Government pension plans depend on annual investment results to help generate the funding needed to pay for the retirement benefits that have been promised to teachers, public safety, and other public workers. Since investment returns contribute to long-term public pension solvency trends, interested parties keep a close eye on the annual return results of these pension funds to see how they are performing compared to their own assumed rates of return. 

Reason Foundation’s list of public pension investment return results includes all major state pension plans that have reported their 2022 fiscal year results as of this writing.

The distribution of 2022 investment returns shows a significant range of results across all of the state pension plans reporting results at this time.

The Oklahoma Public Employees Retirement System reported a -14.5% return for its 2022 fiscal year, which is the lowest return rate among the public pension plans reporting results.

The New York State and Local Retirement System (NYSLRS) and the New York Police and Fire Retirement System (PFRS) reported 9.5% returns—the highest return rate in the nation for fiscal 2022, although their results are mostly attributed to plans’ 2022 fiscal year ending in March 2022, before the largest market losses in the 2022 calendar year.

Overall, the median investment return result for state pension systems in 2022 is -5.2%, which is far below the median long-term assumed rate of return for 2022 of 7% for the plans included in this list. With return results for the 2022 fiscal year so far below pension plans’ return assumptions, most state pension plans will see growth in their unfunded liabilities and a worsening of their reported funding levels.

With each public pension plan achieving different investment returns, the funding impact will also be different for each pension system.

Methodology

'Estimated Investment Gain/(Loss)' is calculated by taking the plan's FY 2020-21 Market Value of Assets and multiplying it by the difference between '2022 Return' and 'Assumed Rate of Return.' Estimated values are meant to approximate total amounts of investment loss that plans would fully & directly recognize this year due to FY 2021-22 return deviating from the assumption (i.e., not accounting for the smoothing mechanism). Investment returns shown are Net of Fees, if not stated otherwise. ‘Deviation from Assumed Rate of Return’ shows the difference between ‘2022 Return’ and ‘Assumed Rate of Return.' Positive returns are highlighted in light blue, and negative in orange. The distribution of the 2022 investment returns chart is based on the `normalized` probability density function, with all probabilities (i.e., all points on a line graph) summing up to 100%. 

The post The 2022 fiscal year investment results for state pension plans  appeared first on Reason Foundation.

With most private firms shifting workers to 401(k)-style defined contribution (DC) retirement plans since the 1980s, the state and local government market is effectively the last bastion of traditional defined benefit (DB) pension plans. However, even among governments, the ubiquity of traditional pension plans has been slipping. And much of the movement away from traditional DB plan designs has been caused by accumulated unfunded liabilities that are fiscally burdening both the pension plan and jurisdictions’ budgets.

Public pension reform has been seen as a binary choice: the traditional DB or a 401(k)-style DC plan, with the latter option frequently presented as a standalone retirement option. In practice, a traditional 401(k) on its own will rarely comprise a core, or primary, retirement plan. This is because this type of plan was designed, and functions best, as a supplemental, employer-sponsored, tax-deferred savings plan.

This study presents a new retirement plan design, the Personal Retirement Optimization— or PRO Plan, which is built on a DC foundation but designed to operate more like a traditional pension. The DC foundation for the PRO Plan was chosen because it allows more public employees to accrue valuable retirement benefits regardless of length of service compared to defined benefit approaches. The design uses cutting-edge financial technologies to focus on providing plan participants with a predictable and customizable retirement income. It uses a liability-driven contribution (LDC) approach, tailored to individual situations and needs, for determining necessary contribution levels. Primarily concerned with risk-managed income adequacy in retirement, it addresses wealth accumulation only as a secondary objective. The PRO Plan provides participants the flexibility to choose an asset distribution methodology but uses several types of currently available annuities as a default method. The annuity default, combined with proper financial education and advice, tailor the PRO Plan income to an individual’s unique situation.

This study illustrates the effectiveness of the PRO Plan design in meeting individual retirement needs while effectively managing employer workplace expectations. To do so, the study elaborates on various scenarios that are relevant for the public sector. This analysis compares the relative funding requirements for three separate longevity scenarios:

• Scenario 1: Do-It-Yourself (DIY) – the individual self-insures their personal longevity for the entire period until age 95.
• Scenario 2: QLAC (deferred annuity) – the individual purchases an IRS Qualified Longevity Annuity Contract to address longevity risk from 85 to 95.
• Scenario 3: 100% Immediate Annuity – the individual purchases an immediate life annuity at retirement age 67 for the entire stream of payments.

Each scenario’s funding requirement is based on an actuarial analysis of net present value of a stream of inflation-adjusted payments starting at age 67 until age 95 (or death). We found that a DIY scenario was the costliest PRO Plan alternative. Our analysis shows that a typical mid-level earner at age 67 would require $1,050,000 under the DIY scenario. The QLAC scenario requires 28% less funding, or only $760,000. The 100% Immediate Annuity scenario requires 38% less funding than the DIY scenario, or $652,000, to achieve the same retirement income.

To show how the PRO Plan would work when the target benefit accumulation is greater or lesser than needed, we analyzed both a shortfall and excess $100,000 in plan accumulations at age 50. These scenarios showed that PRO Plans would better protect individuals by positioning them to adjust savings rates up or down as needed. Similar to the baseline scenarios, the QLAC and 100% Immediate Annuity options require lower additional contributions to allow participants in shortfall situations to reach the target retirement benefits.

This study serves as a hands-on tool for public fund managers willing to implement the PRO Plan option. In addition to providing the reader with various scenarios, it details all the plan features necessary for its successful implementation. The PRO Plan is an innovative way of incorporating the benefits of 401(k)-style solutions into modern-day public sector retirement plans that give their workers flexibility and predictability of their benefits.

A state or local government employer seeking to implement a new retirement plan or redesign their existing retirement plan should always begin by clearly identifying sound retirement benefit design principles and using those principles to determine and articulate the objectives of that plan. The principles and resulting design should include as the primary objective providing a share of lifetime income, attributable to the employee’s tenure, enabling the employee to maintain their standard of living in retirement. The design of the plan should provide the flexibility to meet the needs of employees in varying circumstances. Of course, other workplace objectives of the employer and financial realities for plan sponsors should also be considered.

Standard DB and 401(k)-type DC plans are often compared with little regard to the simple question of what design elements provide the greatest utility to the greatest number of employees while still serving the employer’s workforce management objectives. Many arguments have been advanced on all sides of the issue, some valid, others not so much. The real answer to the question of what type of plan most aids recruiting and retention is a plan that best meets the varying needs of most employees.

This analysis concludes that providing retirement benefits and savings solutions that adjust to meet the different and changing needs of employees is what will more likely aid employers in attracting and retaining quality employees.

The PRO Plan design is specifically crafted to be adaptable to the needs of the broadest cross-section of employees possible. The focus of the plan is on providing employees with the target retirement income replacement ratio determined by the employer. Income replacement is the primary objective, with wealth accumulation a secondary consideration. Importantly, the plan, based on employer-specific criteria, can have a longevity annuity default that can be opted out of by employees meeting certain specific criteria. The mandatory contribution rates for both employer and employee, as defined by the employer, combined with the investment design and distribution controls, are all designed to minimize risks for the employee while meeting employer workplace objectives.

The Personal Retirement Optimization Plan: An Optimized Design For State And Local Government Employees

Frequently asked questions about the Personal Optimization Retirement Plan

Webinar: The Personal Retirement Optimization Plan

The post Designing an optimized retirement plan for today’s state and local government employees appeared first on Reason Foundation.

With the challenge of inflation likely to continue to be at the forefront of all of the state’s major financial discussions when the Texas legislature reconvenes in January 2023, it is essential to understand how the state government determines the health of its public pension funds and how policymakers can protect public retirees from the degradation effects of inflation. 

How Texas defines “actuarially sound”  

In the Sept. 8 hearing, members of the Texas House Appropriations Committee explored the importance of being “actuarially sound” in response to the numerous calls by lawmakers and retired educators to follow up on 2019’s 13^th check by issuing more inflation relief to provide cost-of-living adjustments to retirees during the next legislative session.

Rep. Carl Sherman (D-Desoto) asked Teachers Retirement System of Texas (TRS) Executive Director Brian Guthrie about the health of the state’s largest public pension plan. In posing his question, Rep. Sherman focused on the term “actuarially sound” specifically. Guthrie noted that Texas currently defines “actuarially sound” as taking less than 31 years to amortize, or fully fund, every pension dollar earned by members of the pension plan. That definition is set in statute and applies to all the state’s major public pension systems.  You can watch Guthrie’s full response on being actuarially sound and the timeline for paying off the state’s unfunded liabilities below. 

What does a cost-of-living adjustment (COLA) for retirees have to do with a technical definition? 

This technical issue is on the minds of retirees because the Teacher Retirement System (TRS) of Texas and the legislature can only issue a cost-of-living adjustment or a 13th check if the pension fund is determined to be “actuarially sound.” As Guthrie noted, this is currently defined as the pension fund’s amortization period not exceeding 31 years.

With this year’s high inflation rates hitting retirees living on fixed incomes the hardest, it is not surprising that retiree groups and their allies are advocating for a cost-of-living adjustment in the next legislative session. But just as was the case in 2019, when the state legislature opted to issue a 13th check to make up for the past decade’s inflation instead of adding liabilities to the fund, giving a permanent cost-of-living benefit increase next session would attach future obligations to the state and taxpayer in perpetuity. These obligations should be fully prepaid to limit their impact on the long-term financial health of the pension system. If state policymakers want to address the issue once and for all, they should look at launching a new TRS tier for new hires that includes a predictable cost-of-living adjustment as a core benefit in retirement.

Did TRS suggest the state’s definition of “actuarially sound” is outdated? 

