US State Pensions: Investment Gains Dwarfed by Payouts

(August 5, 2013) — State-administered public pension systems have posted payouts of $196.7 billion in June 2013, some $104.9 billion more than the investment gains made in the preceding 12 months.

Investment returns were down sharply last June, from $414 billion in the fiscal year 2011/2012 to just $91.8 billion.

Contributions to the state retirement systems from employees and government topped $111 billion, but total pension fund assets fell 1% to $2.5 trillion in fiscal 2012, well below 2007 levels when fund assets reached $2.8 trillion.

The Census report also showed that total state pension liabilities amounted to $3.5 trillion at the end of fiscal 2012. Total membership in state-administered pension systems also increased 0.3% to 17.5 million people.

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The vast majority of investments by state pension funds were in corporate stocks–$934.5 billion of the $2.5 trillion, to be exact.

Another $450.7 billion is in foreign and international securities, with $252.8 billion in US governmental assets.

For the Census, federally-sponsored agency securities are classified under federal government securities instead of corporate bonds. Private equity, venture capital, and leverage buyouts are classified under corporate stocks instead of other securities.

However, the figures may not be as bad as they first appear. The Census report covers the fiscal year ended on June 30, 2012, meaning it captured the poor market performance between mid-2011 and mid-2012 when the Standard & Poor’s 500 index rose less than 2%, but missed the 2013 rally that pushed up the index 25% since July 2012.

As Detroit seeks bankruptcy protection, one of Russell Investment’s top strategists asks what happened to the role of plan sponsors as pensions' guarantor?

(August 2, 2013) – The same question has arisen over and over in comment sections beneath news articles announcing America’s largest public bankruptcy: Will the Pension Benefit Guaranty Corporation (PBGC) cover Detroit’s pension promises?

The answer, of course, is no. The PBGC only insures corporate retirement systems, not public. But if not the PBGC, then who?

Bob Collie, Russell’s chief institutional research strategist for the Americas, would point out that Detroit’s pension system does have a sanctioned backstop: the City of Detroit.

“People have forgotten about the role of plan sponsor, which is the entity that’s supposed to step in during the bad times,” Collie told aiCIO.

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In essence, the pension fund-plan sponsor model, whether for a public organization or corporation, was designed to function on Keynesian principles.

When markets are strong and a fund is reaping premia for investment risk, it grows in size and funded status. The sponsoring company, union, or government may be able to dial back its contribution rates.

However, as Collie noted, “there will be times that the market experience is worse than expected. A growth-oriented investment strategy creates a double hit: It fares worse in down markets and—based on a high assumed rate of return—the plan will likely have less money in it. The whole thing only works if the plan sponsor is willing to step in during the bad times.”

“In face of the inevitable uncertainty about investment returns, we need to be a lot clearer about just how important is the role of the plan sponsor or other entity left holding the bill in the event of a shortfall,” the Russell strategist wrote in a blog post. “If you assume an (aggressive) 7.5% and fail to achieve that, what happens? Who steps in to act as backstop? If you assume a (cautious) 3% and fail to achieve that, who is the backstop?”

Poor pension fund investment performance did not itself sink the city of Detroit. Still, the plan sponsor’s delinquency could sink the Detroit Retirement System.

“A lot of the decisions made about how funding policy interacts with investment strategy are based around normal times,” Collie said. “I think the biggest mistake any plan sponsors could make is try to wish the situation away—crossing their fingers, rolling the dice, and hoping they don’t have a bad result.”