On Sunday, February 1, 2015, The Record (Northern, NJ daily) reported that NJ’s pension fund beat market expectations in 2014 with a 7.3% return. However, it was also highlighted that the return fell short of the 7.9% return on asset assumption (ROA) that NJ has established as their annual asset objective. Worse, and not mentioned, is the fact that liability growth (estimated at >20%) far outpaced asset growth in 2014, as long-term interest rates continued to plummet. Even if NJ’s pension plan had achieved the desired 7.9% ROA, the plan’s liabilities grew substantially larger, further exacerbating the plan’s underfunding.
It is truly unfortunate that plan sponsors of defined benefit plans continue to focus exclusively on the asset side of the equation, neglecting liabilities, which at the end of the day are the only reason that these plans exist. Understanding a plan’s liabilities will help with asset allocation decisions, and should lead to more stable funded ratios and contribution costs, which is imperative as the annual contributions become a larger percentage of NJ’s budget.
I am not opposed to the state sponsoring a traditional defined benefit plan. On the contrary, DB plans need to remain the backbone of the US retirement industry, as defined contribution plans (401(k)-type) have proven to be inadequate retirement vehicles for most of our private sector employees today. Why? According to a recently released household survey conducted by the Board of Governors of the Federal Reserve System, as of 2013, approximately 31 percent of Americans reported having zero retirement savings. Worse, the median retirement savings for those 55-64 years old is only $14,500. How do we expect that astonishingly low account balance to support anyone’s retirement, especially as we are on average living longer?
Public fund plan sponsors need to take a different approach to managing these plans. It is truly regrettable that the pursuit of the ROA, as if it were the Holy Grail, has lead NJ and other public entities to abandon traditional equity and fixed income investments in lieu of alternative investments, such as hedge funds, that have failed to generate commensurate returns. In fact, a simple (unrealistic) 60% US equity allocation (Russell 3000) / 40% US bond allocation (Barclays Aggregate index) would have produced a 10% return in 2014, far outpacing the 7.3% result highlighted in the article, and at substantially reduced fees.
Lastly, it was stated that NJ’s pension system was underfunded by roughly $37 billion, as of June 30, 2014. However, according to an analysis by Moody’s, New Jersey’s unfunded pension liabilities doubled to an astonishing $83 billion at the end of June. New more realistic accounting guidelines required by the Governmental Accounting Standards Board (GASB) require New Jersey, and other states, to use smaller discount rates (not the ROA) to determine the true liability. The Moody’s report — New Jersey Reports Surge in Unfunded Liabilities Under New Pension Accounting Rule — indicates New Jersey has limited time to fix its poorly funded public pensions.