To be “actuarially sound” is less of a universal definition or number than a collection of policies reflecting short and intermediate timeframes. Policymakers would do well to listen to Teacher Retirement System’s Guthrie and talk to other actuaries and the Texas Pension Review Board about a more contemporary idea of how the state should judge the financial stability of its public pension systems. For example, Guthrie notes that other groups, including the Society of Actuaries, recommend public pension amortization periods be no longer than 15-to-20 years. Setting an amortization period and allowing rates to adjust—the policy the Employees Retirement Plan (ERS) recently adopted—is also more actuarially sound than the current TRS policy of setting rates and allowing amortization periods to adjust. 

Teacher Retirement System actuaries have now built the increased contributions from 2019’s pension reform, Senate Bill 12, into the plan’s funding valuation. The effect was a shorter amortization period calculation, from 87 years to 29 years, if TRS manages to do something it’s never done: meet all of its actuarial predictions, like investment returns and mortality rate, 100% accurately.

After the market turmoil in 2020 and then record-breaking investment returns in 2021, TRS actuaries are now reporting a 26-year calculation, which is about where the system stood in 2013. The impact of the 2022 investment year, likely well below the pension system’s long-term expectations, has yet to be reported. But the low-to-negative investment returns expected are bound to bring that amortization figure closer to, if not beyond, the 31-year mark.  

If retirees and budget managers want predictable inflation relief that protects the value of pension benefits in a financially prudent manner, updating the state’s definition of “actuarially sound” to align with the Society of Actuaries’ recommendations would be a good first step. 

The post Is Texas’ definition of an actuarially sound public pension system outdated?   appeared first on Reason Foundation.

Recessions can hit retirees and public pension plans hard, so public pension plans reporting large investment losses for 2022 could just be a prelude to rough times for public pension systems.  A continued market downturn could potentially add trillions to public retirement systems’ existing pension debt, and most public pension plans are poorly positioned to withstand a major recession.

The largest pension system in the country, the California Public Employees Retirement System (CalPERS), reported a -6.1% return for 2022. The Oklahoma Public Employees Retirement System (PERS) recently posted a -14.5% loss for its 2022 fiscal year. 

The good news: A single year of returns generally has a limited impact on a pension plan’s long-term horizon, whether that be the great double-digit investment returns that many pension systems reported in 2021 or the losses that many plans are reporting for 2022. 

What matters most to the long-term funding of public pension systems is the ability to average out to, or come in above, the set investment return target so the plan has the money to pay for promised benefits. 

The next investment return prospects over the next 10-to-15 years for institutional investors look slim. Stubbornly high inflation and other economic factors may be increasing the likelihood of a recession in the near term, but for several years forecasts have been warning pension systems to lower their long-term investment return expectations. In 2022,  J.P.Morgan Asset Management, for example, has retained muted average return projections for U.S. public equities, the largest investment category for pension plans, at 4.1% for the next 10-15 years.

The Teachers Retirement System of Texas (TRS) is a good example of what could happen if a major recession scenario occurs over the next year and investment returns are low for a few years. TRS has already accrued $47.6 billion in pension debt since 2002. Most of TRS’ debt is due to investment returns falling below the plan’s lofty expectations, which were set at 8% until 2018. 

Since then the retirement system was wisely started to lower its investment return assumptions. In July, the TRS Board of Trustees prudently decided to lower its assumed rate of return from 7.25% down to 7%. An actuarial projection reveals, however, that TRS is still quite vulnerable to a major market downturn.

The analysis below (figure 1) applies -26% investment losses in the year 2023 and another in the year 2038, with each of those years followed by three years of a positive 11% rebound. Under that scenario, TRS’ unfunded liabilities, inflation-adjusted, are projected to grow from $44 billion in 2022 to $386 billion by 2052, leaving the plan roughly 52% funded.

Constant 7% returns, the system’s own baseline expectations, and 6% return scenarios are also shown for comparison. This forecast demonstrates that despite recent moves to better shield the system, TRS remains very vulnerable to major recessions. Even though the plan’s debt is currently expected to fall, the investment return assumption that was recently lowered to 7% could still set the plan up for future debt. TRS’ debt is expected to grow steadily if the plan realistically produces 6% returns each year.

Figure 1.  Forecast of Texas TRS Unfunded Liabilities: Current Statutory Contribution Policy

Further analysis (figure 2) suggests that Texas policymakers could greatly reduce the impact of a recession on the teachers’ plan by adhering to the contributions calculated by the plan’s actuaries— rather than continuing to base these payments on rates set in statute. If Texas were to transition to actuarially determined employer contributions (ADEC) for TRS, it could shave hundreds of billions off the state’s unfunded liabilities by 2052 (the debt would grow by just $92 billion instead of $340 billion) in the two recession scenarios described.

Figure 2.  Forecast of Texas TRS Unfunded Liabilities: ADEC vs Statutory Contribution Policy

The Teachers Retirement System’s lowered investment return assumption does position the plan to be more resilient to lower future returns, but most 10-to-15-year projections suggest that TRS needs to continue to reduce its investment return expectation. 

Forecasting shows that state policymakers should also consider paying actuarially required contributions (ADEC) to ensure adequate funding. Additional ways to bolster the funding of TRS would be to pay down pension debt faster and to consider alternative risk-reduced options for new hires:

These recommendations apply to most public retirement systems as well, as many pensions carry similar risks and would face equally difficult funding challenges were they to see a recession over the next year. 

Seeing the heightened risk of a major recession in the near term, not to mention the many credible economic forecasts of muted investment returns over the next decade, policymakers need to actively seek out reforms that bolster the long-term funding projections of public pension plans. A failure to fully prepare for potential recessions opens public pension systems—and therefore taxpayers and future government budgets—to significant long-term funding and cost challenges.

The post Most state pension plans are not adequately prepared for a recession appeared first on Reason Foundation.

The turbulence across financial markets to this point in 2022, with virtually all U.S. companies in the S&P 500 index in the red, means TRS will likely be among the public pension plans missing annual investment return targets this year. Just as strong, double-digit investment returns in 2021 greatly enhanced TRS’ funded status, this year’s investment losses are expected to lower the plan’s funding level.  

This dramatic up and down following the COVID-19 pandemic illustrates the folly of reading too much into pension funding measurements based on a single year of reported returns. Prudent public pension plan managers need to maintain a longer perspective and continue lowering investment return assumptions to accurately reflect what most market prognosticators expect to see over the next 10-to-15 years. 

Maintaining an overly optimistic investment return assumption is costly. Doing so raises the risk of significant growth in pension funds’ unfunded liabilities, which historically tend to spiral into colossal costs for taxpayers and take decades to remedy.

The Teachers Retirement System of Texas is a perfect example of this. The plan has accrued $47.6 billion in pension debt since 2002, and most of it, around $25 billion, came from investment returns falling below the plan’s assumptions (displayed in Figure 1 as “Underperforming Investments”). The primary contributor to this was TRS maintaining an unrealistic 8.0% rate of return assumption until 2018, well past the time most other pension plans had started adjusting their return rate targets downward in reaction to a lower yield return environment on financial markets. Policymakers’ failure to be nimble with return assumptions ended up contributing to the system’s current funding challenges, and it would be wise to not repeat that mistake. 

Figure 1. The Causes of the Texas TRS Pension Debt (Cumulative 2002-2021) 

It is critical for Texas policymakers to consider improving the TRS contribution policy by changing “statutorily-set” to “actuarially determined” rates. As the Pension Integrity Project has covered, annual contributions capped by statutory rates have generated significant funding challenges for the system. Since 2004, contributions have routinely fallen below the interest accrued on TRS’ unfunded liability that year (a situation called negative amortization). This has led to the Teachers Retirement System falling further behind in its ability to pay for promised obligations.  

An adjustment of the assumed rate of return down to 7.0% means the plan will recalculate pension debt upwards in 2023, but will also be better positioned to avoid future debt growth over the longer run. The forecast in Figure 2 compares the growth of TRS’ unfunded liabilities under three scenarios: 

1. Returns meet TRS assumptions;

2. TRS experiences two major recessions over the next 30 years;

3. And, TRS makes actuarially determined contributions (also using the two-recession scenario).

With this actuarial modeling of the system, it is clear that statutorily limited contributions will continue to pose funding risks for TRS that will be borne by Texas taxpayers. A proposed 7.0% assumed return will readjust 2023 unfunded liabilities upwards by $6.5 billion, but the plan will suffer fewer investment losses over the next 30 years when the plan inevitably experiences returns that diverge from expectations. TRS’ unfunded liabilities will remain elevated under the rigid statutorily-set contributions. If, however, TRS was to transition to Actuarially Determined Employer Contributions (ADEC) each year, then even by recognizing higher 2023 debt (under a 7.0% assumption) TRS could shave billions off its unfunded liabilities by 2052 ($74.7 billion down from $81.3 billion with current 7.25% assumption).  

Figure 2. Texas TRS Stress Testing: Unfunded Liabilities (2021-2052) 

The lower return target should improve TRS’ ability to withstand turbulent market periods like we are seeing today.  

A switch to an actuarial (or ADEC) contribution policy is what lawmakers did with the state’s other major pension plan—the Employees Retirement System of Texas (ERS)—just last year in a landmark pension reform. Unlike rigid contributions set in statute, actuarial contributions adjust and respond according to needs. This means that in situations of volatile market conditions (as tested and confirmed in the analysis above) contributions adjust automatically to ensure that the state’s unfunded obligations do not get out of control. This change in the ERS contribution policy is projected to save state taxpayers billions in long-term costs, and now would be a good time to consider similar reforms to how the state funds TRS. 

