After two straight years of beating expectations, pension investment earnings have slightly dipped thanks in part to fears of a trade war.
BY LIZ FARMER | AUGUST 16, 2019 AT 4:00 AM
Public pension plans are missing their investment earnings expectations for the first time in three years, a development that could strain future state and local budgets amid rising concerns that the national economy is slowing.
Plans with more than $1 billion in assets earned a median return of 6.79 percent for the fiscal year ending June 30, according to the firm Wilshire Trust Universe Comparison Service. That’s below those plans’ median long-term expected rate of return of 7.25 percent.
Pension plans rely heavily on investment earnings because annual payments from current employees and governments aren't enough to cover yearly payouts to retirees. As it stands, roughly 80 cents on every dollar paid out to retirees comes from investment income.
Market Volatility Played a Role
Some pension plans didn’t miss by much. The California Public Employees' Retirement System (CalPERS), the largest plan in the nation, has reported a 6.7 percent return for the year -- just a few tenths below the expected 7 percent. Its sister plan, the California State Teachers’ Retirement System (CalSTRS), did slightly better, earning 6.8 percent on the same expected rate of return.
Both systems painted the year as a positive given market volatility over the past year. Much of those swings have been in response to fears over tariffs wars between the U.S. and China. “It was a roller coaster year and a very challenging environment in which to generate returns,” CalSTRS Chief Investment Officer Christopher J. Ailman said in a statement. “Thanks to the in-house expertise of our investment team, we were able to come very close to our assumed rate of return despite the instability of the market.”
Other plans saw a bigger gap. The Employees Retirement System of Texas has reported a preliminary 5.29 percent annual investment return on long-term expectations of 7.5 percent. And New York State’s Common Retirement Fund, which ended its fiscal year on March 31, reported an estimated 5.23 percent return on long-term average expectations of 7 percent.
What It Means for Funding
The poorer earnings come after two straight years of beating expectations. Nationally, public pension plans have collectively exceeded their assumed rates of return six times since the financial crisis in 2008, according to data collected by the Boston College Center for Retirement Research.
Yet funding ratios have not markedly improved. After falling sharply for four straight years following the financial crisis, the average plan has hovered around having 72 percent of the money it needs to pay retirement benefits to current and future retirees.
Governments have collectively gotten better at making their full pension contributions in recent years thanks to a stabilizing economy. But because of the way pension accounting is done, every year a government skimps on a payment or investment returns fall short of expectations, a pension's funded ratio gets worse.
Most experts say that pension health is better graded on long-term trends, not annual return results. But given the market volatility over the past decade, the long-term picture is becoming harder to assess. For example, CalPERS’ average investment return over the past 10 years has been an admirable 9.1 percent. But over 20 years, the average has been 5.8 percent.
A recent Moody’s Investors Service report warned of market volatility, highlighting the fact that pensions are becoming more reliant on the stock market (as opposed to bonds) for investment returns. “While public pension systems take a long-term investment focus and there have been favorable returns the last two fiscal years," Moody's said, "equity market losses in late 2018 will translate into larger-than-expected pension cost hikes in 2021 for many governments."