Putting a year of good investment returns for public pension plans in perspective

Headlines extolling the exceptionally high investment returns earned by some state and local government pension plans last year are becoming more and more prevalent. Just a few of the recent news stories on this topic include: “Massachusetts Public Worker Pension Fund Has its Best Year,” “Pennsylvania Public School Employees Chalks up 25% Return for Fiscal Year,” and “San Jose’s Pension Funds Post Record-Breaking Returns.” 

While these very strong investment returns are great news for public workers and taxpayers, some may be tempted to say that this year’s good returns will be the long-awaited salvation for public pension systems that have struggled to recover from the 2008 recession, but that is hardly the case. Unfortunately, a year of great investment returns alone will not fix the years of underfunding and poor plan assumptions plaguing many public pension systems. One year of excellent returns should also not serve as a diversion from the future financial risks facing pension plans and the employees they were created to serve.

The real purpose of a state or local government pension plan is (or should be) to provide a stable income in retirement following a career in public employment that, when combined with other retirement income sources, enables the retiree to maintain something resembling their pre-retirement standard of living. Regardless of recent investment performance, governments, public employees, and taxpayers should be asking if traditional state and local government pensions meet the needs of the modern public employee workforce.

Public Retirement Research Lab’s 2020 “Trends in Public-Sector Employee Tenure” report notes:

“State workers had the shortest median tenure among the public-sector workers at 6.0 years in 2018, compared with 7.0 for local workers and 8.0 for federal workers. In contrast to federal workers, the tenure trends for private-sector, state, and local workers were relatively flat. Specifically, private-sector workers’ median tenure in 2018 was very close to its 2000 level (4.0 in 2018 vs. 3.9 in 2000), local workers’ median tenure was 7.0 years in 2000 and 2018, and state workers’ median tenure was slightly lower in 2018 at 6.0 years compared with 6.5 years in 2000.”

This emphasizes the fact that, like their private sector counterparts, the modern public sector employee is less likely to work for one employer for his or her entire career. In fact, today’s employee will typically have several employers throughout a career. The traditional defined benefit pension plan still favored by most state and local government employers may no longer suit the career mobility needs of the modern public workforce. In reality, this tenure trend is nothing new, but it remains unaddressed by most public pension systems. Retirement plan designs that are much more suited to meeting the portability of today’s public workforce are readily available and can be structured to address the legitimate concerns illustrated by trends of how often today’s workers change jobs.

State and local pension systems that have reported 2021 investment results thus far have had a median investment return of 27%—well above the 7.0% annual return rate assumption used by the median public pension system. As of this writing, the best return reported by a system with a June 30 fiscal year-end date has been the 33.3% return achieved by the San Bernardino County (California) Employees’ Retirement Association. The nation’s largest public pension system, the California Public Employees’ Retirement System, CalPERS, reported a 21.3% return, the lowest return reported thus far.

While these strong investment returns are very welcome and will reduce pension underfunding, they should also be viewed in the context of overall market returns. For the one-year period ending June 30, 2021, the S&P 500 returned 40.79%. A Vanguard Exchange Traded Fund (Ticker: VOO) designed to track the S&P 500, returned 40.77% for the same period, which means it was simple for an average investor to beat many of the experienced professionals managing large public pension funds. Even if a fund manager only invested 90% of assets in VOO and kept 10% in cash to pay benefits in the near term, he or she could have beaten the return rate of all the public pension systems that have reported 2021 results so far.

So, while we can and should applaud the improved market returns recently achieved by many public pension systems, it is important for the plans to see the returns as just one part of a bigger picture. These good returns alone do not guarantee better retirement security for public workers and policymakers and plan managers are still facing long-term economic forecasts that predict lower average investment returns in the decades ahead.

Generating positive annual investment returns is certainly one key element of a successful retirement plan. But public pension plans should also take this opportunity to ensure they are doing everything they can to provide the retirement benefits they’ve promised to workers and to protect future taxpayers from burdensome public pension debt. This is a time for many in the public pension world to examine and improve their investment strategies, look for opportunities to reduce the fees they pay, increase contribution rates where needed, and lower their assumed rates of return to more realistic figures that reduce risks. Making those types of pension reforms would do wonders to build upon one year of excellent investment returns.