Seeing the obvious reduction in funding risks through actuarial modeling, it is clear that lowering the Teachers Retirement System’s assumed rate of return is a step in the right direction to safeguard the pensions for the state’s teachers. In addition to heeding the advice of the pension system’s actuaries, Texas policymakers should also consider addressing the rigid statutory contribution policies, which currently prevent Texas from meaningfully cutting down existing unfunded liabilities and curbing future pension debt. At a time when market results appear to be extremely unpredictable and volatile, the state’s teachers and taxpayers need to ensure that TRS is positioned to weather whatever storms may come.  

The post The Teacher Retirement System of Texas needs to adjust its investment return assumptions  appeared first on Reason Foundation.

Using data from the Bureau of Labor Statistics, the Rockefeller Institute of Government found nearly 12 percent of state and local government employees left their jobs in 2020, almost doubling the 6.1 percent of government employees who left their jobs in 2010.

Similarly, MissionSquare Research Institute’s 2021 online survey of state and local government employees, conducted after the onset of the pandemic in 2020, found the share of public sector employees who considered changing jobs jumped from 20 percent to more than 35 percent by the end of 2021.

These trends are the latest shift away from a previous era where workers would stay with one employer. The defined benefit pension plans offered to many government employees require them to work decades to qualify for a full pension benefit, but many workers are simply not sticking around long enough to maximize the intended benefit of a traditional public pension plan.

For example, a new employee hired at age 27 into the South Carolina Retirement System (SCRS) has to wait roughly 32 years before qualifying for full benefits at age 59. Analysis from Reason Foundation’s Pension Integrity Project showed that after 32 years, SCRS expects to only keep 15 percent of general employees and 22 percent of teachers (newly hired at age 27). Such retention trends are not uncommon in the public sector.

Figure 1: SCRS Retention Rates for a New Employee Hired at Age 27 (Average Employee – Teachers and General Combined) 

Public employees enrolled in traditional defined benefit plans collect more in total pension benefits as they progress through their careers. Yet, these benefit amounts are collected unevenly over time. An SCRS employee hired at age 27 receives as much as a 98 percent increase in pension benefits during their last four years of work leading up to retirement at age 59. But SCRS also offers a 401(k) type defined contribution plan, which provides a more steady growth in retirement benefits

Figure 2: SCRS DB and DC Benefit Accruals for a New Employee Hired at Age 27 (Teachers and General Combined)

Reason Foundation’s analysis shows that a 27-year-old teacher joining the SCRS defined contribution plan would have more lump-sum benefits after their first 20-to-30 years than the amount that would be accrued under the traditional SCRS defined benefit plan. The results would be similar in many other public pension systems.

Given the shorter tenures of today’s more mobile workforce, governments should consider modernizing their retirement plans and options for workers who don’t intend to stay in one position or with one employer for multiple decades. Alternative retirement plans, like defined contribution plans or supplemental benefits and savings, can shift a larger share of compensation toward earlier working years, greatly benefiting today’s workforce by not creating a wealth gap in retirement between them and single-career workers.

The post The Great Resignation highlights the need for public pension plans to adapt to today’s mobile workforce appeared first on Reason Foundation.

In 2005, Alaska enacted one of the most radical retirement system reforms in the public sector by discontinuing enrollment into its defined-benefit pension plan and creating a 401(k)-style defined contribution plan for all new public workers hired after July 1, 2006. The pension reform represented a significant change in accrual patterns, a reduction in benefit generosity, and a transfer of investment risk from the employer to the employees.

Using individual-level data for all Alaska teachers in the Teacher Retirement System (TRS) before and after the retirement benefit change (2005–2017), we assess the effects of the reform on teacher mobility out of employment with the Alaska K-12 system. Using a panel of member-specific data, we examine the short-run and longer-run effects of a radical benefit redesign on the labor market behavior of public educators.

Contrary to expectations, we document a decrease in separations after the reform in the short-run while also showing weaker but still negative longer-term impacts of the reform on teacher separations from public sector employment as educators.

Working Paper: Effects of a Transition to a Defined Contribution Retirement Plan on Teacher Separations in Alaska

The post Working Paper: How shifting to a defined contribution retirement plan impacted teacher retention in Alaska appeared first on Reason Foundation.

Last year, 2021, was one such year. Last fiscal year, most public pension plans saw record-breaking investment returns. In 2022, these pension plans have the opportunity to update their investment return rate assumptions.

Discount rates are used to calculate pension costs, and the assumed rate of returns is used to project asset growth. It is often difficult and costly for pension plans to lower their discount rates and assumed rates of return because doing so causes the plan to recognize that investment returns will be lower in the future. Those lower market return projections mean the cost of funding pension benefits will increase elsewhere. Thus, lowering discount rates and assumed rates of return requires state and local governments to make up the difference between the rate they previously assumed investments would return and the new lower rate of returns. That difference means increased contributions from state and local budgets or higher contributions deducted from plan members’ salaries. 

The Pension Integrity Project’s analysis of the Louisiana State Employees Retirement System’s (LASERS) pension debt growth shows that changes to actuarial assumptions have increased how much the state must contribute to the plan to fund retiree benefits. Around $2.4 billion in previously unrecognized debt was revealed between 2000 and 2021 because of changes to investment return assumptions. While not all of this shortfall needs to be paid immediately, this has contributed to the plan’s growing annual costs.

Adjusting actuarial returns sooner rather than later can reduce long-term costs. For example, LASERS averaged a 7.1% compound investment return rate between 2000 and 2021. If the plan had reduced its return assumption closer to 7% immediately after the 2008 financial crisis, it would have increased state contributions to the fund each year, potentially avoiding the debt accrued between 2008 and 2021 when actual returns were falling below the plan’s assumed rate of return. Lowering investment return assumptions would have taken a larger portion of the state budget each year, but pre-funding public pension benefits in this way would have been less expensive than having to pay interest on the $2.4 billion that has been added to the fund’s total debt load as a result of overly optimistic investment return expectations. 

Last year, the LASERS Board slightly reduced the pension plan’s discount rate and return assumption from 7.55% to 7.4%. Incidentally, last year’s investment return of 31.48% translated into $273 million in asset growth. This figure almost exactly matches the $270 million it cost the plan to make the discount rate adjustment, providing a good example of how extra investment gains can help plans fund costly assumption changes and reduce the chance of adding more debt in the future.

Another great use of one year of outstanding investment revenue is paying down existing debt. Per Act 399 of 2014, LASERS appropriates the first $100 million (indexed annually by growth in actuarial assets) of excess returns toward paying down legacy debt). In 2021, LASERS allocated $117.4 million of the excess investment revenue (the actuarial asset return above the assumed rate) toward paying down its legacy debt. 

Per the same policy, however, 50% of the remaining excess revenue went to fund permanent benefit increases, which is an increase in benefits that is not properly pre-funded and arguably one of the worst parts of the plan’s pension funding policy.

Louisiana is not alone in taking action to reduce actuarial assumptions after a year of excellent investment performance. The California Public Employees’ Retirement System—the world’s largest public pension plan—is implementing a plan to lower its assumed return and discount rate from 7.0% to 6.8%, and many other state-managed plans are going below the 7.0% target and bumping up the inflow of annual contributions to brace for the expectation of lower long-term returns. The New York State Common Retirement Fund, the third-largest public pension plan in the U.S., has lowered its return rate target from 6.8% to 5.9% following a staggering 33.5% return in 2021. 

“We have a unique opportunity to better position the funds for the long term because of the outsized returns that we’ve had in the past year [2021],” New York State Comptroller Thomas DiNapoli told Bloomberg.

Lowering investment return assumptions and discount rates are also supported by recent market forecasts which show public pension plans are likely to achieve closer to 6.0% investment returns over the next 20 years.

It is wise for public pension systems to use a single year of impressive investment gains to better prepare their fund for the future. Lowering investment return rate assumptions can help reduce the risks of future shortfalls and ensure proper funding of retirement benefits for teachers and other public workers.

The post How public pension plans can use last year’s investment returns to reduce debt and future risk appeared first on Reason Foundation.

Some industry experts have commented on how higher allocations to equities and alternative investments contributed to record 2021 investment results for public pension systems. For example, the Arkansas Teacher Retirement System earned 31.9% in 2021 and the system’s stock and private equity investments accounted for the majority of these gains, returning a whopping 47.4% and 33.3% in 2021, respectively. Even more outstanding, the American Investment Council reported that state pension funds in Nevada, Iowa, Florida, Tennessee, and Massachusetts had their large private equity allocations returning over 60% this year.

But for long-term public pension policy, stakeholders need to weigh these welcome and positive short-term investment results with a healthy understanding of the potential downsides of alternative assets. Chasing higher returns with these types of investments can be a double-edged sword for public pension plans.

On the upside, pension plans’ bets on riskier and less transparent alternative assets (think of private equity, hedge funds, and real estate) can potentially hedge against inflation and provide higher investment returns like we have seen this year.

However, this investment strategy also introduces risks of colossal decreases or losses in annual returns like we saw during the Great Recession, which ran from Dec. 2007 to June 2009. Just last year, for example, private equity returns dragged down the investment return results for quite a few plans.

In addition, alternative investments are more difficult to evaluate, making them less transparent and often less liquid. Without transparency, public pension funds could be taking on more unpredictable risks over time.

The long-term impact of volatility is evident when looking at the last two decades of asset growth for state-managed pension plans, which saw major investment shortfalls largely due to one very bad year (the 2008-2009 fiscal year). A compound asset growth analysis shows that state pension plans are still in the process of catching up from the massive losses of the great recession (see Figure 1).

Figure 1: Compound Percentage Growth Based on Median Assumed vs. Actual State-Managed Pension Plan Returns (2001-2021)

Under significant pressure to make up for past investment losses and meet their often overly-optimistic investment return expectations, state-managed pension plans have increased their investments into high-risk, high-reward assets by roughly three-fold in the last 20 years.

