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Pension earnings came up short this year. Eventually, that will require bigger contributions to make up the difference.
A three-month stock market rally has helped public pension systems stave off massive financial losses, but the pandemic-driven recession is still expected to drive up government retirement debt in the coming years.
Results are still preliminary, but early figures show public pension systems reporting annual earnings between 3% and 5% for the fiscal year ending June 30. That represents about half of what the annual earnings assumption was for most plans. Unless governments make up the difference—an unlikely response in a budget climate even more dire than the 2008 recession—unfunded liabilities will increase.
“All else being equal this will push [required] contributions up,” said Moody’s Investors Service analyst Tom Aaron. “And that’s happening at a time when revenues are broadly being hit by impacts of the coronavirus.”
Pension plans rely heavily on investment earnings because annual payments from current employees and governments aren't enough to cover payouts to retirees. More than 60 cents on every dollar paid out to retirees comes from investment income, according to the National Association of State Retirement Administrators.
But this year, plans with more than $1 billion in assets earned a median return of 3.2% as of June 30, far below their median long-term expected rate of return of 7.25%, according to the firm Wilshire Trust Universe Comparison Service.
Some plans have reported their own preliminary data, with similar findings. The California State Teachers' Retirement System announced a net return of 3.9% for the fiscal year; Rhode Island’s pension fund performance tracker shows a one-year return of 3.8% as of June.
California Public Employees' Retirement System, the nation’s largest, did a bit better although its 4.7% earnings is still far below its annual target. The plan’s chief investment officer, Yu (Ben) Meng, noted the plan has been shifting its investments over the last decade with an eye toward protecting against market volatility.
“When it came, we were in a strong position to reduce its impact on our portfolio and take advantage of new opportunities created by the changing economic climate,” he said in a statement. “I’m proud that our strategy enabled us to navigate volatile markets and end the fiscal year on a strong note.”
This year makes the second straight year pensions missed their investment targets, although last year most plans didn’t miss by much. And because of the way pension accounting is done, any year in which plans miss their target, government bills increase. But rarely, if ever, does the annual bill decrease when plans do better than expected.
It could have been worse. Back in March, stocks tumbled by more than 25% as concerns over the rapid spread of the coronavirus ground the economy to a halt. At that point, pension funds, which rely heavily on public equities to boost investment returns, were on track to have their worst year since the 2008 financial crisis.
But the final three months of the fiscal year brought some relief as pensions returned a median 11.1% from April to June, which helped recover some of those earlier losses. New York’s state pension fund, however, ended its fiscal year on March 31 while the market was still in turmoil. It has announced an annual loss of 2.7%.
During the last recession, governments struggling to balance budgets often did so by cutting short or skipping their annual pension payments. While this helped with budget deficits, it also made unfunded liabilities much larger and created even bigger pension bills for future budgets. In an effort to make up ground, some governments have been making supplemental payments into their systems.
The higher pension bills won’t hit budgets for another year, and it’s not clear if governments will skimp on payments in this downturn. But some are already canceling those extra payments. Colorado, for example, nixed its $225 million supplemental pension contribution to the state’s retirement system to help close a $3 billion budget shortfall at the end of the 2020 fiscal year.
Natalie Cohen, president of National Municipal Research, Inc., said she expects more governments to pull back on contributions over the coming year as the full effect of high unemployment hits budgets in the form of lower income tax payments and spending.
But, she added, the pension changes over the last decade that have created less generous benefit tiers for new employees may also start making a marked difference. While such changes don’t affect existing liabilities at the time the law is passed, they do lower newly accrued liabilities. This can stabilize government pension payments in the out years, something Cohen called bending the curve.
“At some point, the curve is going to bend and it’s just now starting to happen for those plans that have a multi-tier system,” she said. “On the positive side, that should still continue.”
Liz Farmer is a journalist and fiscal policy expert who often writes about budgets, fiscal distress, and tax policy. She is currently a research fellow at the Rockefeller Institute’s Future of Labor Research Center.