Public Pensions Shouldn’t Prioritize Political and Social Goals Over Investment Returns

In recent decades, many companies have heavily promoted “social responsibility” campaigns that emphasize their efforts to reduce carbon emissions, buy local, increase diversity, and achieve other social and political goals.  This philosophy is now gaining traction among public pension plans but it comes with great risks to workers and taxpayers.

State policymakers and pension managers in California, Connecticut, Maine, and New York are among those instructing their public pension plans to divest from certain industries, like fossil fuels, gun manufacturers, and tobacco products to help influence social change. On the other side of the political spectrum, Texas lawmakers have demanded the state’s pension plans not invest in companies that want to reduce or eliminate fossil fuel consumption. Both efforts are short-sighted.

Playing politics and focusing on the social impact of pension investments, rather than on the pension plans’ financial promises, can jeopardize employee benefits. If the goal of public pension fund managers becomes ensuring investments are perceived as things like “environmentally-friendly” instead of ensuring the pension plan has enough money to pay out the retirement benefits that have been promised to workers, investment returns will likely suffer.

Public pension plans in the United States are already chronically underfunded. The average state pension plan is only 72% funded. Total public pension debt across the country is nearing $1.5 trillion. Needless to say, most public pension plans are not in a position to take any additional financial risks by prioritizing social responsibility over investment returns.

Private companies are free to do what they want, but when governments gamble with public pension investments, other budget priorities and taxpayers are likely to suffer. After all, public pension benefits have legal protections that put taxpayers on the hook for unfunded liabilities that come with any failure to meet a plan’s investment expectations. If a pension portfolio consistently underperforms, it falls to the state or local government—thus taxpayers—to fund the gap with tax revenue.

Nonetheless, several public pension plans have been instructed to put significant efforts into achieving political goals.

Last month, for example, the Maine State Senate passed a bill that requires the state’s retirement system to divest from fossil fuels by 2026. In April, Rhode Island’s public pension funds announced that they are scheduled to reduce investments in fossil fuel assets by 50%. Rhode Island State Treasurer Seth Magaziner cited building “a cleaner and more climate-resilient world” as a motivation behind this divestment.

Similarly, last year, New York announced its state public pension plans would prioritize divesting from oil and gas companies by 2025.

Political leadership in California has also voiced support for fossil fuel divestment in an attempt to advance “California’s climate leadership.” This is especially concerning for California since the state’s largest public pension system, the California Public Employees’ Retirement System’s (CalPERS’) own consultants found the plan missed out on almost $3.6 billion in investment returns when it undertook a similar socially motivated move by divesting in tobacco stocks back in 2001.

Last month, Texas passed a law that prohibits the state’s pension plans from investing in companies that “discriminate” against the oil and gas industry. This is the opposite of Texas’ supposed free-market mindset and creates the same risks for taxpayers as blue state’s divestment policies. As many companies are attempting to move away from fossil fuel consumption, this policy will surely leave Texas pension investors in a tough position as they try to maximize investment returns for their underfunded pension plans.

There is a precedent of these socially motivated investments resulting in financial losses. In addition to the aforementioned losses associated with California’s divestment from tobacco stocks, Connecticut’s pension systems lost $25 million after a push to invest in local businesses. In Kansas, it is estimated that the state pension fund lost upwards of $200 million after in-state investment program borrowers defaulted on their loans.

Private companies are completely free to set their own social responsibility policies, but governments have obligations to citizens, taxpayers and public workers. Generating investment returns that can help provide promised retirement benefits to workers without overburdening taxpayers ought to be a top priority for public pension plan management. Using funds contributed by public employees and employers to achieve other socially motivated political goals, rather than serving the pension funds’ primary purpose of providing a secure retirement to workers is irresponsible and dangerous. Such policies risk the retirement income of public servants and the tax dollars of citizens who are on the hook to pay if pension funds are unable to earn what is required to fully fund pension benefits.

Policymakers and pension boards should avoid making political statements with pension funds and instead focus on fulfilling the promises they’ve made to retirees without saddling future taxpayers with pension debt.