Despite its healthy return profile and 100% funded status, the South Dakota Retirement System is gearing up to weather what many industry analysts are predicting could be a potentially significant downward spike in the markets after they closed at record highs recently.
“Because of our fixed contributions and volatile investment returns, we acknowledge that our funding goals will not be met under all economic scenarios,” SDRS Executive Director Rob Wylie told CIO. “We are believers in planning for the unexpected in advance so that specific corrective actions can be immediately implemented when necessary based on statutory triggers.”
Retirement Consultant Paul Schrader said that the SDRS had some “great accomplishments over the past few years,” but shouldn’t take the situation for granted, and advised the board to establish a general framework for changes and a prioritization of these changes to avoid dire consequences should the markets drop.
The SDRS is sustaining a 100% fair value funded ratio, but should it ever fall below that, the board agreed that formal, prioritized corrective actions would be needed. A reduction in subsidies would be the first priority, including raising the normal retirement eligibility age to 66, raising the early retirement to age 56, and increasing the actuarial reduction to 4% for each year if a member retires early.
If a negative situation progress past these actions, the board then agreed it would eliminate the subsidies. This would also raise the normal retirement age to 67, raise early retirement eligibility to 57, and increase the actuarial reduction to 5% for each year a member retires early.
And if the rain continues, the board agreed it would modify future service benefits, providing the Generational benefit structure for all future service for current foundation members. The subsequent ultimatum, if the funded ratio’s hypothetical free-fall proceeds, would be to suspend, freeze, and restructure benefits. SDRS would suspend the cost-of-living adjustments (COLA), free accrued benefits, reduce the future service multiplier if needed, and base future benefits on career-average pay rather than final average compensation (FAC).
However, the SDRS said based on current market conditions, it has an 18% chance of achieving a 120% ratio in the next three years. Should this figure reach 122%, the board considered the possibility of allocating 2% of assets for benefit improvements (approximately $250 million in today’s environment.)
That funding success is attributable to the SDRS’ two-pronged approach between specialized investment and retirement plan teams, Wylie told CIO. The state’s investment council “actively manages the majority of assets internally,” he said. “[The plan’s] success has been a team effort, both in the direct management of the assets and the interaction with the executive and legislative branches of state government and other entities.
“From the perspective of the SDRS, the efforts to attain and maintain a 100% funded ratio have existed since SDRS was consolidated in 1974. Benefits are automatically adjusted based on affordability… and policy constraints on actions taken when overfunded have also helped avoid many of the pitfalls impacting other plans.
“The coordinated efforts [between the state’s investment council and retirement system] have resulted in the SDRS being 100% funded in 28 of the last 33 actuarial valuations,” Wylie said.
Based on the pension’s FY18 net investment return of 5%, there’s a 32% chance that the SDRS would necessitate these corrective actions.
The SDRS recently had its COLA formula amended so as to not exceed 3.5%, and not fall below 0.5% in any given year, provided the system is 100% funded. However, if the funding ratio falls below 100%, the retirement system’s board can enact a “restricted COLA maximum” so the funding ratio can increase back to 100%.
“Both the SDIC and SDRS focus on risk whether 100% funded or not. The well-funded status of the plan and adjustable benefit features result in greater flexibility in the management of assets and liabilities,” Wylie said.Related Stories:
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