The ROA Isn’t The Holy Grail!

Asset consultants and plan sponsors of DB pension plans continue to pursue the return on asset assumption (ROA) as if it were the Holy Grail!  Believe me, it is not! In fact, if one ever believed that achieving the ROA automatically brings funding success, the following statistics will debunk that thought, and quickly!

The following information is from the Public Employee Retirement Administration Commission (PERAC) website. PERAC was created for and is dedicated to the oversight, guidance, monitoring, and regulation of the Massachusetts Public Pension Systems. The professional, prudent, and efficient administration of these systems is the public trust of PERAC and each of the 104 public pension systems for the mutual benefit of the public employees, public employers, and citizens of Massachusetts.  A very admirable objective!

To PERAC’s credit, they annually publish a summary of performance results and the Funded Ratio for each of the 104 plans for which they have oversight.  As we’ve highlighted before, the “average” ROA objective for public funds nationally is about 7.5%.  According to the most recent performance report from PERAC covering periods through June 30, 2014 all 104 public entities achieved a 30-year return that exceeded the 7.5% average objective. Amazingly, only 6.7% of the funds failed to achieve a >8% return for 30 years! In fact, 45% of the plans generated a return for 30 years that eclipsed 9% – truly outstanding.

Since the ROA is the objective for most sponsors and consultants, and given the fact that most MA public plans have far exceeded that objective, it must be safe to assume that these plans are currently fully funded. WRONG! Despite the fact that 100% of the plans have exceeded the average ROA not one plan (0%) have a Funded Ratio above 100%.  How can that be?  In fact, only one plan had a Funded Ratio that exceeded 90%. It gets worse, as 81 of 104 plans have Funded Ratios that fall below 70%, with Springfield achieving a woeful 27% Funded Ratio despite generating a 30 year return of 8.53%!

Well, if beating your return objective doesn’t assure funding success, what does? DB plans will achieve success only when they outperform their liabilities. As a reminder, the plans only exist to fund a promise that has been made.  It doesn’t matter how well the assets perform as long as they exceed liability growth. Given the numbers cited above, clearly plan LIABILITIES do not grow at the ROA, and they have had a growth rate that has far exceeded the growth in assets.

Unfortunately, results for most of these plans in 2015 and 2016 will reveal underperformance to both the ROA objective and liability growth, as asset performance has been modest at best, while declining interest rates continue to inflate liabilities. If PERAC was created for and is dedicated to the oversight, guidance, monitoring, and regulation of the Massachusetts Public Pension Systems, then I would suggest that PERAC insist that a new approach be taken by the sponsors of these plans because what is being done currently is not working.

We need to preserve DB plans, but we are afraid that they will continue to come under greater public scrutiny as contribution costs escalate, while Funded Ratios plummet. That isn’t a formula for long-term success.  Liabilities need to be monitored more frequently, and the output from that exercise (review) should be used to drive the plan’s investment structure and asset allocation decisions. I would definitely describe myself as being stubborn, but even I would seek an alternate approach if what I’d been doing for 30 years failed to achieve my ultimate objective – full funding!


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