Massachusetts Treasurer Steven Grossman favors lowering the assumed return rate on his state’s pension-fund assets. He’s not alone. While particulars vary, many states have lowered assumptions in the face of the European debt crisis and diminished returns.
In Pennsylvania, lawmakers this week held hearings on an unfunded pension liability that Moody’s Investors Service cited last month while lowering the state’s general obligation bond rating to Aa2 from Aa1.
Cities, too, are examining the problem.
New York City, for example, has proposed lowering the assumed rate to 7% from 8% for its five major pension funds, while Pittsburgh may lower from 8% as it petitions Pennsylvania officials to emerge from distressed status.
There’s a trade off, however — cities and states must replenish the funds, which in some cases could strain budgets.
Grossman, whose state has one of the highest assumptions in the country at 8.25%, expects state lawmakers to approve lowering it to 8% by year’s end.
Investors and rating agencies are on board with the move, he said, even though Massachusetts would have to make higher contributions to benefit plans or increase its unfunded liability.
“The consensus was that it is the right thing to do. It’s a net credit positive for Massachusetts,” Grossman said.
Discussions among Massachusetts public- and private-sector finance leaders, he said, took place over several months.
“It was important that we engage all the economic players in our talks, and that included the investor community and the bond rating agencies. We didn’t find anyone who was opposed to our doing it,” he said in an interview.
Grossman called the 8.25% “a bit of an outlier,” saying it reflected an allocation weighted toward more stocks than bonds. “Our asset allocation reads more like an endowment fund,” he said. “We have a very high percentage of alternative investments.”
While others say Massachusetts should drop its assumption below 8%, Grossman prefers a methodical approach.
“Obviously, 8% may be too high, but we want to take it one step at a time, be careful and keep our fingers on the pulse, quarter by quarter and year by year,” he said.
Nationally, state and local-government pensions ended fiscal 2012 fiscal year with only a 1.15% median gain, according to Wilshire Associates.
“Despite a rising bond market, falling equity returns — especially international equity — proved to be a drag on the performance of all institutional plan types,” according to the Santa Monica, Calif., firm.
In Pennsylvania, Moody’s last month said widening pension liabilities will challenge the return to fiscal balance for a state already wobbly. The move affects $364 million of debt.
In a report, Moody’s cited “high combined debt position driven by growing unfunded pension liabilities, and a seven-year history of significantly underfunding pension contributions that will be reversed slowly over the next five years.”
The state government and finance committees of Pennsylvania’s House held hearings Tuesday on state pensions. Liability is estimated at $40 billion and rising. That figure exceeds the state’s fiscal 2013 budget by $13 billion.
Rep. Warren Kampf, R-Paoli, has filed bills that would require future state and school district employees to enroll in an employee-directed defined contribution plan, similar to private-sector 401(k) plans, instead of a traditional public-sector defined benefit plan.
Current state workers could stay with the current system or join the employee-directed plan.
“Pension contributions create a ripple effect downstream for all other line items. We just cannot continue to expand a program that is crippling the finances of school districts across the state,” Kampf said.
Connecticut Treasurer Denise Nappier reported two weeks ago that investment returns for the Connecticut Retirement Plans and Trust Funds came in at 0.90% for the fiscal year that ended June 30, compared with a nearly 21% gain the previous fiscal year. Over three years, the pension funds have gained 10.5%
“Such a significant swing in performance results only underscores the wild global financial ride that hasn’t quite come to a full stop yet,” Nappier said. “We expect continued uncertainty in the markets.”
Rhode Island last year passed landmark legislation that created a hybrid plan combining 401(k) and traditional plans. Other changes that were implemented included raising the retirement age and suspending cost-of-living adjustment increases for retirees. Public-sector unions are challenging the law in court.
State law requires Massachusetts to study alternatives to defined-benefit plans, but Grossman favors traditional plans.
“The defined-benefit model has been a solid, time-tested model,” he said.
Transparency, according to Grossman, is essential, whichever plans states choose.
“Investors and the rating agencies want to know about pensions and [other post-employment benefits], and they want direct answers to both,” he said. “They don’t want to know that you’re kicking the can down the road.”