The Casino of US state pension plans

US State Pension plans remain significantly underfunded and yet they are playing a high-risk game of investing an ever-larger proportion of their funds in risk assets to match or beat abjectly unrealistic return assumptions. Quite frankly, too many State Pension fund trustees are behaving as if they are on a weekend break in Las Vegas. Huge and growing pension fund deficits are yet another element of the ever-building US government deficit.

Even the vibrancy of financial markets is not helping to reduce the massive deficits of state pension funds in the United States. The Pew Charitable Trust, in its recently released study, analysed the state pension funding gaps at the end of 2016. They calculate that the State pension schemes have a cumulative deficit of $1.4 trillion: a $295 billion increase from 2015 and the 15th annual increase since 2000.

Future liabilities

Pension fund coverage of their future liabilities is just 65%. Part of the growing deficit is because states fail to contribute what is needed to move their pension schemes to safe solvency levels. In 2016 contributions were $96 billion short of what was needed.

The deficits are in reality probably much bigger than currently stated. Pew Charitable Trust notes that the pension funds continue to make what to many investors see as an unrealistic assumption of future fund returns. The assumed per annum return from financial markets is on average 7.5% – way beyond likely returns in markets. Between 1992 and 2016 the assumed average asset return has come down just 50 basis points from 8.0% to 7.5% whereas the US 10-year government bond redemption yield has fallen from 8.0% to 2.7%, a full 530bps.

The State Pension funds have steadily but significantly increased their equity weightings in the past twenty-five years to try to hit their long-term investment return target. Between 1990 and 2016 the average weighting of equities in state pension funds has increased by 30 percentage points to over 70%. Large allocations to equities increase the riskiness of the state pension fund investment portfolios. It is almost if they are in a casino and going all-in on one bet. Whatever happened to asset class diversification to reduce risk and smooth returns?

Impact of accounting standards

As we have already shown, despite the increased weighting in equities the aggregate deficit of US State Pension schemes continues to climb and is likely to rise still further. Changes in accounting standards mean more and more states are being forced to reduce their assumptions about investment returns, thereby pushing up their assumed deficits. The $150bn Texas Teachers’ Retirement System and the $17.4 billion Public Employee’s retirement scheme are considering lowering their return assumptions. The Teachers scheme is still assuming an 8% return over the next 30 years, but that could come down to 7.25%. The Idaho scheme seems a little more realistic. They already have one of the lowest assumptions amongst schemes but are set to lower their assumption to less than 7.0% – maybe as low as 6.5%.

When will ‘casino’ behaviour stop? Only when they are told to stop. But for the moment few funds want to face up to the reality of lower returns… they can’t afford to!


This article was attributed and provided by PG International


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