There are supporters and critics of almost any action or decision, especially in today’s hyperactive social media environment. The movement to consolidate downstate fire and police pension systems in Illinois is no exception. There were 649 police and fire plans merged for investment purposes into two large funds with about $15 billion in total AUM at the time of the consolidation. The primary motivation was to gain access to more investment opportunities because of scale, while also capturing some economies of scale in terms of fees, as many (roughly 65%) of these plans were <$20 million. I’m sure that there were other factors, as well.
What concerns me about this recent action has to do with asset allocation decisions based on the funded status of the individual systems that have been rolled up into these larger entities. Every plan’s funded status, contribution history, and unique liabilities should be factored into an asset allocation framework. However, that is not the case here. Every plan gets the same asset allocation depending on the pool that they invest in. How does this make sense? Asset allocation decisions should reflect the funded status. A plan that has a 90% funded ratio should NEVER have the same asset allocation as a plan that is 40% funded. Yet, that is precisely what will happen in Illinois.
Plans that are well funded should be able to reduce the risk inherent in the asset allocation, while those plans that are challenged from a funding standpoint should be given the opportunity to inject more risk into their asset allocation framework. We’ve seen what can happen to a well-funded plan when markets get hit, and they will again. Most public pension systems were overfunded in the late ’90s. Instead of securing the promised benefits and winning the battle, plans reduced their fixed income exposure and ramped up equity and alternative allocations. This decision proved disastrous, as two major market corrections decimated the funded status of Pension America during the ’00s leading to an explosion in contribution expenses as a direct result of this action.
We are once again at a point where public pension funds (and those of corporate America and multiemployer plans) have seen improvement in their funded status. It would be fiduciarily imprudent to not take risk off the table at this time. With equity valuations teetering at very expensive levels and US interest rates forecast to rise, perhaps rapidly so, markets could destabilize fairly quickly. It’s not like we haven’t seen this story play out before our very eyes. I applaud Illinois for trying to do something to sure up their unfunded police and fire plans, but not providing each system with the opportunity to tailor their plan’s asset allocation is a huge mistake. I wouldn’t want to be the municipal finance officer who has to inform their citizens that the 90+% funded plan is now at 65%.