Figure 2 shows that in 2001 less than 8% of state plans’ portfolios were invested in alternatives in 2001, but in 2021 that number has increased to nearly 30%.

Figure 2: Average Asset Allocation by State-Managed Pension Plans (2001-2020)

As public pension systems move toward higher volatility risks, chances of major investment losses go up.

To quantify implications of this strategy, Andrew Biggs of the American Enterprise Institute has estimated that return volatility (generally measured by standard deviation—range of increases or falls relative to expected portfolio returns) for a pension portfolio with the same 8% expected return had been about 2.7% in 1985 and approximately tripled by 2013 to 12%.

A new report from BlackRock suggests that over half the public pension plans in the U.S. may fall short of their current assumed investment return rates in the near term (based on current asset exposures and BlackRock’s May 2021 Capital Market Assumptions). The median return assumption in 2021 among public pension plans was 7.0%, according to the National Association of State Retirement Administrators (NASRA). Forecasts show that actual investment returns over the next 20 years for public pension funds, on average, are estimated to be closer to 6.0%—based on the average response from 39 financial advisors in a Horizon survey. BlackRock has also said that U.S. pension plans may need to add more alternative assets to help portfolios deliver on expectations while also de-risking through diversification.

Public pension plans need to remain mindful of the balance between long-term returns and the volatility risk inherent in some asset classes. Despite great investment performance in 2021, the lower-yield environment projected over the next 15 years suggests that public pension plans should lower their investment return expectations and assumptions accordingly.

Public workers are depending on these pensions and taxpayers are on the hook to make up for unfunded liabilities so policymakers should make pension systems more resilient and de-risk their investment portfolios by lowering investment return targets to more achievable annual rates.

The post Market risks remain a long-term challenge for public pension systems appeared first on Reason Foundation.

While the good returns are a welcome development—and long-needed given relatively poor pension system performance since 2000—there are three reasons why policymakers should take strong one-time investment returns with a grain of salt and continue to advance prudent reforms to improve the financial resiliency of underfunded public pension systems:

1. 2021 investment returns will have limited impact on long-term pension funding
2. Long-term returns are expected to remain low
3. Many plans remain vulnerable to increasingly volatile market outcomes

Reason #1: 2021 investment returns will have a limited impact on long-term pension funding

A recently updated Pension Integrity Project database of the latest reported public pension investment returns shows that, at press time, the 33 U.S. public pension systems that have reported thus far had a median return 27.6% for the 2020-2021 fiscal year. Figure 1 below shows the distribution of these returns.

Figure 1: Probability Distribution of FY 2020-21 State Pension Plan Returns

These excellent returns are mainly a product of the market rebounding as the economy started to reopen in late 2020, with vaccination rates increasing, and the Federal Reserve lowering interest rates. The S&P 500 index—which tracks the 500 largest U.S. stocks—gained as much as 32%  from Sept. 2020 to Sept. 2021. Since around 50% of public pension assets are invested in stocks, it’s highly likely that virtually all state-managed pension plans will exceed their return expectations for FY 2021.

As an example, the Louisiana State Employees’ Retirement System (LASERS) reportedly earned 35.6% gross of fees in 2021, which is equivalent to roughly $3.4 billion in immediate asset increase (market value). The plan’s unfunded liability on a market value basis is projected to fall from $8.3 billion to less than $5 billion this year. Our projections for the funded status of LASERS and all other state-managed plans’ finances can be found in the interactive chart below. Simply choose a state pension plan from the dropdown tab on the left side of the chart and select a protected investment return rate on the right side to see how a plan’s funded ratio and unfunded liability are projected to change.

Figure 2: Anticipated Impact of FY 2020-21 State Pension Plan Returns

Despite the optimistic picture these projections show, the vast majority of pensions are not funded on a market basis in real life. Instead, they employ a variety of actuarial smoothing tactics to constrain how much market gain or loss is recognized in any given year in an attempt to avoid major budget swings related to pension contributions. Hence the latest investment returns should be taken with a grain of salt since they will be phased in over time to calculate actuarial unfunded liabilities and required contributions, just like the investment losses from last year were. For perspective, the same LASERS plan earned -3.8% for FY 2020, creating a whopping 11.4% market value shortfall relative to its 7.6% return assumption.

Since pension plans smooth out the impact from any single year returns to stabilize annual pension contributions, neither one very good year nor a very bad one will likely have a major long-term effect on funding. Consequently, gains from 2021 will look less extreme when updated valuation reports start coming out this fall, and it will take years for pension plans to fully realize the benefits of one good year in returns.

As such, one year of returns – good or bad – usually has a muted impact on a plan’s ability to maintain long-term funding in any significant way. But a long streak of subpar investment yields can deplete pension assets to the point where plans cannot get back the assets they lost through investments alone. This highlights one of the greatest challenges facing underfunded public pension plans now: proper prefunding of pension benefits requires decades of hitting return targets, along with maintaining the fiscal discipline of making actuarially sufficient pension contributions to ensure long-term solvency.

Reason #2: Long-term investment returns are expected to underperform

Another reason to not get too excited about a strong year of pension investment returns is that there is no evidence that excellent returns in 2021 will repeat themselves in the long run. In fact, based on recent capital market forecasts it appears likely that investment returns will face significant headwinds over the next decade and underperform relative to pension plan assumed rates of return.

Well before the COVID-19 pandemic, most financial consultants were projecting a lower-yield investment environment for institutional investors over the next 10-to-15 years. Recent revisions are even less optimistic. For example, JPMorgan recently lowered its return expectations for U.S. stocks over the long-term. A recent update from Horizon Actuarial Services, which surveys multiple investment advisors, confirms the same pattern. The survey notes that “over the last five years, expected returns have declined for all but a few asset classes.” The steepest of these declines was fixed-income investments—a staple of pension investment strategy—which have dropped more than 100 basis points just in the last two years.

Looking beyond 2021, the shortage of certain resources (e.g., semiconductors and qualified employees) is already contributing to rising price inflation (see Figure 3), and another major round of proposed federal spending may potentially spur further growth in consumer prices. Rising inflation matters because it has an insidious effect of raising prices on inputs, leading to corporations suffering profit hits, and the value of stocks potentially going down.

Figure 3. Consumer Price Index (Year-Over-Year Change)

Several plans have recognized these long-term forecasts of lower returns and even after an outstanding 2021 have acted to better prepare for that future. The New York State Common Retirement Fund just lowered its assumed rate of return from 6.8% to 5.9%. CalPERS is leveraging the 2021 windfall to lower its assumed return from 7.0% to 6.8%.

The Maryland State Retirement and Pension System just reduced its return rate assumption from 7.4% to 6.8%. On that decision, the system’s executive director, Martin Noven, explained:

“We didn’t believe we’d be able to sustain or actually beat our 7.4% [assumed return], so we reduced it to a level that we think we’ve got a better than 50/50 chance of achieving.”

Public pension plans need to continue to evaluate the investment environment with a long-term perspective and adjust their investment assumptions accordingly.

The bottom line is that public pension plans, on average, need to hit their return assumptions over a very long period to ensure that promised pension benefits are fully funded. This year will certainly help offset meager yields from previous years, but investment returns will likely be much less exciting in the coming years. Navigating such volatility demands caution on behalf of the public pension funds that rely on investment returns to prefund pensions promised to teachers, law enforcement officers, and other public employees.

Reason 3: Many plans remain vulnerable to increasingly volatile market outcomes

Due to the unpredictable market swings brought on by the pandemic and after a “lost” decade of an unimpressive recovery from the Great Recession it became evident that financially fragile public pension funds need to focus on maximizing their ability to remain resilient in a volatile investment environment. A once-in-a-generation year of investment gains doesn’t change that there is a  fundamental need for pension resiliency.    

The following two case studies from Arkansas and Florida demonstrate that public pensions still need to seek resiliency through improved contribution and assumption policies.

Case Study: Arkansas Teacher Retirement System

Pension plans that rely on statutory contributions—annual contributions rates set in law—are still very vulnerable to market fluctuations. The Arkansas Teacher Retirement System (ATRS), for example, has annual contributions determined in state statute. This means that payments going into the system will not reflexively adjust to funding needs if market outcomes do not match the plan’s assumed rate of return.

Pension Integrity Project modeling of ATRS—which includes the system’s 30% return in 2021—sheds light on the future challenges for the system (see Figure 4). According to the forecast, a 6% return over the next 10 years—an outcome that leading financial firms believe is very likely—would keep the system from making progress on reaching full funding, which is exactly the same issue that has plagued the system for 25 years.

Figure 4. Forecast of Arkansas’ Teacher Plan Funding Under Stress Scenarios

Source: Pension Integrity Project actuarial forecast of ATRS funding. The state is assumed to make statutory contributions.

Adding to that forecast analysis, ATRS also remains very vulnerable to stress scenarios. Applying one or two major recessions that match that experienced in 2008 would result in a major drop in the plan’s funded ratio, and would create significant long-term challenges in providing promised benefits to the state’s public workers.

Pension plans that are still bound by statutory contribution policies need reform to counteract an increasingly volatile market, and this remains true despite a positive year in returns. Policymakers in some states, like Texas’ Employee Retirement System (ERS), have taken prudent action to adopt contribution policies that ensure annual contributions meet actuarial needs (or ADEC contribution policy), which has made them more resilient to an unpredictable future.

Case Study: Florida Retirement System

Even for public pension systems that use reflexive contribution policies, the challenges that existed before the good results of 2021 still remain, and will still need to be addressed. Florida’s contribution policy for the Florida Retirement System (FRS) is relatively responsive to market outcomes, but the system still presents significant risks to state budgets in the form of runaway costs. Simply lowering the assumed rate of return for FRS over the past two fiscal years from 7.4% down to 7.0% has added a net new $800 million in annual pension contribution increases into the Florida state budget, demonstrating the fiscal fragility of the system.

