defined contribution plan to a defined benefit plan. The unknown cost and minimal actuarial scrutiny given to the Alaska measure, including the lack of long-term forecasting and stress testing, mirrors the level of review given to SB 10 to date. If market outcomes diverge from TRSL assumptions, the funds transferred will end up being inadequate to provide the promised pension benefits and responsibility for the shortfall will once again fall to taxpayers.

State Sen. Price and State Rep. Bacala introduced a major overhaul to LASERS addressing the fact that only 2.5% of new hires joining LASERS at age 35 will receive full, unreduced retirement benefits. Over two-thirds of LASERS members will leave public employment with only their contributions refunded, leaving more and more Louisianans without Social Security and very little savings for retirement. The new LASERS-specific plan intends to provide non-career members a better means to build their own retirement nest eggs by offering a traditional predefined retirement benefit combined with contributions toward individual retirement accounts. However, as proposed, the measure offers lower individual retirement account contributions than other similar hybrid systems in favor of higher than standard predefined benefits. For the vast majority of LASERS members, the hybrid approach would be an improvement over the current retirement benefit, but the reform falls short in other critical areas. Unfortunately, the hybrid structure being proposed in this legislation not only lacks the technical reforms needed to address the LASERS benefit gap, but it also leaves the state with as much risk going forward, if not more. 

Beyond those two major issues, State Rep. Bacala also introduced a measure that would allow retired members of the Municipal Police Employees’ Retirement System to essentially come out of retirement and accrue additional pension benefits while they are already collecting pension benefits. State Rep. John Illg introduced a similar measure covering the District Attorneys’ Retirement System (DARS) retirees, while a proposal from State Reps. Larry Frieman and Rick Edmonds want to allow teachers to return to work without a suspension or reduction of their retirement benefits.

On a similar note, a number of legislators are attempting to increase the compensation for retirees returning to public employment. State Rep. Lance Harris wants to repeal a required benefit suspension for retirees who are reemployed in certain positions in MPERS, while State Rep. Troy Romero wants to increase the amount a retired teacher may earn while reemployed without a reduction of retirement benefits. State Rep. Phillip DeVillier wants to take a more direct approach and open the LASERS Hazardous Duty Service Plan to certain employees of the state fire marshal’s office not eligible for benefits. 

Pension Fund Investment Activism 

The third trend in pension legislation identified by the Pension Integrity Project at Reason Foundation in the 2022 regular session deals with activism in public pension fund investing. Nearly every state lawmaker has heard at least one call for their respective state to divest from Russian assets in the past weeks. Both the American Federation of Teachers and the American Federation of State, County and Municipal Employees (AFSCME) are urging their pension trustee members to immediately review public pension systems’ investments with ties to Russia following the country’s invasion of Ukraine. 

Calls for activism through public pension fund investments are not new. Even Louisiana Attorney General Jeff Landry recently sent a letter to Louisiana State Treasurer John Schroder asking him to follow the lead of West Virginia State Treasurer Riley Moore, who announced his state would no longer invest with BlackRock, Inc., which has been under fire from Republicans since its CEO talked of “decarbonizing the global economy”

“Divesting from entire sectors – or simply passing carbon-intensive assets from public markets to private markets – will not get the world to net zero. And BlackRock does not pursue divestment from oil and gas companies as a policy. We do have some clients who choose to divest their assets while other clients reject that approach. Foresighted companies across a wide range of carbon-intensive sectors are transforming their businesses, and their actions are a critical part of decarbonization. We believe the companies leading the transition present a vital investment opportunity for our clients and driving capital towards these phoenixes will be essential to achieving a net-zero world.” Blackrock CEO Larry Fink wrote:

“Based on nothing more than a political calculation, many of these calls for divestment run afoul of fiduciary obligations and veer from the primary purpose of public pension systems. These divestment calls would leverage retirement benefits to achieve political goals. As honorable as it is to want assurances that public dollars are not being used to support authoritarian regimes, the complicated global investment strategies propping up these public pension systems make achieving those goals through legislation detrimental to the financial health of these important systems.”

Other Retirement Bills Worth Mentioning

Outside of the national public pension trends that have already made their way to the Louisiana legislature, a few other of the state’s standalone measures related to pensions are worth exploring briefly. 

State Reps. Richard Nelson and Phillip Tarver both offered constitutional amendments requiring a minimum of 50% of all nonrecurring state revenues to be applied to the debt being serviced by Louisiana’s public pension systems. The process by which the infusion is deposited and the impact those transfers would have on the state’s financial health is unclear, but any supplemental appropriation to underfunded pension systems protects retiree benefits and saves taxpayers from costly interest payments on unfunded liabilities. 

Louisiana State House Appropriations Committee Chairman Jerome Zeringue also introduced a supplemental funding measure that would appropriate more than $69 million in additional state general funds from nonrecurring revenue. 

Although previous experience would dictate that many of these measures now under consideration by lawmakers in Baton Rouge are not likely to make it through this session, each touches the financial security of thousands of Louisianians—public workers in the retirement systems and the taxpayers funding them. Like almost everything being considered this session, these bills come with costs and trade-offs that put millions of taxpayer dollars on the line.

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