Maryland State Retirement Pension System lowers investment return assumption, but more reforms are needed

In August, the Maryland State Retirement Pension System announced it would be lowering its assumed rate of investment return from 7.4% to 6.8% and adjusting inflation assumptions down by 40 basis points. These wise changes signal that the public pension fund, which serves nearly 200,000 state employees, is adjusting to the predictions of most experts that there will be muted investment returns over the next few decades. 

These investment return rate assumption adjustments come on the heels of a record investment performance of 27% in the fiscal year 2021, the best investment return performance the Maryland State Retirement Pension System (MSRPS) has had in 35 years. While this is an impressive return, future projections still show the fund’s long-term market forecast well below previous decades’ investment returns. Lowering the plan’s assumed rate of return will more accurately represent the true cost of the plan, which is a good first step in addressing larger challenges facing MSRPS.

Despite an excellent year, the market is still incredibly volatile. A 27% return is nearly impossible for a pension plan to achieve over a number of years. According to a recent report by Horizon, the near-term outlook for public pension funds is actually worse than it was just last year. In the Horizon report, investment advisors find the probability of achieving a 7% return over the next 20 years is now 38%. The previous year’s report said plans had a 45% chance to meet a 7% return. 

This is consistent with the Monte Carlo simulation analysis developed by the Pension Integrity Project, which is an iterative analysis of 10,000 market scenarios over 20 years considering expected returns, correlations, and volatilities to predict a pension plan’s probability of achieving certain return targets. Based on the correlation data provided by market analysts such as JP Morgan and BNY Mellon, along with our analysis, MSRPS’s probability of hitting a 7.4% return is between 30-40% in the near term.

The pension plan’s probability of hitting its new assumed rate of investment return of 6.8% ranges between 40-50%.  Plan administrators might counter this point with the fact that MSRPS consistently outperformed the 7.4% return target with an average return of 8.2% over the last 10 years. While this is true, over the last 20 years the plan returned only 4.7%. This illustrates how dramatically market conditions can change from decade to decade.  

Some experts believe that thanks to the record-setting returns being reported by many pension systems, the average funded status for public pension plans in the U.S. will jump by 10 percentage points, from being 71% funded to being 81% funded, on average. Rather than get complacent after a year of good investment returns, however, public pension plans like MSRPS should be motivated to make changes that will further improve their solvency.

MSRPS has taken good steps towards improving its funding by adopting an actuarially determined contribution rate (ADEC) in 2015, which was eventually implemented in 2017. Up until that point, MSRPS had consistently fallen short of making adequate pension contributions for more than 10 years. MSRPS still needs to make up for funding shortfalls from previous years though.

MSPRS should consider lowering its assumed rate of return even lower than 6.8% to align with market projections. This year New York state, for example, lowered its investment assumption to 5.9% from 6.8% after reporting an impressive return of 33% in the latest fiscal year.

Maryland policymakers should also seek ways to accelerate pension debt payments with shorter amortization periods. This would increase annual contributions but would also reduce long-term costs while simultaneously making the retirement system more resilient to future economic uncertainty. 

The last fiscal year provided great news via much-needed investment returns for public pension plans across the country. Many pension systems have struggled to rebound from the Great Recession (2007-2009) and were concerned they’d be further negatively impacted by the economic impacts of COVID-19. Despite this year’s excellent returns, pension reforms are still very necessary for most public pension systems. MSRPS is no exception. The reduction to the pension plan’s assumed rate of return is a welcomed change and will hopefully be the first step toward making Maryland’s public retirement system more secure and resilient.