Nearly half of the largest state pension funds have actuarial interest rates above their expected portfolio returns, a study by Wilshire Associates reveals.
The Wilshire findings underscore the difficulty pension funds face in the 1990s in making the amount of money they need each year from their investments to avoid higher contributions or worsened underfunding.
Stephen L. Nesbitt, a senior vice president at Wilshire, said the report's findings are a "yellow caution flag" for pension funds. He said many are unaware of the problem.
The Wilshire report used the firm's own estimates of annual investment return over the long term based on individual plan asset allocations.
Wilshire calculated the expected return and risk using long-term assumptions for the major asset classes together with each retirement system's actual asset allocations. Wilshire said the long-term assumptions used were "fairly common among investment professionals."
The assets classes and expected returns for them were: U.S. equity, 10%; U.S. bonds, 6.5%; cash, 5%; international equity, 10%; international bonds, 6.5%; real estate 8%; and alternative investments 14%.
Wilshire found the state teachers plan in West Virginia had the sharpest difference between what it assumes it will make on its investments and what Wilshire believes will be its expected return.
The West Virginia plan has an actuarial interest rate assumption of 8%, but an annual expected return of 6.11%.
Nine other pensions plans have differences almost as wide:
The South Carolina retirement system has an actuarial interest rate assumption of 8%, but an expected annual return of 6.38%.
The Indiana State Teachers' Retirement Fund has an actuarial interest rate of 7.5% and an expected annual investment return of 6.35%.
The Public Employees' Retirement Fund of Indiana has the same 7.5% actuarial rate as Indiana Teachers' and an expected annual investment return of 6.4%.
The Alabama public employees fund has an actuarial interest rate of 8.5% vs. an expected annual investment return of 7.41%.
The West Virginia public employees fund has an actuarial interest rate of 7.5% but an expected annual expected return of 6.44%.
The Alabama teachers fund has an actuarial interest rate of 8.5% but an expected annual investment return of 7.47%.
The Employees' Retirement System of Texas has an actuarial interest rate of 8.5% and an annual expected investment return of 7.62%.
The Alaska teachers fund has an actuarial interest assumption rate of 9% but an expected annual investment return of 8.17%
The Missouri teachers fund has an actuarial interest assumption rate of 8% but an annual expected investment return of 7.17%.
Ten years ago, said Mr. Nesbitt, few pension funds would have expected returns below their interest rate assumption levels.
But Bob Newland, investment officer for the Indiana teachers fund, said, "Our actuaries have been telling us this for quite some time."
The key problem, said Mr. Newland, is neither Indiana state fund can invest in equities. The West Virginia teachers fund has the same investment restrictions.
Both Indiana and West Virginia are seeking permission to invest in equities.
Wilshire's estimates show the median state fund has a yearly expected return of 8.2%, "only slightly greater than the current average interest rate assumption of 8.1%," the report said. Such a finding is "of some concern," the report noted.
The state fund with the highest expected return, said Wilshire, is Massachusetts Pension Reserve Investment Management Board, at 9.4%. But Minnesota state employees and teachers funds are close seconds, with expected returns of 9.3%.
The West Virginia teachers fund's expected return of 6.1% is the lowest.
Wilshire used interest rate assumption information from the Governmental Accounting Standards Board. The statistics are the latest available, and were filed in 1992, 1993 and 1994, although some information was older.
Not surprisingly, many of the pension funds with the biggest gap between assumptions and expected returns have some of the poorest funding levels now. And, four of the five worst are teachers funds.
The Wilshire study also found:
The ratio of assets to liabilities for retirement systems collectively has improved, rising to 90% in 1994 vs. 80% in 1990.
The funds' median equity allocation was in 1994.
Unfunded liabilities are still large - a total of $100 billion at 82 funds - and 56 of the 82 have unfunded liabilities.
When assets and liabilities for all 82 plans surveyed by Wilshire are considered as a whole, the funding level was at 89% of PBO in 1994.
Wilshire also evaluated the financial health of the plans based on retiree liability, comparing assets to liabilities for those now receiving benefits. It found four plans that did not meet what Wilshire consultants said was the "minimum hurdle of financial health."
Three of the four again are teachers programs. West Virginia teachers has assets accounting for only 21% of retiree liability; Oklahoma teachers, 88%; and the District of Columbia, 77%. The Wilshire report noted the Oklahoma plan has made significant progress toward funding 100% of retiree liability.
The difference between teacher and employee best and worst funded plans is stark when looking at the best funded of all of the state plans. When listing the 10 best funded programs, half were public employee plans, four were combined plans and only one was a teachers plan - the New York State Teachers' Retirement System.
Using the ratio of assets to PBOs, the five best funded plans were Tennessee Consolidated Retirement System, 131%; Arkansas Public Employees Retirement System, 127%; Indiana Public Employees, 126%; North Dakota public employees, 125%; and Oregon Public Employes' Retirement System, 122%.
To make better comparisons among plans than the funding numbers from the plans themselves would indicate, Wilshire used uniform methods and uniform financial assumptions to calculate liabilities.