By: Russ Kamp, Managing Director, Ryan ALM, Inc.
There appears in today’s WSJ an article titled, “Pensions’ Bad Year Poised to Get Worse”. The writer of the article, Heather Gillers, references data from the Wilshire Trust Universe Comparison Service (TUCS). As she describes, the first quarter of 2022 for public pension systems was the most challenging from a return standpoint since before the pandemic with the median fund producing a -4.1% return. Performance has obviously continued to deteriorate since the end of the quarter with both bonds and stocks recording double-digit declines. But is that the full story?
Yes, the asset side of the pension equation has performed poorly recently. However, pension plan liability growth has been even more negative. You’ll find that public pension funding has actually improved when one uses a discount rate that is more responsive to changes in the interest rate environment, such as FASB’s ASC 715 rates (AA corporate yield curve) rather than the return on asset assumption (ROA) used under GASB accounting. The appropriateness of the discount rate is a major issue with public pensions. Given GASB accounting rules, public pension liabilities have been habitually understated since US interest rates fell below the ROA target (@ 1988). As a result, the true cost of offering these pension promises has been masked as US interest rates fell to historically low levels.
Now, the relationship of assets vs. liabilities (funded status) may be entering a more favorable environment despite the lower asset values witnessed so far in 2022. The duration of a public pension’s liabilities is likely 12-15 years. A 1% move up in rates creates a significant negative return for pension liabilities, which are bond-like in nature. Assets don’t need to achieve the ROA in such an environment. A -4.1% asset return may look just fine compared to a reduction in the economic present value of plan liabilities that decline by 10% or more.
With all due respect to Heather and all the reporters covering Pension America, there should be no reporting of pension asset performance without the context of how the liability side is performing, too. As a reminder, we believe that the primary objective in managing a pension plan should be to secure the promised benefits at both reasonable cost and with prudent risk. The pension objective is not achieving a specified return (ROA). With this understanding comes the ability to make more informed decisions regarding asset allocation, asset management, and performance measurement.