This newsletter from Reason Foundation’s Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions here.
In This Issue:
- CalPERS Says 7.5% Returns Over the Next Decade Unlikely
- Baby Boomers and the New Normal
- Federal Court Upholds Chattanooga COLA Adjustments
- Moving Forward Despite Low Market Returns
- Are Discount Rates and Funded Ratios Correlated?
- Goodbye (and Good Riddance) to Kentucky’s Hedge Fund Investments
After announcing last year a gradual 20-year reduction in its assumed rate of return, the California Public Employees Retirement System (CalPERS) is now considering bringing that rate down faster. In a recent blog post, Reason’s Anthony Randazzo explains why this would be a sensible move and could portend a more widespread shift by other public pension plans nationally, given CalPERS’ position as an influential market leader.
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The “new normal” of low investment returns poses a challenge for many pension systems, forcing them to invest in riskier assets to meet unsustainably high investment return assumptions. Experts cite declining interest rates, slowing growth in China, political instability, and low inflation as some of the culprits. But a recent Federal Reserve study attributes almost all of the decline in GDP growth and interest rates to one factor: the aging of the baby boom generation. Reason’s Daniel Takash explains in a recent blog post why, for public sector pension plans, this is yet another warning that 30-year average returns meeting current expectations is not a meaningful measure for the probability of future investment success.
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A Sixth U.S. Circuit Court of Appeals ruling earlier this month upheld an ordinance passed by the city of Chattanooga, Tennessee in 2014 to reduce COLAs for retirees in the Chattanooga Fire and Police Pension Fund (CFPPF) until the plan is 80% funded. The court held that the CFPPF COLA was not explicitly included in the provisions of the law that outline vested benefits; thus, since it was not a vested right, the COLA provisions could be amended. While simply reducing COLA payments today in order to kick the can on meaningful, structural reforms should not be considered real pension reform, Reason’s Daniel Takash writes in a recent blog post that COLA reductions—to the degree they are legally allowed and do not undermine retirement security—could be one piece of a larger pension reform package.
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Despite recovery in most areas of the financial markets, pension funds have not seen their long-term averages rise to expected levels, and bleak future market outlooks suggest significantly lower returns over the next few decades relative to the last few. In a recent blog post, Reason’s Anil Niraula examines a recent report by S&P Global that provides a good explanation of the implications of the new investment return realities for public pension plans around the country. By looking at factors that influence pension plans’ funded status, along with analysis of different approaches states have taken to address growing unfunded liabilities, the report offers some helpful insights for public plan managers on how to move forward in the market “new normal.”
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The Society of Actuaries recently published a study looking at the relationship between the funded status of defined benefit retirement systems and the discount rates they used. The report focused on the biggest public and private defined benefit plans in the U.S. between 2009 and 2014, concluding that there is no clear causal relationship between the unfunded liabilities of a plan and how the plan values its liabilities. However, public sector pension plans should not surmise from this finding that all is well with the discount rate practices they are using, as Reason’s Anil Niraula and Anthony Randazzo explain in a recent blog post.
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The Kentucky Retirement System’s (KRS) investment committee recently announced plans to remove hedge funds from the pension system’s portfolio. If successful, this would completely eliminate hedge funds—currently about 10% of KRS’s portfolio—from the retirement system’s investment mix by 2019. In a recent article, Reason’s Daniel Takash explains why moving out of risky assets the Commonwealth has a poor history with is a step in the right direction to address the misfortune that KRS currently faces.
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Arizona Supreme Court Ruling Strikes Down 2011 Pension Reforms: Earlier this month, the Arizona Supreme Court upheld a lower court ruling finding some provisions of a 2011 pension reform law unconstitutional. The provisions required increased employee pension contributions and limited permanent benefit increases in various pension plans operated by the state’s Public Safety Personnel Retirement System (PSPRS). The ruling is expected to create at least a $220 million hit to the system by way of employee refunds, according to the Arizona Republic, as well as increase unfunded liabilities in the affected pension plans.
The ruling does not affect the 2016 reforms to PSPRS—which Reason’s Pension Integrity Project team helped design and negotiate on behalf of state officials—that replaced the permanent benefit increase mechanism with a CPI-capped COLA, as well as created a new benefit tier with defined benefit and defined contribution options for new hires starting in July 2017. The full ruling is available here.
New Report Examines Longevity Risk for Pension Funds: A new report by PGIM, Inc.—the principal asset management business of Prudential Financial, Inc.—finds that while investment and interest rate risks have been a primary focus of U.S. pension plan sponsors, steadily increasing life expectancy poses significant longevity risk problems for plans to contend with, problems exacerbated by the current ultra-low interest rate environment. The full report is available here.
Moody’s Report Finds Growing Municipal Pension Stress: A recent report by Moody’s Investors Service finds that unfunded pension liabilities for the top 50 local governments have more than doubled over the last decade, with nearly two-thirds of those governments now seeing pension liabilities at levels exceeding that of bonded debt. The report found that municipalities with the highest adjusted net pension liabilities as a percentage of FY 2015 operating revenue were Chicago (719%), Dallas (549%), Phoenix (434%), Houston (414%), and Los Angeles (407%). More details are available here.
“Using actuarial sleight of hand to deny hard realities is a recipe for disaster. In the end, it’s no better than trying to recoup gambling losses by doubling down on the next bet.”
—Ed Bartholomew, “Public Pensions: Don’t Look Now, But…,” Milken Institute Review, November 1, 2016.
“It is horribly ironic that a city that has enjoyed such tremendous success, a city that has made Texas so strong and so proud is potentially walking into the fan blades that look like bankruptcy […] Shame on me. Shame on you. Shame on all of us if we allow that to happen.”
—Dallas (TX) Mayor Mike Rawlings, presenting to the Texas Pension Review Board, cited in Stephen Young, “Mayor Rawlings Warns Of ‘Fan Blades That Look Like Bankruptcy’ Over Police and Fire Pension,” Dallas Observer, November 4, 2016.
“California’s public pension and other retirement costs are at the inception of a steep rise caused by dishonest governance, reporting and funding. The consequences for citizens are enormous. To protect them, elected officials and candidates must fully understand the math.”
—David Crane, “Defined Benefit Plans Per Se Are Not The Problem,” Medium.com (blog), November 4, 2016.
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Senior Managing Director, Pension Integrity Project
Managing Director, Pension Integrity Project
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Reason Foundation’s Pension Integrity Project has helped policymakers in states like Arizona, Colorado, Michigan, and Montana implement substantive pension reforms. Our monthly newsletter highlights the latest actuarial analysis and policy insights from our team.