Pension Integrity Project modeling of FRS—which includes the 2021 return of 29.45%—demonstrates that while the system funding would be relatively stable when compared to plans like ATRS, annual contributions still face major upward pressure (see Figure 5). Under a 6% return scenario, the contributions needed to fully fund benefits promised under FRS would remain high for the next three decades. Market stress scenarios would bump annual contributions up considerably. To counteract the risk of significant jumps in annual costs, Florida policymakers should consider adopting a lower return assumption that better matches future market projections.

Figure 5: Forecast of State Contributions in the Florida Retirement System

Conclusion

The extremely positive market results of 2021 are a welcomed development for beleaguered public pension plans around the country that have long needed a jolt, given subpar investment returns since 2000. But policymakers should not take the year’s excellent returns as a sign that pension reform is no longer needed.

What do policymakers need to do to make their pension systems more resilient? There are three major types of reforms that effectively address this:

• Reduce investment risk by aligning assumed returns with more realistic probabilities of success
• Ensure contribution policy is based on actuarially determined rates and is designed to pay down pension debt as quickly as possible
• Manage risk through plan designs that reduce the chance of runaway costs (i.e. risk sharing, defined contribution, or other design options)

The same challenges that led to chronic funding problems and costly, slow recoveries from previous losses still remain for many state and local pension plans. Those looking to interpret how the past year will affect public pension plans should keep in mind that one year of returns has relatively little impact on long-term solvency and that future average returns are still predicted to be below the assumed rate for most plans. Consequentially, most pension systems will still need reform to improve their financial resiliency and allow them to better navigate long-term underperformance and increased volatility going forward.

The post Three reasons why public pensions still need reform appeared first on Reason Foundation.

We recommend viewing this interactive chart on a desktop for the best user experience. If you are having trouble viewing the chart and interactive options on your device, please find a mobile-friendly version here. 

The post Investment return results for state pension plans appeared first on Reason Foundation.

Still, the rebound in institutional returns is welcome after the economic dip and fears the world could be facing a long-term economic crisis when the COVID-19 pandemic hit last year. The S&P 500 index has gained a staggering 38 percent since July 2020, and all major indexes are on the upswing. This market performance will bolster the assets of most U.S. public pension systems and improve their funding in the short term.

The Center for Retirement Research at Boston College recently projected a two-basis point aggregate increase in the funded ratio for public pensions plans —from 72.8 percent funded in 2020 to 74.7 percent funded in 2021.

But retirees, taxpayers and policymakers should not get too excited yet.

Before the COVID-19 pandemic, the U.S. experienced its longest streak of economic growth in history, but during that time most public pension plans only made minor progress in improving their funding levels. In fact, many public pension plans’ funding got dramatically worse, which highlights one of the greatest challenges facing underfunded public pension plans—proper funding requires decades of hitting investment return goals, along with making sufficient pension contributions each year.

As many of these public pension plans struggle to significantly improve their funded ratios, it is becoming clear that they will not be able to simply invest their way out of their current shortfalls.

Take Louisiana’s pension plan for state employees for example. The Louisiana State Employees’ Retirement System (LASERS) had an average 7.7 percent return during the longest period of economic growth in US history between 2011 and 2020. But the return barely beat the plan’s assumed rate of return— 7.55 percent. In the longer term, the plan averaged just 5.7 percent over the last two decades, from 2001 to 2020. As a result of failing to meet overly optimistic investment return assumptions during that period, the pension system added around $3 billion in debt, bringing the plan’s total debt to $7.1 billion as of 2020. Investment shortfalls and overly optimistic assumed rates of return like this tend to be the largest culprits driving growing pension debt for state and local plans across the country.

Figure 1. Louisiana State Employees’ Retirement System: A History of Investment Returns (2001-2020)

Source: Pension Integrity Project analysis of plan’s valuation reports and comprehensive annual financial reports.

Although most public pension funds are seeing excellent investment returns this year, the economic prospects are less optimistic in the long run. As vaccinations increase and regions try to return to pre-pandemic activities, economies are facing a variety of risks, including rapid consumer price increases. Per the U.S. Bureau of Labor Statistics, for example, inflation in the United States increased by double digits in April and May. The Federal Reserve is also considering increasing interest rates by the end of 2023, which would likely slow real economic growth in the country.

Even before the COVID-19 crisis, financial experts were projecting a continuation of a lower-yield investment environment in the next 10-15 years. Revised economic expectations are even less optimistic right now. For example, J.P. Morgan’s recent Long-Term Capital Markets Assumptions report shows that they have lowered return expectations for U.S. stocks.

Simply put, public pension systems should view this year’s excellent investment returns as an outlier, not a norm. Once the current market rebound ends, most experts say the long-term funding prospects for state and local pension plans remain poor.

Public pension plans, on average, need to hit their return assumptions over a very long period to ensure the retirement benefits promised to teachers, law enforcement officers, and other public employees are fully funded and future taxpayers are not saddled with public pension debt. A single year of good investment returns, while quite welcome, is not a solid indicator that public plans that have struggled to improve their funding over the past two decades are now heading in the right long-term direction.

The post One Year of High Investment Returns Does Little to Improve Long-Term Public Pension Funding Levels appeared first on Reason Foundation.

During an August Investments and Pensions Oversight Committee (IPOC) meeting, the Educational Retirement Board’s administrative leadership spoke to state legislators about the long-term funding prospects of the plan and laid out three options they believe could get ERB back on track to being fully funded by 2050.

These suggestions were to increase employer contribution rates, transfer the pension plan’s reported $9 billion in unfunded liabilities to the state’s general ledger through a bond offering, or decrease retirement benefits offered to ERB members.

Legislators and ERB seem to have come to an agreement on a plan to increase employer contributions and ERB has already drafted legislation to do so.

The bill is set to be introduced by State Sen. Mimi Stewart (D-Albuquerque) in the 2021 legislative session. The proposed bill increases the annual statutorily-set ERB employer contribution rate from 14.15 percent to 18.15 percent, increasing one percent a year over four years.

In its latest presentation to IPOC on December 10, the New Mexico Educational Retirement Board’s administrators used the plan’s latest valuation report to walk policymakers through its current $9 billion shortfalls and 60 percent funded status by way of highlighting the fact that there is currently no path for ERB to fully fund retirement benefits. Plan administrators warned that, historically, ERB has had the ability to pay benefits in perpetuity, but for the first time in its history, ERB is expected to exhaust that ability soon absent changes to current funding policy.

The employer contribution rate is the amount of funding that the state is required to contribute to the plan each year. This funding increase recommendation is the latest legislative attempt by ERB to ensure the retirement benefits of state-employed educators are fully funded and available to retirees over the long-term.

Previous well-intentioned efforts to increase retirement eligibility requirements, increase member contributions, and tie retirees’ cost-of-living-adjustments (COLAs) to ERB’s funded ratio (all of which focused on the member’s influence on the funding formula) have made a small impact on the resiliency and long-term solvency of ERB.

Figure 1 below displays the funding history of the plan.

Figure 1: History of the New Mexico Educational Retirement Board’s Solvency

Actuarial analysis of ERB’s latest proposal suggests that the increased employer contribution rate, while a positive step, would only make a difference in the plan’s long-term sustainability if all actuarial assumptions are met over the next 30 years.

The Pension Integrity Project at Reason Foundation modeled the proposal and found that if implemented, ERB’s 2050-projected unfunded liability would decrease by nearly 40 percent, decreasing from $34.2 billion in debt to $20 billion. The ERB proposal, however, would still ultimately result in the plan’s accrued benefits being only 66 percent funded in 2050.

In short, the proposed changes could be a good, small reform and the plan’s funded status would marginally improve if all actuarial assumptions are met over the next 30 years, but ERB would still have significant structural problems and remain far short of full funding.

From a solvency perspective, the impact of increased contributions on ERB is clear: the more contributions the better. However, our analysis also finds that when accounting for potential future market underperformance, absent addressing the systemic issues driving the growth of unfunded benefits, ERB’s funding issues are bound to worsen.

To be sure, increasing contributions to address growing unfunded liabilities is a good policy step for many public pension plans, but often more changes are necessary to fully address the fiscal stress pension debt puts on employees, retirees and taxpayers.

Figure 2 illustrates this important finding by comparing the current state of ERB, where all actuarial assumptions governing the plan—including ERB’s current 7 percent investment return rate assumption—are accurate each year, to a less optimistic forecast that shows the condition of ERB after 30 years of more conservative investment returns and two recessionary periods.

Figure 2: The Effect of a 4 Percent Employer Contribution Increase on ERB’s Funded Ratio

In the event that all of the plan’s assumptions are consistently accurate over the next 30 years, additional state funding would improve ERB solvency. But the proposal to increase contributions does nothing to address the current unfunded liabilities or the system’s exposure to market volatility.

Additionally, ERB funding improvement relies on the theory that the system’s investment return rate assumption of 7 percent, among others, will either be met or exceeded in the near-term, which ERB administrators and consultants say they believe is a reasonable assumption.

When assumptions are missed, especially the plan’s investment return rate assumptions that serve as the only other funding source outside of members and taxpayers, ERB’s unfunded liabilities would grow despite increased contributions from the state. Thus, in the overall picture, the proposed contribution increases wouldn’t prevent the further accrual of unfunded retirement benefits by public educators, who, for their part, have honor the obligation their side of the agreement entered in when first hired.

Figure 3 shows the projected increase of ERB unfunded liabilities under various economic and investment return scenarios.

Figure 3: The Effect of a 4 Percent Employer Contribution Increase on ERB Unfunded Liabilities Under Lower Investment Return Rates

A less lucrative investment portfolio and recurring recessions over the next 30 years, which most economists expect, would likely result in significant drops in ERB’s funding regardless of the proposed employer contribution increase.

