In Missouri, as in most states, teachers and other public employees belong to state-supported defined-benefit pension systems, which means when they retire these workers are guaranteed a specific amount of money annually for the rest of their lives.
Actuaries charged with overseeing these plans have to make assumptions, such as how long people will live and collect benefits and how successful pension investments will be. In practice, these assumptions tell plan managers how much money needs to be contributed today to meet the obligations of tomorrow. If the assumptions are wrong, benefits could be cut for pensioners or taxpayers could be held liable for the shortfall, which can be substantial.
Missouri’s Investment Assumptions
In Missouri, the state’s largest public employee pension system is the Public School Retirement System (PSRS), which manages roughly $38 billion in assets. One major assumption plan managers make is the fund will achieve an 8 percent annual rate of return on investments. If this is correct, the system is roughly 86 percent funded and has nearly $5 billion in unfunded liabilities, which is money Missouri taxpayers will owe beneficiaries if the shortfall isn’t covered in the future.
There are reasons to believe the fund won’t achieve an 8 percent rate of return: Markets rise and fall. A 2013 paper by Andrew Biggs, a former director of research on Social Security in the George W. Bush administration, found if the plan achieves a more realistic 4 percent rate of return, it will have less than half of the needed funds to cover liabilities. Unfunded liabilities would soar to more than $31 billion. In short, pension plan assumptions matter.
As a result, there is growing support for plan actuaries to produce financial reports forecasting fund balances with multiple assumed rates of return. Have we contributed enough if we achieve a 4 percent rate of return? How about 6 percent? Eight percent? This is exactly the point Michael Rathbone and I made in our recent paper, “Betting on the Big Returns: How Missouri Teacher Pension Plans Have Shifted to Riskier Assets.”
Investing in Riskier Assets
Our paper also highlights the fact Missouri’s teacher pension plans, similar to other defined-benefit programs, are increasingly investing in riskier assets in the pursuit of the 8 percent return they’ve promised.
For example, in 1992, PSRS held more than 80 percent of its investments in fixed income and cash, relatively low-risk investments. As of 2014, the plan held less than 25 percent in those safer options.
What does this mean for plan assumptions? PSRS and other pension plans are attempting to meet their high assumed rates of return by pursuing a higher-risk, higher-return investment strategy. It might work, but it might not. At minimum, Missouri taxpayers and public employees should know about the assumptions plan managers are making and what the health of the fund looks like under different assumptions.
Fund managers scoff at this idea. In an August 7 three-page response to our paper, Steve Yoakum, executive director of PSRS, attempted to discredit our work. What he really did was confirm everything we wrote. Yoakum acknowledges the plan has shifted to riskier assets and attempts to explain why. He also defends the 8 percent expected rate of return by reasoning the plan has historically surpassed the 8 percent benchmark. In doing so, however, he ignores what every financial planner has ever told me: “Past performance is not necessarily indicative of future results.”
For whatever reason, public employee fund managers are hesitant to increase transparency and check their assumptions.
This is where state governments can and should step in. They can require fund managers and plan actuaries to report fund balances under various expected rates of return. This would give pension boards greater information to determine the appropriate contribution levels. It would also help ensure pensioners received their promised benefits.
Indeed, it is the pensioners themselves who may suffer the most if states do not accurately plan for the future.
James V. Shuls, Ph.D., is an assistant professor of educational leadership and policy studies at the University of Missouri–St. Louis and a distinguished fellow of education policy at the Show-Me Institute.
Image by Simon Cunningham.
Steve Yoakum, “PRSR Response to Show-Me Paper on Teacher Pension Plans,” August 7, 2015: https://www.heartland.org/policy-documents/psrs-response-show-me-institute-paper-teacher-pension-plans
Michael Rathbone and James V. Shuls, “Betting on the Big Returns: How Missouri Teacher Pension Plans Have Shifted to Riskier Assets,” Show-Me Institute, July 2015: https://www.heartland.org/policy-documents/betting-big-returns-how-missouri-teacher-pension-plans-have-shifted-riskier-assets
Andrew G. Biggs, “Public Employee Pensions in Missouri: A Looming Crisis,” Show-Me Institute, March 2013: https://www.heartland.org/policy-documents/public-employee-pensions-missouri-looming-crisis