When Louisiana policymakers eventually return to Baton Rouge they’ll face an unpredictable economic outlook anchored by the weight of historically low energy prices. Few state programs are as exposed to the volatility of the current economy than the largest single source of state debt—the Teachers’ Retirement System of Louisiana.
Long before the COVID-19 pandemic disrupted financial markets, public pension plans’ investments were underperforming expectations with regularity. Across-the-board investment underperformance relative to a plan’s assumed rate of investment return has been the primary culprit of the nation’s growing pension debt. Even before the recent economic downturn, it was clear this lower yield, higher risk environment should be considered the “new normal” in public pension investment returns and that plans like the Teachers’ Retirement System of Louisiana need to adjust.
Our updated analysis recently published by the Pension Integrity Project at Reason Foundation found investment underperformance over the past 20 years accounts for over 50 percent of the $6.3 billion worth of unfunded liabilities plaguing the Teachers’ Retirement System of Louisiana (TRSL). Another roughly 10-to-15 percent of unfunded liabilities come from negative amortization — annual pension contributions failing to cover even the interest payments on past pension debt.
According to 2019 capital market assumptions done by Horizon Actuarial Services, TRSL had less than a 40 percent chance of achieving investment returns at, or above, its 2019 target rate of 7.55 percent. And the plan has only a 55 percent chance of reaching that threshold over the next 20 years — and those were the odds before the market downturn of March 2020.
When public pension systems fail to meet their investment return targets, it piles debt onto an already underfunded retirement system.
Lower investment yields also mean that most public plans are going to assume increasing risks to try and maintain their higher target return rate assumptions. In 1996, TRSL investment volatility stood at just 9 percent. Based on 2019 capital assumptions, TRSL is likely to experience roughly 12 percent year-over-year volatility in portfolio returns in the next 10 to 20 years. It is clear that in response to underperformance, Louisiana plan investors are welcoming higher risk.
Although the long-term economic effects of COVID-19 remain unclear, the “new normal” analysis of the previous decade’s recession gives a glimpse at the fate many public pension plans face after the pandemic.
After the financial crash of 2007-08, several state pension systems—including pension plans in Kentucky, Connecticut, Illinois, and New Jersey—were so underfunded that even the longest economic recovery in history, over a decade of economic growth, did not appear to help them dig out of their deep underfunding trenches. Now that the bull market has come to a grinding halt, it is more important than ever to adjust target rates and avoid further insolvency.
Policymakers should be proud that the tough decisions they made over the past several sessions to fill the multibillion-dollar state budget hole has better prepared Louisiana for the COVID-19 crisis. But they again face serious state and local budget problems, including questions regarding the long-term solvency of TRSL.
A changing investment reality and the “new normal” for pension plans is here. For Louisiana, the new normal means it is time to take proactive steps to secure the pensions that have been promised to workers and to get TRSL in a financial position that allows it to better weather the fiscal storm we’re entering.