Increasing the contribution rate is a good idea but without also addressing the volatility inherent in the ERB investment portfolio and adjusting how the state is paying off its debt and unfunded liabilities, ERB will remain less and less resilient to economic and stock market shifts over time and will continue to accrue ever higher unfunded liabilities.

The proposed contribution increase would certainly be beneficial from a solvency perspective, but ERB’s situation requires far more substantive adjustments to how unfunded liabilities are tackled and how the plan reacts to underperforming investment results if it is going to ensure retirement benefits for New Mexico’s teachers and educators are sustainable and financially resilient to market shocks over the long-term.

During New Mexico’s recent PERA reform effort, state policymakers simultaneously increased employer contributions while also addressing systemic design flaws like the guaranteed cost-of-living adjustments that were untethered to actual inflation and reducing PERA’s long-term exposure to market risk by lowering investment return assumptions.

Elsewhere, in 2018, the state of Colorado not only increased employer and employee contributions to its main public pension system but also established an automatic adjustment feature— automatically increasing annual pension contributions and lowering the pension plan’s cost-of-living adjustments if certain funding thresholds are not met. The city of Fort Worth soon followed suit, enacting a similar automatic adjustment policy for its public workers’ pension system.

Adding an automatic adjustment policy to increased contribution proposals would not only improve the trajectory of ERB funding but could also insulate the system from unpredictable market returns in the future. Such a policy would allow annual contributions to respond more freely to changing conditions and ensure that if any future investment returns come in below expectations, they do not derail the public pension system’s trajectory towards full funding.

The best way for New Mexico lawmakers to address the problem of contributions not adjusting to market volatility and performance would be for the legislature to contribute annually to ERB at an actuarially determined employer contribution (ADEC) rate.

Every year, ERB’s actuaries calculate the amount of funding the pension plan needs from all sources to avoid any growth in unfunded pension liabilities. Currently, the state does not rely on this ADEC value to determine its annual contributions, as many pension plans across the country do. Instead, ERB relies on a fixed percentage of payroll set by law at the discretion of legislators. The result of this policy has been chronic underpayments, adding to the system’s long-term solvency concerns.

Figure 4 illustrates this problem, showing that state contributions into the fund have been below actuarially required amounts for nearly 20 years.

Figure 4: Actual vs Required ERB Contributions

ERB would benefit from adjusting its funding policy to match the many other states that rely on the actuarially-determined amount to set annual contributions. This change in policy, like the proposed automatic adjustment feature, would protect the post-employment security of New Mexico educators from the unpredictable future of the market.

Figures 2 and 3 above also include scenarios modeling an ADEC-based policy, which shows ERB’s funded ratio rising to nearly 100 percent and its unfunded liabilities being nearly eliminated in 30 years.

The ERB-backed state funding increase proposal represents a commitment to securing the retirement of New Mexico educators.

However, despite the contributions increases moving ERB off the path of insolvency, the proposal’s success relies heavily on the ability of ERB to achieve expected returns. Because of this, the retirement security of the 12 percent of New Mexico educators who serve their communities long enough to earn an unreduced ERB retirement benefit, will continue to be exposed to a great deal of risk and ERB will still need additional adjustments in the future.

Adopting more risk-averse investment return assumptions and funding policies to prevent the further growth of unfunded benefits, while establishing a plan to pay off the plan’s existing unfunded liability as quickly as possible would directly address the systemic underfunding that has created the challenges facing ERB today.

The post Contribution Increases Could Help New Mexico’s Teacher Pension Plan, But More Changes Are Necessary appeared first on Reason Foundation.

In fact, the average investment return rate of the 84 state-managed public pension plans that have reported their fiscal year 2019-2020 returns so far is just 3 percent. Despite the stock market having a strong year, Reason Foundation’s analysis shows that the nation’s 10 largest public pension systems averaged just a 2.6 percent rate of investment return, which is significantly short of what the plans were expecting. The shortfalls of these 10 public pension plans account for $68 billion of the estimated $200 billion expected to be added to the nation’s total public pension debt.

Although 3 percent is well above the negative return rate that some experts feared pension plans might see after the pandemic hit, any time that a pension plan’s investment returns fall short of its set assumed rate of return debt is added to the retirement system.

The average assumed rate of return for state-managed public pension plans in 2019 was 7.25 percent. Falling short of that goal by more than 4 percentage points at the aggregate level should be concerning to public employees, plan administrators, and taxpayers alike.

Figure 1 below shows the growth of pension liabilities (promised benefits) vs the growth in pension assets since 2001. The difference between the two, highlighted in gray, is accumulated unfunded liabilities, or pension debt.

Figure 1: Total State-Managed Public Pension Unfunded Liabilities And 2020 Projection 

Source: Pension Integrity Project at Reason Foundation analysis of U.S. public pension actuarial valuation reports and Comprehensive Annual Financial Reports (CAFRs). 

One bad year of market returns can significantly impact near-term pension funding. For example, we estimate the New York State and Local Employees Retirement System’s negative 2.7 percent return this year could increase its debt burden by more than $17 billion (based on the market value of assets, see methodology section in the app for more details).

A smaller plan, like the New Mexico Educational Retirement Board, which earned a negative 0.6 percent return, could see a $1 billion increase in unfunded pension liabilities.

While investment performance in any single year may have a relatively limited impact on long-term pension solvency, our analyses demonstrate that consistent investment underperformance relative to the investment return assumptions made by pension systems have been the biggest culprit behind the growth of public pension debt across the nation. Even during a period of strong stock market performance, including the longest bull market in history, public pension plans failed to make significant funding progress as their pension investment results repeatedly failed to match expectations throughout the last decade.

According to Reason Foundation’s analysis, most fiscal year 19-20 investment returns fell within a positive return range of  1.3 percent to 4.0 percent.

Figure 2 below shows that 75 percent of reported returns were under 4.0 percent, 50 percent were below 3 percent and 25 percent were below 1.3 percent.

Figure 2: 2020 Investment Return Distribution 

Source: Pension Integrity Project at Reason Foundation analysis of publicly reported FY20 investment returns,

The worst return so far reported has been the Louisiana State Employees Retirement System, which saw a negative 3.8 percent rate for its fiscal year.

At the other end of the spectrum is the Delaware State Employees’ Pension System, which finished its fiscal year with an impressive 10 percent yield. At the time of this publishing, of the 84 pension systems that have posted complete fiscal year results, only the Delaware State Employees’ Pension System has met its assumed rate of return in FY 19-20.

It’s also worth mentioning that return results for systems with fiscal years ending on Sept. 30 and Dec. 31 will likely look better than the results for pension plans that have fiscal years that ended on June 30, 2020. Markets continued improving in the second half of calendar 2020 after the early stages of the COVID-19 pandemic and recession so those plans had more time to recover from the pandemic’s initial impact on markets.

Although COVID-19 and the recession’s impact on markets and the economy were less disastrous than many experts had forecasted in the spring of 2020, public pension systems continue to face significant challenges in the years ahead.

In its latest World Economic Outlook, the International Monetary Fund projects that real gross domestic product (GDP) in the world’s advanced economies will settle at around negative 5.8 percent for 2020 (with the U.S. expected to post a final figure of around negative 3.6 percent) and average 2.2 percent growth rates in the 2022-25 period. The low economic growth forecasts at a minimum portend lower returns on equity investments (e.g. corporate stocks).

Figure 3: Real Gross Domestic Product Growth Projections

Source: International Monetary Fund, “World Economic Outlook October 2020”.

Even before this year’s COVID-19 related market volatility, experts were forecasting a new normal low-yield environment for institutional investors like pension funds over the next 10-15 years. If pension plans and policymakers do not adjust their investment return assumptions to these forecasts, more public pension debt will be added to most systems. As pension assets get more and more depleted, it also becomes more difficult to depend on market returns as a method to climb back to full funding.

The 2020 investment return results add to concerns that public pension plans will continue to struggle with investment return realities that are below the return rates they are counting on, which could have long-lasting negative effects on taxpayers. Long-term underfunding could potentially:

• Increase the risk of pension plans not being able to pay out promised benefits.
• Trigger benefit cuts or much lower benefit accrual formulas for new hires.
• Require future taxpayers to cover high costs for current and past public employees, whose services they will receive no benefit from.
• Pull public funds away from other priorities like K-12 education and public safety.
• Put public pension systems into a “point of no return” where assets are so depleted that it becomes almost impossible to invest their way to full funding, even with double-digit yields later (recent examples include the Puerto Rico, Illinois, and Kentucky pension systems in the last decade).

The first vaccines have arrived but the coronavirus pandemic is not over yet, and states will feel the effects of the COVID-19 recession in their budgets for quite some time.  Policymakers should take this unique moment to revise investment return assumptions and other expectations for public pension funds in order to fully-fund pension promises that have been made to workers.

The post Pension Debt Grows as Public Pension Systems Post Low Investment Returns for 2020 appeared first on Reason Foundation.

The New Mexico Educational Retirement Board (ERB), the public pension plan serving educators in the state, is descending into insolvency and putting the retirement benefits of teachers at risk. In the year 2001, ERB had less than $1 billion in public pension debt, but in the two decades since, this number has risen dramatically. The latest, official numbers reveal that the New Mexico Educational Retirement Board now has $7.9 billion in unfunded pension liabilities.

Reason Foundation’s latest solvency analysis, updated this month (November 2020), shows that the past two decades of underperforming investments, insufficient contributions, and undervaluing debt, have driven benefit costs higher while crowding out other programs and priorities clamoring for public funding in New Mexico.

