Pensions

Employees Retirement System of Texas Lowers Return Assumptions

As Harvey hits Texas hard in terms of lives and finances, more bad news (not to compare the scale of the two) came from the state from the giant known as Employees retirement system of Texas

As markets gradually transition from the tranquil landscape painted by central bank quantitative easing and some of the lowest volatility in market history – 89% of futures markets experienced a contraction of volatility in the first half of 2017 – forward looking investment managers assess the potential for lower returns with risk swirling all around. In perhaps a sign of the times, the $26.9 billion Employees Retirement System of Texas ‘ board of trustees voted on Wednesday to lower its expected rate of return to 7.5% from 8%. Some on the board had even recommended a cut to “as low as” 7%. And they are not alone.

Get Our Activist Investing Case Study!

Get the entire 10-part series on our in-depth study on activist investing in PDF. Save it to your desktop, read it on your tablet, or print it out to read anywhere! Sign up below!

employees retirement system of Texas Employees Retirement System of Texas

Faced with widening pension gap, politicians ask taxpayers for more or for pensioners to shoulder some of the burdens

Not just Employees retirement system of Texas, but public pension fund investments like  have been underperforming the market by meaningful levels, with the average return of 0.6% in 2016 pointing to the worst decline since 2009, according to a study from the Center for Retirement Research at Boston College. The S&P 500 Total Return Index, by contrast, delivered 12.25% to investors in 2016.

The poor pension funds performance come as plans across the country from Illinois, New Jersey Mississippi and California have lower returns. The trend most noticeably started in December 2016, when the California Public Employees’ Retirement System (CalPERS) lowered its expected rate of return from 7% to 7.5%.

Dropping the expected target return has a significant impact, requiring often strapped state and local governments to fill the gap, which can result in unpopular tax increases. Faced with a widening pension gap, Chicago Mayor recently defended plans to raise property taxes a second time, this time boosting revenue by $120 million annually, to cover increasing contributions to the Chicago Teachers’ Pension Fund.

GRS Retirement Consulting, which advises pensions, is behind recommendations that the $27 billion Mississippi lower its expected return a full percent from 7.75% to 6.75%. The state’s Public Employees Retirement System was making the assumption of 3% inflation, which models to a 4.75% return on yield-related investments. GRS recommended the board lower the inflation assumption to 2% to 2.5%, which results in a bottom range total return estimate of 6.75%. The contribution gap in Mississippi could be as much as $450 million per year.

In Texas, state retirees are concerned that the state legislature won’t compensate the pension fund for the entire gap and instead might require retirees to shoulder some of the burden through increased contributions or reduced benefits.

“Many anti-pension lawmakers will certainly use the situation to call for doing away with state employee pensions and switching new state workers into risky 401(k)’s,” the Texas State Employee Union said in a statement, pointing to a political showdown. “The fight is not over!”

Employees Retirement System of Texas New accounting standards mean lower net funding levels, but just 0.5% differential in performance makes a difference

If confronting political leaders with the specter of a pension fund bailout is most pragmatic, there are other methods being employed that involve shifting accounting methods.

While the average funding level for the 170 pension plans studied by Boston College was 72%, in 2014 new accounting standards effectively lowered that rate to 68%. The old Governmental Accounting Standards Board standard (GASB 25) method of measuring liabilities, which uses a smoothed value of assets, shows a nearly 4% gap with the new GSAB 67 method, which values assets at the market.

The Employees Retirement System of Texas , for instance, is currently 75% funded, slightly above the national average and thus has room for lower funding levels, but at a long-term cost to members, particularly if another market price readjustment such as what occurred in 2008 occurs. While pensions were then hedged — pension plans in the Boston College survey were down only -3.9% in 2008, for instance, in a year when the S&P 500 was down -37%.

While hedging has costs to performance, just a 0.5% differential in performance can mean a lot for big pensions like

 

Employees Retirement System of Texas

While hedging has costs to performance, just a 0.5% differential in performance can mean a lot. If the assumption were an 8% annual return, it would be 100% funded in 35 years, according to TSEU. But with just a 0.5% drop in performance expectation, the plan will run out of money in a matter of decades.

“We were promised when I went to work: Yes, our salaries are low, but you’d have good benefits and good retirement,” 17-year state employee Pamela Scott told the Texas Tribune. Looking at her future nest egg, she was sardonic. “I have nothing to lose but retirement money.”

Leave a Reply

Your email address will not be published. Required fields are marked *

seven − one =