Why Pensions’ Last Defense Is Eroding
Long-term returns for U.S. public pensions are expected to drop to the lowest levels ever recorded
The above is the title of an article appearing in today’s WSJ. The “lowest levels ever recorded” is a bit of a reach! Wilshire’s Trust Universe Comparison Service (TUCS) has been measuring the 20-year return for public pension plans for the last 16 years. They are estimating that the June 30, 2016 20-year return will be 7.47%, which is below the average return on asset assumption for public DB plans, and if the estimate is correct, it will be the lowest 20-year return ever recorded by TUCS. That said, we’ve certainly had some shorter-term periods that were far more onerous for Pension America.
Unfortunately, pension plans continue to focus almost exclusively on the asset side of the equation, and if that is all one does, of course one would be concerned about that 20-year result, especially given that traditional bond and stock markets appear frothy at this time. However, DB pension plans can certainly survive and even thrive in a low return environment if their plan’s liabilities are performing more poorly than the asset side. Liabilities are assumed to grow at the ROA (GASB), but that is not how they grow, as they are bond like and go up and down with changes in interest rates (and other benefit and workforce related factors).
Should we get into an environment of improved economic growth, with a little inflation, U.S. interest rates could back up. If that were to happen, liability growth would be modest, if not negative. A DB plan’s funded status could see significant improvement in such an environment. However, given that most plans don’t know the term-structure, growth, rate, and yield of their liabilities, they likely wouldn’t know that assets are outperforming liabilities.
The U.S. retirement industry needs to change its approach to managing DB plans. It isn’t a return arms race! The ROA is not the Holy Grail. These plans must be sustained, and in order to accomplish that objective, they must be derisked! Measure and monitor your plan’s liabilities, and use that information to create an investment structure and asset allocation that reflects your current funded status. Your plan’s beneficiaries are counting on you, and so are the taxpayers of your fine state, city and / or municipality.