State pension systems across the country collectively held $1.2 trillion in underfunded pension benefits prior to the onset of the COVID-19 pandemic. Due in part to this year’s market volatility, most of these pension systems did not hit their investment return targets for the 2019-2020 fiscal year, which means unfunded liabilities will continue to grow.
Instead of clearly stating that their public pension plans are falling short of expectations, states like Kentucky, Vermont, Hawaii, and others have chosen to downplay their subpar investment returns and instead highlight their ability to meet or beat certain “investment benchmarks.”
Investment managers typically use benchmarks as a standard to gauge portfolio performance against the wider investing world. In public pension investing, benchmarks are a way for plan administrators to see how a certain asset class or market segment is performing. But these benchmarks are not a reflection of the current health or long-term resiliency of the public pension systems.
As the pandemic and economic shutdowns continue to cause economic uncertainty, layoffs, bankruptcy filings, and stock market volatility, it is strange to see a stream of news headlines from some state public pension plans boasting about ‘outperforming benchmarks’ even though they are reporting bad overall investment performance numbers.
In short, instead of just being forthright with the public and admitting that they missed their investment return targets—a common occurrence evidenced by over $1 trillion in state pension debt nationally—some public pension systems are seeking praise for not performing worse.
It is disappointing, but perhaps not be that surprising, to see state and local government pension funds trying to explain away yet another year of missing their assumed rate of investment returns by moving the goalposts.
If an NFL team’s offense made a good play in the first quarter but its defense allowed the other team to score every possession and lost the game 49-7, we wouldn’t focus the postgame analysis on the one good offensive play the losing team made early in the game.
For public pensions, the issue is whether or not investment returns are meeting expectations and fully funding the public pension plans. These public systems are legally obligated to pay out a defined amount of pension payments to every one of their retirees. So tangential investment benchmarks aren’t important if these massive state-sponsored public pension systems are falling short of their set investment return rate assumptions and are adding millions in unfunded pension liabilities.
State-sponsored retirement systems are designed to combine contributions from taxpayers and members with investment returns each year to ensure accrued retirement benefits will be fully funded when workers retire. Any difference will need to be made up eventually, either via extraordinarily good investment returns in the future, or, more likely, by increased contributions from taxpayers and/or members themselves.
Defenders of using investment benchmarks might argue that these large investment portfolios are managed based on complex long-term investment strategies and claim ‘it could have been worse’ this year. But focusing on hitting benchmarks within an investment subcategory does not matter if the portfolio’s overall performance has fallen short over time and the money needed to fund pension benefits promised to workers isn’t there.
Investment benchmarks are tied to short-term investment expectations in various asset classes and are not relevant to the long-term return. Outperforming consultants’ expectations about the performance of different asset classes this year is all well and good, but that has no bearing on the likelihood of hitting a specific overall portfolio investment return expectation over the next 30 years.
Back to a football analogy, if an NFL quarterback is making the right reads and finding open receivers downfield but the receivers drop those passes or don’t gain enough yards to get first downs and keep the drives going, then the quarterback may be making good individual short-term decisions but those decisions aren’t translating to scoring the points needed to actually win the game.
The same goes for public pension investing. If plan managers and consultants achieve decent, or even solid, results relative to short-term benchmarks but the pension system falls short of meeting its long-term assumed rate of return, then the pension system members and taxpayers lose in the long-run. The goal is to fully fund the pension system so it has the money to pay for the benefits promised to workers.
Unfortunately, some state-sponsored pension systems are misleadingly reporting isolated, out-of-context investment benchmarks that are not barometers of pension system health.
The ‘success’ of these arbitrary benchmarks dilutes and distorts the true condition of the pension systems that employees and retirees are counting on. The only standard that matters to plan members and taxpayers is whether the public pension system is meeting its expected investment returns—because if a pension plan’s overall performance falls short of those expectations, public workers and taxpayers will have to pay the bill one way or another.
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