Los Angeles Scheme Realizes Expected Investment Return Is Too Rosy

(October 26, 2011) — The Los Angeles pension board has voted to cut its annual expected investment return to 7.75%, lowering its earnings estimates for the next several years.

In a 5-1 vote, the City Employees’ Retirement System board decreased its expected investment return from 8% to 7.75% per year, acknowledging that the scheme’s long-term expected 8% return on its investments may be too optimistic. If the board had remained loyal to its original plan to reduce the expected return in a single year, it would have cost the city $26 million to $50 million, according to The Los Angeles Times.  

“We have a major American city saying that as far as the eye can see, it has nothing but deficits on the horizon,” attorney Harvey Leiderman told the panel, according to the newspaper. “That gives me great concern for this board — and the ability of this board to carry out its constitutional responsibilities.”

“We’ve been talking about the unrealistic 8% investment assumption for a number of years, and 7.75% is still an unrealistic rate,” added City Administrative Officer Miguel Santana, who had urged the board to delay a decision for one year.

The Los Angeles scheme is not the only fund to realize that its investment target has been too optimistic. In March, the roughly $230.1 billion California Public Employees’ Retirement System (CalPERS) weighed the possibility of making a small accounting change to reduce its investment target. CalPERS staff suggested that the board lower its estimate about the amount of money the fund will make in the future, reducing its discount rate assumption from 7.75% to 7.5%. However, in the end, the board voted to keep the rate at 7.75%

The decrease in the investment earnings forecast would have put greater pressure on the state and municipalities, forcing them to increase the amount they pay into the pension fund, probably by $200 million or more. “There appears to be a consensus that returns are expected to be lower than historical returns over the next 10 years,” Alan Milligan, CalPERS’ chief actuary, said in a March report. “Given that the median investment return net of administrative expenses is 7.80%, we recommend that the discount rate assumption be lowered to 7.5% per year to have a margin for adverse deviation similar to that currently used. Given that the state of the economy has put severe pressure on employers’ budgets, we recognize that it may be appropriate to reconsider the level of margin for adverse deviation,” the report noted.

In September, following the decision by CalPERS to keep the forecast at 7.75%, Joe Dear, CalPERS’ investment chief, said that the return may be tough to meet. In an interview with Bloomberg Television, Dear said: “That’s going to be tough this year and maybe for the next few years. This low-return environment is structurally driven, and there’s not a lot of policy to move it.”