An August 2020 New Mexico ERB investment committee report showed annualized returns of 5.7 percent for the last five years, falling well below the plan’s return target of 7.25 percent. In fact, investment returns failing to meet unrealistic expectations has been the largest contributor to the public pension plan’s unfunded liability growth, adding $3.3 billion in debt since 2001.

Reason Foundation’s analysis finds that the New Mexico Educational Retirement Board has less than a 50 percent chance of meeting its 7.25 percent investment return assumption in the next 10 years. If the plan continues to fall short of this unrealistic goal, the analysis shows it could add $10 billion to $20 billion in long-term pension costs, depending on a variety of market scenarios.

Today, ERB has only 63 percent of the assets needed to fully fund the pension system in the long-term. This underfunding not only puts taxpayers on the hook for growing debt but also jeopardizes the retirement security of New Mexico’s educators. Left unaddressed, ERB’s structural problems will likely lead to more education funding crowd out, more debt for future generations, and less retirement security for the state’s educators.

The solvency analysis looks at the primary factors driving unfunded liabilities for ERB over the past few decades and offers stress-testing designed to highlight potentially latent financial risks the pension system is facing. It also provides a number of policy suggestions that, if implemented, would address the declining solvency of the public pension plan.

A new, updated analysis will be added to this page regularly to track ERB’s performance and solvency.

Bringing stakeholders together around a central, non-partisan understanding of the challenges ERB faces—complete with independent third-party actuarial analysis and expert technical assistance—Reason Foundation’s Pension Integrity Project stands ready to help guide New Mexico policymakers and stakeholders in addressing the shifting fiscal landscape.

New Mexico Educational Retirement Board (ERB) Pension Solvency Analysis

The post New Mexico Educational Retirement Board Pension Solvency Analysis appeared first on Reason Foundation.

The Louisiana State Employees’ Retirement System (LASERS) has seen a significant increase in public pension debt in the last two decades. With $7.1 billion in unfunded liabilities, the retirement security of Lousiana’s state workers and retirees may be in jeopardy.

Reason Foundation’s latest analysis, updated this month (November 2020), shows that deviations from investment return assumptions have been the largest contributor to the system’s unfunded liability growth, adding $2.7 billion to its unfunded liability since 2000. This growth in unfunded liabilities has driven benefit costs higher while crowding out other programs and priorities that may be clamoring for public funding in Louisiana.

The chart below, from the full solvency analysis, shows the increase in the Louisiana State Employees’ Retirement System debt since 2001:

Today, LASERS has only 64 percent of the assets needed to fully fund the pension system in the long-term. This underfunding not only puts taxpayers on the hook for growing debt but also jeopardizes the retirement security of Louisiana’s state employees. Left unaddressed, the Louisiana State Employees’ Retirement System’s structural problems will continue to resources from other state priorities.

The solvency analysis looks at the primary factors driving unfunded liabilities in LASERS’ over the past few decades and offers stress-testing designed to highlight potentially latent financial risks the pension system is facing. Reason Foundation also provides a number of policy suggestions that, if implemented, would address the declining solvency of the public pension plan. A new, updated analysis will be added to this page regularly to track the system’s performance and solvency.

Bringing stakeholders together around a central, non-partisan understanding of the challenges the Teacher Retirement System of Louisiana and the Louisiana State Employees’ Retirement System face—complete with independent third-party actuarial analysis and expert technical assistance—the Pension Integrity Project at Reason Foundation stands ready to help guide Louisiana policymakers and stakeholders in addressing the shifting fiscal landscape.

Louisiana State Employees’ Retirement System (LASRS) Pension Solvency Analysis

The post Louisiana State Employees’ Retirement System (LASERS) Pension Solvency Analysis appeared first on Reason Foundation.

The Teachers’ Retirement System of Louisiana (TRSL), the public pension plan serving educators in the state, is descending into insolvency and putting the retirement benefits of teachers at risk. In the year 2000, TRSL had just over $3 billion in public pension debt, and, in the two decades since, this number has risen dramatically. The latest, official numbers reveal that the Teachers’ Retirement System of Louisiana now has over $10 billion in unfunded pension liabilities.

Reason Foundation’s latest analysis, updated this month (October 2020), shows that the past two decades of underperforming investments, insufficient contributions, and a flawed process of issuing cost-of-living adjustments, has driven benefit costs higher while crowding out other programs and priorities that clamoring for public funding in Louisiana. In fact, investment returns failing to meet unrealistic expectations has been the largest contributor to the public pension plan’s unfunded liability growth, adding $4.2 billion since 2000.

The chart below, from the full solvency analysis, shows the dramatic increase in the Teachers’ Retirement System of Louisiana’s debt:

Today, TRSL has only 67 percent of the assets needed to fully fund the pension system in the long-term. This underfunding not only puts taxpayers on the hook for growing debt but also jeopardizes the retirement security of Louisiana’s educators. The pension debt also continues to pull funding away from Louisiana classrooms and teachers’ salaries.

Left unaddressed, TRSL’s structural problems will lead to more education funding crowd out, more debt for future generations, and less retirement security for the state’s educators.

The solvency analysis looks at the primary factors driving unfunded liabilities in TRSL over the past few decades and offers stress-testing designed to highlight potentially latent financial risks the pension system is facing. Reason Foundation also provides a number of policy suggestions that, if implemented, would address the declining solvency of the public pension plan. A new, updated analysis will be added to this page regularly to track TRSL’s performance and solvency.

Bringing stakeholders together around a central, non-partisan understanding of the challenges TRSL faces—complete with independent third-party actuarial analysis and expert technical assistance—Reason Foundation’s Pension Integrity Project stands ready to help guide Louisiana policymakers and stakeholders in addressing the shifting fiscal landscape.

Teacher Retirement System of Louisiana (TRSL) Pension Solvency Analysis 

Reason Foundation’s previous solvency analysis of the Teachers’ Retirement System of Louisiana (TRSL) is available here:

• 2019 Teacher Retirement System of Louisiana Solvency Analysis

The post Teachers’ Retirement System of Louisiana Pension Solvency Analysis appeared first on Reason Foundation.

For this analysis, we determined each state’s funded status by calculating the total reported market value of assets and actuarially accrued liabilities. This allows us to estimate the weighted average based on each pension plan’s liabilities.

Reason Foundation’s Pension Integrity Project finds the average state-level funded status dropped from 97.7 percent in 2001 to roughly 73.6 percent in 2019. This decline of 24.1 percentage points is cause for concern.

But, it’s worth noting that not all changes in public pension plan funding status are equal. For example, Washington state’s pension plans fell from 165 percent to 110 percent funded between 2001 and 2019, while Kentucky saw its total funded status drop from 95 percent to 46 percent over the same period. Even though both states saw their funded ratios fall significantly, Washington still has fully-funded pension systems. In contrast, none of Kentucky’s three major public pension plans is even 60 percent funded.

Our new interactive tool allows you to see how every state’s public pension plan’s funded ratios have changed since 2001.

The features of the tool can also be adjusted to show important information such as how funded ratios faired during the Great Recession of 2008, the states that have the worst-funded pension plans, and the average funded status decline or growth each year.

We recommend viewing this interactive chart on a desktop for the best user experience. If you are having trouble viewing the chart and interactive options on your device, please find the full dashboard here. 

As the National Association of State Retirement Administrators (NASRA) notes, many factors affect a public pension plan’s funded status as every pension plan has a unique set of actuarial assumptions, methods, and experiences.

Additionally, by discounting pension liabilities at high-interest rates, many state and local governments understate their actuarial accrued liabilities and overstate their funded status. This means that some states may be in worse shape than their data shows here. Even so, examining the funded status of public pension plans can be a simple and transparent way to track the financial health of the plans over time.

The post The Funded Status of State-Managed Public Pension Plans appeared first on Reason Foundation.

Because most public pension funds failed to recover from the Great Recession—despite a historic, decade-long bull market—they won’t be able to quickly recover from the current recession and future market events absent major reforms.

This is why New Mexico’s bipartisan effort by Gov. Michelle Lujan Grisham and the state legislature to enact Senate Bill 72 was a particularly well-timed move. Signed in March, this legislation was designed to improve the solvency of the state’s Public Employees Retirement Association (PERA) pension plan. These changes sought to better shield the plan from the types of uncontrollable market risks that manifested just weeks later as the COVID-19 pandemic reached the US.

New stress testing shows that such efforts might save New Mexico employers and taxpayers as much as 28 percent in total pension costs over the next 30 years. These results show that because of the reform, PERA will certainly be better off in the event of future worst-case recession scenarios.

New Mexico’s SB 72 Reform

SB 72  was a bipartisan reform designed to begin tackling PERA’s solvency challenges – which included over $6.7 billion in unfunded liabilities. The legislation was effectively the end product of a process launched by a gubernatorial task force that began examining the system in the summer of 2019.

Among the core provisions of SB 72 were:

• Raising the statutorily-set employer and employee contribution rates each by 2.0 percent of payroll over four years, with a two-year delay for county and municipal employees and employers, and
• Transitioning from a static, fixed 2.0 percent cost-of-living adjustment (COLA) most current and legacy members receive—regardless of any actual change in inflation—to a profit-sharing COLA model for retirees that ranges between a 0.5 percent floor and a 3.0 percent cap, dependent on both investment performance and the plan’s funded status.

After conducting an actuarial analysis of PERA’s funding, the Pension Integrity Project at Reason Foundation notes that absent SB 72 the plan’s unfunded liabilities would likely have nearly doubled to over $12 billion in the next 30 years.

This would have put greater stress on both public budgeting priorities and PERA cash flows compared to the pre-reform situation. With the passage of SB 72, PERA is more likely to eliminate its pension debt entirely by roughly 2047.

Still, under current economic conditions—and accounting for future “Black Swan” market-impacting events that may occur more frequently in the future— policymakers need to understand that improvement is by no means guaranteed.

