For the last 20 years, state and local pension plans’ assumed rates of return have been far too optimistic. The distributions of average (geometric mean) assumed investment returns and actual returns from 2001 to 2020 demonstrate this. The figure below shows the distribution of the average assumed investment return rate versus actual investment returns for 200 of the largest state and local pension plans in the United States. The median assumed rate of return over the last 20 years was 7.7 percent per year, the median actual rate of investment return for these public pension plans was 5.7 percent.
This two percent difference helps to explain the nearly 30 percent drop in the average pension plan funded ratio over the same period. In recent years, many pension plans lowered their assumed rates of return.
The calculation error that upended the state’s largest pension fund has been traced back to a single month in 2015, according to an investigation from Spotlight PA.
The discovery came to light in a trove of documents obtained by reporters that found a tiny discrepancy that boosted the $64 billion Public School Employees Retirement System (PSERS) by a third of a percentage point in April of that year.
The consultant firm hired to review PSERS’ investment returns between 2011 and 2020, ACA Compliance Group, performed limited checks that skipped over the month in question, according to the report. The company that crunched the actual numbers, Aon, blamed the discrepancy on a data entry error.
No matter the fault, the miscalculation unraveled PSERS’ rate of return, dropping it from just above the mandated 6.36% threshold to prevent a contribution increase down to 6.34%. Now, about 100,000 workers who joined the system in 2011 or later will pay more beginning on July 1.
Main Comments • Stabilization goal is reasonable to consider • However, public sector’s approach to funding with risk assets creates additional issues for this type of debt (unfunded pension liabilities) relative to government bonds • Instability due to market risk isn’t in the model, because the model is deterministic: no distribution of possible outcomes ➢ Higher expected return you target, the greater the distribution of outcomes • Only meaningful scenario is r=d=0% → fiscal adjustment is 14.9% of payroll vs. current 29%. So a 51% increase. ➢ I will provide some reasons I think this might still be too low
Now The Inquirer and Spotlight PA have obtained new internal fund documents that shed light on that consequential mistake. The material traces the error to “data corruption” in just one month — April 2015 — over the near-decade-long period reviewed for the calculation.
The error was small. It falsely boosted the $64 billion PSERS fund’s performance by only about a third of a percentage point over a financial quarter. Even so, it was just enough to wrongly lift the fund’s financial returns over a key state-mandated hurdle used to gauge performance.
The documents reveal that a fund consultant, Aon, blamed the mistake on its clerical staff for inputting bad data. The material also shows that even though the fund hired a consultant, the ACA Compliance Group, to check the calculations, the consultant made only limited checks, and skipped over the month with the critical errors.
Author(s): Joseph N. DiStefano, Craig R. McCoy, Angela Couloumbis
I predict that state and local government balance sheets, already reeling from the pandemic, will be devastated in coming years by the stock and bond markets’ disappointing returns.
That’s because these governments’ pension plans are based on unrealistic assumptions about how those markets will perform in the future, and are therefore woefully underfunded. In fact, even with their optimistic assumptions, those funds are already underfunded. Their “actuarial funded ratio” (the ratio of the actuarial value of their assets to the actuarial value of their liabilities) is just 71.5% currently.
These plans are hoping to make up their actuarial deficits by earning outsized investment returns. I’m willing to bet their earnings instead will fall far short of historical averages, and they will have to make up the shortfall either by raising taxes, cutting services, or declaring bankruptcy.
State pension systems dropped the rate of return they assume for their investment portfolios again, continuing a two-decade long trend that public-finance experts say is necessary, even as it presents some challenges for the entities that participate in such plans.
The search for high returns takes many pension funds far and wide, but the Pennsylvania teachers’ fund went farther than most. It invested in trailer park chains, pistachio farms, pay phone systems for prison inmates — and, in a particularly bizarre twist, loans to Kurds trying to carve out their own homeland in northern Iraq.
Now the F.B.I. is on the case, investigating investment practices at the Pennsylvania Public School Employees’ Retirement System, and new questions are emerging about how the fund’s staff and consultants calculated returns.
The error in calculating returns was a tiny one, just four one-hundredths of a percentage point. But it was enough — just barely — to push the fund’s performance over a critical threshold of 6.36 percent that, by law, determines whether certain teachers have to pay more into the fund. The close call raised questions about whether someone had manipulated the numbers and the error wasn’t really an error at all.
“If you can’t change the benefits, and you can’t change the contributions, the only lever left for these people to pull is investment policy — that’s it,” said Kurt Winkelmann, a senior fellow for pension policy design at the University of Minnesota’s Heller-Hurwicz Economics Institute. “And that exposes younger beneficiaries and taxpayers to a lot of risk.”
Private equity investments underperformed broad US stock indexes for the fiscal year that ended June 30, 2020. Importantly for taxpayers and governments, this underperformance of private equity weighed down public pension system asset returns during a particularly difficult year for investments.
These investment results may mark the beginning of the end of superior private equity returns that have characterized early 21st century institutional investing. If private equity returns have now fallen “back to earth,” many public pension systems can expect heightened scrutiny over their allocations to this asset class and the high investment costs that go with it.
The very notable exception is New Jersey’s Teachers’ Pension and Annuity Fund (TPAF), which is by far the single-worst public pension in the Brookings study. TPAF is New Jersey’s largest public pension fund and covers all active and retired teachers. New Jersey’s Public Employees Retirement System (PERS), the pension plan for state and municipal workers, is second-worst but not nearly in the dire predicament of TPAF.
This is what Brookings had to say about TPAF: Under any of their investment return scenarios, TPAF is in “near-term trouble” — meaning near-term insolvency. Brookings projects that TPAF will run out of assets in 12-to-15 years, at which point the $4.5 billion-plus in benefits payments will have to be made from the New Jersey’s perpetually strained state budget. This would be a fiscal disaster for New Jersey and a retirement crisis for TPAF’s 262,000 beneficiaries.
The board of Pennsylvania’s biggest pension fund adopted an inflated number for its investment performance even after the state treasurer raised skeptical questions about the calculation last summer, newly obtained documents show.
That decision by the PSERS board has emerged as a costly and disruptive mistake, raising the possibility that the $64 billion pension fund for teachers may soon have to hike their payments to support the mammoth but underfunded plan. The panel is to meet Monday to consider doing that.
In his August 2020 letter, then-Treasurer Joe Torsella raised doubts about a decision by the fund’s professional staff to go back almost a decade to revise — and improve — figures for past investment performance.
The board in December found that PSERS yearly investment returns had averaged 6.38% over the last nine years — just above the 6.36% threshold needed to avoid an increase in pension payments from 100,000 school employees hired since 2011.
In 2010, the state adopted a so-called “risk sharing” mandate that requires school staff to pay more, as taxpayers do, when PSERS investments underperform. The law mandated that the review in 2020 look at average returns over the past nine years.