Market, budgetary, political pressures spur reductions
Public retirement systems increasingly are taking a more conservative approach toward return assumptions in light of weak market performance and strapped public budgets.
“The need to balance long-term considerations with short-term considerations has led to a certain degree of conservatism” when it comes to assumed rates of return, said David Driscoll, a principal with Buck Consultants, Boston, who works with many public plans. Public plan executives “are at a point where they need more than 50% of their surprises to be pleasant ones.”
Among recent moves:
- The $1.96 billion Baltimore County Employees' Retirement System, Towson, Md., on July 10 lowered its rate to 7.25% from 7.875% after seeing its funding level drop to 77.3% last fiscal year.
- California Public Employees' Retirement System, Sacramento, with $229.8 billion, voted in March to drop its rate to 7.5% from 7.75%; and
- California State Teachers' Retirement System, West Sacramento, in February dropped the rate on its $150.6 billion pension fund to 7.5%, after previously lowering it to 7.75% from 8% in 2011.
Other plans took action earlier.
The $53.6 billion Virginia Retirement System, Richmond, has dropped its return assumption twice since 2005, and “we are now at 7%,” from 8% in 2005, said spokeswoman Jeanne Chenault. “It reflects the board's belief that the outlook for economic growth and equity returns will be muted as a result of economic issues globally.”
The $147.2 billion New York State Common Retirement Fund, Albany, lowered its rate to 7.5% from 8% in 2010.
Still, not everyone is on the bandwagon.
The board of the $36.3 billion Maryland State Retirement & Pension System, Baltimore, came close to changing the system's assumed rate during a July 16 meeting but decided instead to change demographic assumptions about payroll growth, retirement and benefit withdrawal rates and other factors. That decision will add nearly $25 million in employer contributions next fiscal year and $311 million over five years, but less than the $28 million and $372 million, respectively, that a rate drop to 7.5% from the current 7.75% was projected to cost.
The board discussed the return rate often in recent meetings, reviewed all its assumptions and considered what peer plans were doing, but “in the end, the conclusion was that sticking at 7.75%, based on 3% inflation was clearly within the appropriate actuarial bounds,” said Nancy Kopp, state treasurer and board chairwoman.
By comparison, assumed rates of returns among corporate pension funds have been declining since their peak of 9.17% on average in 2000, according to Howard Silverblatt, senior index analyst with S&P Dow Jones Indices in New York. At year end 2011, the average rate was 7.6%.
“The rate of return is becoming more realistic. It's a very slow acknowledgement that returns are not as high as they used to be,” Mr. Silverblatt said in an interview.
43 act since 2008
Of the 126 public plans in the National Association of State Retirement Administrators' Public Fund Survey, 43 have reduced their investment return assumptions since fiscal year 2008. The predominant rate is 8%, but that drops to 7.75% when weighted by asset size, with larger plans having lower return assumptions.
Long term, the public funds have weathered economic downturns and negative investment returns well enough to exceed their assumed rates of investment return, according to the NASRA survey, which found a median annualized investment return of 8.3% for the 25 years ended Dec. 31, 2011.
But shorter term - and volatile — results are keeping return assumptions under the microscope. NASRA found that for 2011, the median return rate was 0.8%. For the three years ended Dec. 31, the median was an annualized 11.4%, and for the five years, an annualized 2%.
While it has been some of the biggest funds, such as CalPERS, taking the lead in lowering rates, plans of all sizes are feeling the pressure.
Even though Baltimore County officials will have to find an estimated $15 million in next year's budget to pay for the larger contribution the lowered rate creates, “we felt it was so important to do,” said Keith Dorsey, the county's budget and finance director and secretary of the retirement system's board.
“We've been thinking about it for a while. We've been trying to lower our overall retirement costs, but returns were not meeting our valuation rate,” he said. The fund had a -1.8% return in 2011 and an annualized 11.8% for the three years.
In Florida, an asset allocation analysis by the State Board of Administration “does not refute the possibility of lowering” the 7.75% assumed rate of return when officials overseeing the $122.8 billion Florida Retirement System and other retirement funds gather this fall for their annual actuarial conference, said spokesman John Kuczwanski. He said revisiting the rate is a frequent topic of conversation. It “is a component of what we look at in our asset allocation study, which we look at every year to build our (FRS) portfolio.”
New public accounting rules that highlight unfunded liabilities are likely to increase the downward pressure on rate assumptions. “I think it's going to put more rigor into how plans come up with these rates, and that's good,” said Donald Fuerst, senior pension fellow at the American Academy of Actuaries, Washington.
But public plans have other assumptions to consider, such as changes in wages and tenure, or whether they can find enough cash to make up the difference when a lower rate pushes up contributions. Policymakers don't want to pass the bill onto future generations or make the problem too unwieldy, but they also don't want to tie up too much taxpayer money with a rate assumption that is too high.
“You have to take out the politics and the sentiment,” said Olu Sonola, a senior director with Fitch Ratings Ltd.'s credit policy group in New York. “That's why you have actuaries. This is a very tough debate and the answer is somewhere in the middle. We seem to have entered an era of crises, and it makes sense to be conservative.”
This article originally appeared in the July 23, 2012 print issue as, "More state plans cutting assumed return rates".