Average Public Pension Assumed Rate of Return Hits 40-Year Low

The average investment return rate assumption for U.S. public pension funds has fallen below 7.0%, to its lowest level in more than 40 years, according to the National Association of State Retirement Administrators.

Among the 131 funds that NASRA measured, more than half have reduced their investment return assumption since fiscal year 2020 as rising interest rates and other factors have contributed to more volatile investment returns.

For the 30‐year period that ended in 2020, public pension funds accrued approximately $8.5 trillion in revenue, according to NASRA, of which $5.1 trillion, or 60%, came from investment earnings. Employer contributions accounted for $2.4 trillion, or 28%, and employee contributions totaled $1 trillion, or 12%.

“The large portion of revenues from investment earnings reflect the important role they play in funding public pension benefits,” says a NASRA brief on the subject.

NASRA’s report also notes that a challenging aspect of setting the investment return assumption that has emerged recently is a divergence between expected returns over the next five to 10 years and expected returns over the next 20 to 30 years. Because many near‐term projections calculated recently are well below the long‐term assumption that most plans are using, according to NASRA, some pension funds face the choice of either maintaining a return assumption that is higher than near‐term expectations or lowering their return assumption to reflect near‐term expectations.

“If actual investment returns in the near‐term prove to be lower than historic norms, plans that maintain their long‐term return assumption risk experiencing a steady increase in unfunded pension liabilities and corresponding costs,” says the NASRA brief. “Alternatively, plans that reduce their assumption in the face of diminished near‐term projections will experience an immediate increase in unfunded liabilities and required costs.”

The investment return assumption used by public pension plans typically contains two components: inflation and the incremental return above the assumed rate of inflation, also known as the real rate of return. The sum of these components is the nominal rate of return, which is the rate that is most often used.

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The NASRA issue brief shows that although the average nominal public pension fund investment return has been declining, the average real rate of return rose to 4.60% in fiscal year 2020 because the average rate of assumed inflation dropped more quickly.

One factor that may be contributing to the higher real rate of return, according to NASRA, is the higher allocation public pension funds are devoting to alternative assets, particularly private equities, which tend to have higher expected returns than other asset classes. As of the end of the first quarter of the year, the Federal Reserve reported that public pension assets totaled $5.76 trillion, a decrease of 2.5% from $5.90 trillion the previous quarter and higher than the same quarter a year earlier by approximately $460 billion, or 8.7%.

As the NASRA brief notes, actuarial assumptions fall into one of two main categories: demographic and economic. Demographic assumptions pertain to factors such as changes in the number of working and retired plan participants, as well as when participants will retire and how long they’ll live after they retire. Meanwhile, economic assumptions relate to factors such as the rate of wage growth and the future expected investment return on the fund’s assets.

“Because investment earnings account for a majority of revenue for a typical public pension fund, the accuracy of the return assumption has a major effect on a plan’s finances and actuarial funding level,” says the NASRA brief. “An assumption that is significantly wrong in either direction will cause a misallocation of resources and unfairly distribute costs among generations of taxpayers.”

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Tags: actuarial rate of return, Assumed Rate of Return, investment return assumption, NASRA, National Association of State Retirement Administrators, Public Pension, public pension funds

The pension risk transfer market is burgeoning, and nothing illustrates that better than the emergence of Athene Holding as its leader. The insurer, now a unit of private equity powerhouse Apollo Global Management, only got into the PRT business in 2017.

Athene, which previously had been mainly an annuity provider, had the largest portion of disclosed deals in 2021, with five transactions totaling $10.1 billion in obligations transferred, according to S&P Global Market Intelligence. Its biggest deal was a $4.9 billion transfer from Lockheed Martin.

Prudential Financial and Massachusetts Mutual were ranked second and third last year. No PRT ranking has been done yet at this point in 2022, but the biggest transfer this year was MetLife’s $1.26 billion transaction with Pactiv Evergreen, a food packaging company.

In an interview with S&P, Richard McEvoy, Athene’s senior vice president and pension group annuity leader, said the Apollo involvement gives them more firepower. “Apollo’s expertise in retirement services asset management gives us a competitive advantage through its alpha-generating portfolio management and structuring, M&A sourcing and operational support,” he said.

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Senator Chris Murphy, D-Connecticut, has raised questions about the Apollo-Athene connection, and has proposed a bill to provide greater federal regulation of PRTs. He fears that Athene, at Apollo’s behest, will put the assets backing benefits into riskier areas, thus endangering retirees’ financial security.

Athene’s McEvoy told S&P that is not the case. Apollo, he said, is not “involved in the insurance market in order to make money fast and turn things around quickly,” but is a long-term investor. Apollo and Athene have been strategic partners for years, and the PE firm acquired the insurer in January.

In the century’s first decade, PRTs amounted to just around $2 billion. Then came the financial crisis, which savaged many corporate defined benefit plans and increased the burden of shouldering pension obligations. The current era of companies offloading their obligations came in 2012, with two huge transfers, from General Motors and Verizon, to Prudential.

In 2022, the PRT market is $3.2 trillion, per LIMRA International, the insurance and financial services research organization. It says it expects more entrants into the PRT field, a la Athene.

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