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How to overcome public fund risks

Public employee pension plans are exposed to several risks, not all of which are fully considered by fund officials, and especially state and local legislators.

Robert Stein, chairman of the Society of Actuaries Blue Ribbon Panel on Public Pensions, listed the most important of these risks at a seminar on risk reporting for public plans at the Mossavar-Rahmani Center at the Harvard Kennedy School last month.

The first is the obvious one: Actual investment results not equaling the investment return assumption. Mr. Stein showed one large pension fund's 20-year annual return through 2017 was 7%, and its 10-year return was 4.1%, but its investment return assumption during that period was never lower than 7.25%, its current return assumption.

Other key risks identified by the Blue Ribbon Panel included asset/liability mismatch; interest rate risk — the risk that interest rates will change; the risk that beneficiaries will live longer than expected; and plan maturity — fewer active employees supporting more and more retirees.

Perhaps the biggest risk for public employee pension plans is contribution risk — the risk that the required contributions are not paid, as has happened at several large plans that are now drastically underfunded.

Public employee fund officials should identify and measure each of these risks for their plans, decide how much risk should be taken, and set asset allocations that best reconcile the plan funding programs with the plans' tolerance for adverse outcomes.

Attendees at the seminar, who included academics, actuaries and fund officials, agreed new tools are needed to provide better measurement of the risks confronting public funds.