Pew Says Modest Economic Downturn Could Spell Doom For The Most Underfunded Pension Systems

A relatively healthy US economy has helped keep state pension funds afloat over the past several years but a recent study from The Pew Charitable Trusts suggested that even a modest downturn in economic fortunes could push off the cliff some of the more troubled state pension funds like those in New Jersey and Kentucky.

Here is an excerpt from a report on pension funds from CBS:

“Even after eight years of economic recovery — eight straight years of stock market gains — the public pension plans are more vulnerable than they’ve ever been to the next recession,” researcher Greg Mennis said in an interview.

Governments have been ramping up contributions to the funds to help cover the promises they’ve made to retirees, but that leaves less money to spend on schools, police, parks and other core government services.

Another option is reducing pension benefits. A plan to do that in Kentucky led to teacher walkouts earlier this year.

Some Risk Is Good For Defined Benefit Plans, Says Study

Safe investments are good. But investments that are too safe also carry potential risks for beneficiaries. A study by two Iowa University professors suggests that defined benefit plan sponsors should expand their investment choices to riskier assets and go beyond liability-driven strategies that rely on fixed-income assets.

“Employees have some desire to have a fair risk-return trade-off,” said Wei Li, one of the authors of the study. “They would prefer to have some risk exposure.”

Alicia McElhaney reported on the Iowa University study in this article printed in Institutional Investor:

The research contradicts the view held by some defined benefit plan sponsors that given their fixed-income-like payouts, they should engage in liability-driven investment strategies, which rely on fixed-income assets to secure returns.

According to the research, this isn’t exactly beneficial for employees. Here’s why: many employees rely on their pension funds completely for retirement savings, according to the research. Regardless of how their plan sponsors invest, these employees are taking on some risk because their pensions could be wiped out if their employers file for bankruptcy. And while the Pension Benefit Guaranty Corp. (PBGC) provides insurance for pension funds, retirees are only insured up to a ceiling, the paper noted. For higher-paid employees expecting to retire with large pensions, a bankruptcy could spell trouble.

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There is, perhaps, a better way to distribute the risk fairly according to the paper: defined contribution plans. These plans make up 48.6 percent of pension assets in the seven major pension fund markets, according to Willis Towers Watson, and are steadily increasing their market share. Assets under management at these defined contribution plans increased by 5.6 percent over the past 10 years, while they grew by 3.1 percent at defined benefit plans during the same time frame, the report shows.

“A more efficient contract would let employees to shoulder all the pension investment risk while keeping them insulated from firm-specific risks,” according to the paper. “Interestingly, this arrangement resembles what a defined contribution plan offers. Our analysis shows that such an arrangement may substantially reduce firms’ pension funding costs.”

CalPERS “Direct” Isn’t So Direct

The California Public Employees Retirement System (CalPERS) is considering launching two new investment partnerships that would manage more than $20 billion over the next ten years. But that plan has encountered fierce opposition from inside CalPERS.

The opposition to the plan has centered over the lack of control CalPERS will have over the investments that will be made by the partnerships. It was also not clear what were the benefits to be gained by giving up that control to the partnerships, said CalPERS investment Committee Member Margaret Brown.

Randy Diamond filed this report in Chief Investment Officer:

CalPERS plans to allocate $20 billion to two partnerships, one that would invest in later-stage companies in the venture capital cycle in technology, life sciences, and healthcare. The second would buy stakes in established companies like Warren Buffet and hold those stakes for extended periods of time.

(Former CalPERS CIO Ted) Eliopoulos told the investment committee at its Nov. 13 meeting that the pension plan’s investment staff had looked at CalPERS running the program itself or owning it directly as a captive company but what “we really settled on is the traditional partnership structure where you have a general partner and a limited partner.”

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Critics of the plan say it is misleading to call the program “CalPERS Direct,” since the pension system will not make direct investments in private equity, like some of the Canadian pension plans.

“What they are proposing makes no sense,” said J.J. Jelincic, a former CalPERS Investment Committee member as well as a former CalPERS investment officer. Jelincic said Eliopoulos and other CalPERS investment officials haven’t detailed a logical rationale as to why they are giving up control of investment decisions or showed that they will be saving on the high fees that are part of CalPERS’s traditional private equity program.