A recent study of public employee retirement systems in the United States reaches conclusions, that, after a fair amount of “grey tsunami” alarmism in recent years, sound reassuring.
The study, based on a recent survey of system managements conducted by the National Conference of Public Employee Retirement Systems (NCPERS) in conjunction with Cobalt Community Research, finds: that funding levels are rising, so that between 2017 and 2018 the average funding level of pensions went to 72.6% from 71.4%; that funds gradually are becoming more conservative in their investment return assumptions; and that public funds are cost-effective. On that latter point, regarding the period from 2017 to 2018, “the average expense (total of administrative and investment) remained flat at 60 basis points.”
Long Planning Horizons
Those surveyed represented a wide range of plans. About 45% of the 2018 respondents served city and village employees and beneficiaries and approximately 23% served state employees. Most surveyed are defined benefits plans (92%). About 62% of the responding funds have members who are eligible for Social security. As the study observes, this matters because funds whose members are not Social Security eligible—who may be entirely dependent on the public employee retirement system for their income as seniors—t end to be more generous in payouts than funds that are supplements to Social Security.
Retirement funds are paradigms of long planning horizons. This means they may invest in illiquid assets, but it also means that they must work to ensure that they can meet liabilities many years in the future.
To that end, as the authors of this study write, “funds make actuarial assumptions to estimate what investment and demographic experience is likely to be over that time horizon,” and these assumptions in turn “have powerful effects on the funded level of a plan and what the required contributions will be to pay for future benefits.”
As to benefits, the survey shows that there has been little change of late, “minimal activity” in terms of the creation of additional benefits to members. Most respondent funds offer a disability benefit, an in-service death benefit, and cost of living adjustments, although there is variation as to how the COLA works from one fund to another. The aggregate average COLA offered to fund members at the time of the latest survey is 1.7%. For those funds whose members are not eligible for Social Security, the COLA average is 2.3%.
On average, the return on investment for respondents is now 13.4%. For funds with members not Social Security eligible, this number is 14.3%. For those with Social Security eligible members, it’s 12.7%.
Pensions have been getting their best results of late from international equity investments (18.9%, one-year gross return), and their skimpiest results, as one would expect, from cash equivalents (1.4%) and domestic fixed income (2.6%). Their allocations to private equity and hedge funds have been doing well (12.9%). Allocations to real estate not so well (6.8%).
Allocations, Including “Other”
The survey finds little change in allocation decisions by public pension fund managers. From 2017 to 2018 there was a slight decrease in the allocation to equities, both global and domestic. There has been a slight increase in allocation to private equity and hedge funds, and in that to high-yield bonds. Further, the respondents’ targeted allocation to both the alternatives and the high-yield bonds is somewhat higher than the actual allocation, so one can reasonably expect this slow shift to continue into 2019.
In asset allocations for both years there is a fairly large number for the amorphous asset category, “Other.” In an appendix to the study, the authors provide us with some of the assets that are included within the “Other” class: timber, credit funds, risk-parity funds, and infrastructure all make this list.
Investment returns are by far the largest source of pension funding for these respondents: well beyond employee or employer contributions or both together. This is true regardless of whether the members are Social Security eligible.
Final Numbers: Contribution Rates
Employer contribution rates as a percentage of payroll have been flat (22% in 2017 and again in 2018). Employee contribution rates rose somewhat (to 9% from 8%). Such an increase works as a hedge, as it can assist with the stability of the funding of future obligations.