Overall, the typical pension fund is now expected to return approximately 6% annually over the next 20 years, compared with 6.4% pre-pandemic (Figure 4). This change in outlook is consistent with the reduction in the median long-term return found by a recent survey of pension investment consultants13 and aligns with revisions for public pension return expectations published by S&P Global.14
The $116 billion North Carolina Retirement Systems has lowered its assumed rate of investment return for the third time in four years, cutting it by 50 basis points (bps) to 6.5% from 7% annually.
The target return had already been reduced to 7.2% from 7.25% in 2017 and again in 2018 to 7%. Prior to then, the rates had been left unchanged for nearly six decades even though the two main state pension funds—the Teachers’ and State Employees’ Retirement System and the Local Government Employees’ Retirement System—have, on average, underperformed their assumed rates of return over the past 20 years. In fact, the new target rate of 6.5% is still higher than the fund’s estimated 20-year return of 6.28%.
One of the most important assumptions built into pensions is the guess at how much investments will grow over time. If investments provide high returns, then lawmakers don’t need to set aside as much money today to pay for pensions to be paid out in the future. If investments do not return as much as assumed, a gap develops between what has been promised and what has been saved. The bills cap the rate at which administrators can assume their investments will grow, allowing them to be no more risky than current policy allows. They also let administrators use less risky assumptions if they think it is prudent.
This is a smart approach. Much of the current pension debt exists because administrators overestimated investment returns. Taxpayers now owe more to the pensioners than they do to the lenders and bondholders who willingly lent the state money. Putting a cap on the assumptions administrators make can prevent future pension debt.
Author(s): James M. Hohman
Publication Date: 1 March 2021
Publication Site: Mackinac Center for Public Policy