This analysis, derived from a larger Pension Integrity Project risk assessment that involves Dodd-Frank-style stress testing to gauge PERA’s resiliency to future down-market scenarios, will reveal what PERA’s pension costs and overall solvency would have looked like both with and without the provisions of SB 72.

Persistent Economic Volatility 

In June the Federal Reserve Bank of Atlanta projected that U.S. GDP could contract by as much as 53 percent in the April-June period. Capital markets have felt the whipsaw. In the previous quarter, the S&P 500 index dropped by 20 percent, with both equities and fixed incomes underperforming.  While the S&P 500 index fully rebounded by the end of June, the global economic outlook remains very uncertain. For example, massive economic disruptions related to COVID-19 remain, and state and local budgets have only just begun to enter what is expected to be a period of financial distress that rivals or exceeds that of the Great Recession.

It is likely that the current financial environment could fuel potential investment losses for many public pension plans this year and maybe years to come. Investment shortfalls will result in the accrual of additional unfunded liabilities, which drive up long-term costs for both employers and employees. Further, recent increases in unemployment rates mean that individual consumption and incomes could be depressed for some time, which is expected to translate into lower state and local tax revenues over the next several years. Lower revenues can undermine governments’ ability to make full pension contributions.

Stress Testing Meathods

As a way to stress test a pension plan’s financial resiliency the Pension Integrity Project has applied a risk assessment methodology that, similar to the process used to test bank solvency under Dodd-Frank, simulates a one-year market downturn followed by a rebound. Similar to methodology used by Moody’s Investors Service, for the first year the test assumes pension plan experiences a significant investment loss equaling twice the expected portfolio volatility (as measured by standard deviation). The analysis then assumes a follow-up three-year market recovery with 11 percent average returns each year.

The results were found by analyzing 2019 capital assumptions, PERA’s asset allocation, applying the custom stress testing technique, and the assumption that PERA’s portfolio returns a -19.8 percent return in 2020, followed by three years of 11 percent average returns. The test also assumed that long-term investment returns eventually average out to 6 percent (less than PERA’s 7.25% return target) once markets rebound, as a way to reflect a more realistic target given the “New Normal” diminishing capital market outlook. It is worth emphasizing that the assumptions for stress testing scenarios are for informative purposes only, and are not meant to be interpreted as Reason’s projections of the actual fiscal year 2020 outcomes for PERA or any other pension system. You can find an interactive tool that shows how a variety of investment return scenarios would impact public pension plan funding across the nation here.

Given the relative frequency of economic downturns over the past two decades, the assessment also includes scenarios incorporating a second Black Swan crisis event in 2035. In the interest of reflecting some degree of appropriation risk—the risk politicians fail to fully fund pension contributions on a sound actuarial basis during a recessionary period amid budget deficits—scenarios that contemplate a hypothetical five-year employer pension contribution freeze are also included.

Overall, four separate stress testing scenarios below were evaluated, both pre- and post-SB 72:

1. 2020-23 Crisis + Average 6.0% Long-Term Returns
2. 2020-23 Crisis + 2035-38 Crisis + Average 6.0% Long-Term Returns
3. Scenario 1 + 5-Year Employer Contribution Freeze
4. Scenario 2 + 5-Year Employer Contribution Freeze

State statutes currently establish the PERA contribution rate. This means that the rate is fixed by politicians and does not automatically adjust to keep up with the actuarially determined employer contribution rate (ADEC) needed to keep the system on track to full funding. For the purposes of examining stress and resiliency across scenarios most effectively, the four pre- and post- SB 72 crisis scenarios assume that the state pays the actuarially prescribed contribution amounts (ADEC) each year. Using the more responsive ADEC method allows one to see the progression in contribution rates and make a more informative comparison of multiple scenarios.

Stress Testing Results

The true cost of a defined benefit pension plan over a period is not only in the total annual contributions over that time but also in any unfunded liability the plan accrues. This unfunded liability has to be paid off at some point. Making progress on paying down pension debt will ensure that pension costs are kept in check, thereby securing promised benefits. Thus, for conceptual purposes, an “All-in Employer Cost” concept that combines the total amount paid in employer contributions and adds what unfunded liabilities remain at the end of the forecasting window (adjusting both for inflation) to get a sense of the total scope of taxpayer obligations over time will be used.

PERA modeling results show that absent SB 72, employers’ “all-in cost” for PERA through 2049 would have amounted to $17.1 billion, assuming all plan actuarial and demographic assumptions are met.

SB 72 improved this situation markedly. The total present value of employer cost after SB 72 stands at just $12.2 billion over the same 2020-49 period (See Figures 1 & 2). This is roughly $5 billion, or 28 percent, in long-term savings over the next 30 years.

SB 72 established shared increases in employee and employer contributions over the next four years. This combination of more funding and other benefit changes is expected to help eliminate the plan’s unfunded liability by 2049 versus without the reform (e.g. 100 percent funding under SB 72 vs. 73 percent without the law).

The lower long-term “all-in” employer cost for PERA suggests that accelerating this progression to full funding will save New Mexico employers and taxpayers a significant amount of money in the long run. But that baseline forecast assumes that no market shocks will occur, so it is important to also test how SB 72 affected PERA’s ability to respond to the current and any future recessions.

Figure 1: Pre-SB 72 – Stress-Testing Without Reform.

Source: Pension Integrity Project actuarial forecast of PERA funding. Values are rounded and adjusted for inflation.

The “All-in Cost” includes all employer contributions over the 30-year timeframe, and the ending unfunded liability accrued by the end of the forecast period.

Figure 2: Post SB 72 — Stress-Testing With Reform.

Source: Pension Integrity Project actuarial forecast of PERA funding. Values are rounded and adjusted for inflation.

The “All-in Cost” includes all employer contributions over the 30-year timeframe, and the ending unfunded liability accrued by the end of the forecast period.

Per analysis of PERA’s funding under the first crisis scenario—a 2020 crisis and 6 percent long-term average returns—the combination of more funding and other changes enshrined in SB 72 will save roughly 16 percent in total employer contributions, and reduce ending unfunded liability by around 20 percent (both adjusted for inflation). This yields a net reduction in “all-in” long term costs of $3.3 billion (or 16 percent) by 2049. The additional stress scenarios (see Table 1) show similar new reductions in cost under SB 72 relative to the previous status quo in every case, indicating just how important the reform effort was for reducing long-term employer and taxpayer exposure to financial risk.

Table 1. Pre/Post SB 72 All-In Employer Costs, 2020-49.

Source: Pension Integrity Project actuarial forecast of PERA funding. Values are rounded and adjusted for inflation.

The “All-in Cost” includes all employer contributions over the 30-year timeframe, and the ending unfunded liability accrued by the end of the forecast period.

Conclusion

In short, analysis shows that SB 72 reform made PERA more resilient to single and recurring recessions, long-term investment return shortfalls, insufficient employer contributions, and cash flow strains caused by increasing benefit payouts.

The legislation’s approach of equal contribution rate increases between employees and taxpayers and adopting a benefit adjustment mechanism designed to not pay out automatic, fixed-rate benefit increases represent a smart and collaborative balancing of interests between taxpayers, public employees and current retirees.

Senate Bill 72 created a solid platform to begin the critical work of improving PERA’s long-term solvency. The reform sets PERA up to be much more resilient to the investment and government revenue volatility that New Mexico is already facing in 2020. Other plans should follow New Mexico’s lead and take steps to reduce pension and investment risks and fortify their plans to better withstand future market shocks.

The post Risk Assessment Shows New Mexico Pension Reform Protects Plan Members and Taxpayers appeared first on Reason Foundation.

As the state prepares for budget problems related to the pandemic and recession, PERA administrators and stakeholders are likely to face persistent challenges made more pronounced by ongoing market and revenue volatility.

This solvency analysis, produced by the Pension Integrity Project at Reason Foundation, reviews how recent legislative changes are expected to improve asset levels and shorten PERA’s debt burden, while also providing stress testing and spotlighting opportunities to build in additional risk safeguards to improve long-term financial sustainability.

Prior to the start of the COVID-19 pandemic, PERA had amassed over $6 billion in unfunded liabilities, and the system had, on hand, only 70 cents of every dollar needed to be invested today in order to generate sufficient funds over time to pay out all promised pension benefits.

This systematic underfunding is largely the result of missed investment and other assumptions, insufficient contributions fixed into state law, and negative amortization. Only some of these challenges were addressed in the 2020 legislative session, leaving additional opportunities for policymakers and PERA trustees to shore up the plan further in 2021 and beyond.

Highlighted in the report are the technical aspects of the various issues identified as contributors to the growing debt reported by PERA. The problem of investment returns averaging below the long-term assumed rate of return has added $2.93 billion in unfunded liabilities to PERA’s balance sheet since 2010. Investment expectations contribute to this problem, and despite the recent lowering of the investment return assumption to 7.25 percent, PERA remains exposed to significant investment underperformance risk.

Stress testing designed to highlight potentially latent financial risks and exposure to market volatility is also provided to stakeholders to help contextualize this risk under volatile market conditions. Reason’s solvency analysis also explores other existing structural challenges within PERA before providing a framework around which stakeholders can work together to ensure current funding, risk and actuarial policies best support the pension system’s long-term sustainability.

To further protect taxpayers, employees and retirees, legislators and stakeholders should continue to find bipartisan solutions to the funding issues at hand. With independent third-party actuarial analysis and expert technical assistance, our organization stands ready to continue assisting New Mexico policymakers and stakeholders address the shifting fiscal landscape.

New Mexico Public Employees Retirement Association (PERA) Solvency Analysis

The post New Mexico Public Employees Retirement Association Solvency Analysis appeared first on Reason Foundation.