The Public Pension Plan Debate: How do you value liabilities? Is the right story being told?

Posted on January 30, 2018

AndCo By AndCo

Public service employees work for decades in hopes that a well-earned retirement awaits them as they enter their golden years. But, before they reach that milestone, their public pension plan must be prudently managed so the pension they have accrued can actually be paid. For trustees charged with making the right decisions for a diverse set of employees, understanding the intricacies of their retirement structure, as well as its proper management, can be understandably intimidating.

Mike Welker, president and CEO at AndCo, was recently part of a Florida Public Pension Trustees Association (FPPTA) debate discussing views as to how trustees, plan sponsors and the general public should look at these retirement pools and common misconceptions regarding funding public pension funds. Watch the discussion below, as Mike and a panel of industry experts provide their take on how to deal with these risks and misconceptions.

5 Key Takeaways from the FPPTA Debate

  • 5:52 Does increased volatility of investments lead to higher returns and lower pension costs? Historically, it has been shown that over time, there is a positive correlation between increased volatility, higher returns and lower pension costs.  The key words in that statement are “over time”.   During shorter time periods, say 1, 3, 5 and 10-year time periods, the capital markets may be volatile to the downside and returns are lower and pension costs will rise.  That is why we believe it’s important for trustees and their advisors to balance volatility, return and pension costs with sound asset allocation and a strategic plan outlined in the Investment Policy Statement with an astute understanding of the time frame involved with managing these public pension assets.
  • 28:30 Going back to 1999, would you immunize the liabilities of a public pension plan portfolio? No, in the long run, we would generally expect the portfolio to be able to return what we assume it would return because it has one key benefit: time. As a public plan, there is security in the fact that, unlike a private or public company that could sell at any point, local and state governments, for example, do not incur that risk. Therefore, time is the principal asset of public pension plans.
  • 31:31 How is the assumed rate of return calculated and by whom, and should the return on investments be calculated at all? The assumed rate of return for public pension funds is established by the actuary, investment advisor and trustees.  The number utilized is what the professionals and trustees believe is the rate at which the assets will grow going forward based on capital market expectations and an asset allocation study.  The key about any asset allocation study and rate of return calculated in the public pension world is that the return expectation is based on assumptions made LONG into the future.  At least 10, 15 or even 30 years.  Unfortunately, this creates a disconnect in public perception. Asset allocations results and overall returns are often viewed over 3 and 12-month time periods by the press and local/state officials while plan allocations are more properly aligned with a 30-year timeline.
  • 44:45 What happens when the plan has a bad investment market experience? How should trustees react (or not react)? How long should trustees be patient? Unfortunately, a poor market experience can lead to a change in a strategic approach at exactly the wrong time.  Near term experiences drive long-term systems and unintended consequences may occur.  Instead, it is more prudent to react based on longer rolling year timelines, such as 30 years or longer. Shorter-term reports can be great to help ensure there aren’t smaller issues in your portfolio, but you shouldn’t compromise public pension plans strongest asset (time) by emotional short term “knee jerk” reactions.
  • 58:20 Why don’t we focus on liability funding vs. return on assets? You should, you just need to understand with public pension funds most of the liabilities are calculated based on what market rate the pension assets grew over the trailing time period.  Depending on what those results were, the plan sponsor needs to fund accordingly.  During periods where pension returns are significantly greater than the assumption plan sponsors should NOT take funding holidays.  Why? Markets are volatile and there will be shorter term time periods where pension returns do not equal the expected rate.  However, over longer periods of time, i.e., a rolling 30-year time frame, statistically speaking, a 100% stock portfolio has historically delivered at least an 8% return.
  • 1:17:17 Why do I need a funding policy and what should they address? A funding policy provides discipline and supports and encourages process.  Markets over short and intermediate terms can be volatile and expectations may fall short or significantly outperform.  In both environments, the plan sponsor could make dramatically different decisions.  A funding policy, which provides enough flexibility but contains components such as a funding floor, can provide consistency and a better path to public pension plan solvency.

Though the experts in this debate may disagree with each other, it is these kinds of discussions that can help our industry grow and inform those who may not be specialists in pension plan management. When the market grows volatile and your plan appears to be at risk, remember that a public plan’s best asset is time itself. Avoid making knee-jerk reactions that could adversely affect all those within the pension plan that you are charged with protecting and managing.

Important Disclosure Information:

The views and opinions expressed by Mike Welker represent solely those of AndCo Consulting. The intended audience for the debate consisted of trustees and the information was provided for educational purposes only. This should not be regarded as investment advice or as a recommendation regarding any particular course of action.

The “5 Key Takeaways” do not purport to precisely quote Mike Welker’s responses, but rather to serve as a summary of his views and/or statements. The views and statements expressed are not guarantees, predictions or projections of future performance. Past performance is not a guarantee of future results.

This blog contains a link to a third-party website (Vimeo), which is not maintained by AndCo. AndCo does not operate this third-party website and is not responsible for its content, privacy or security.

AndCo Consulting serves as an Associate Member Sponsor of the Florida Public Pension Trustees Association (FPPTA).  Additionally, Dave West, Senior Consultant at AndCo, serves on the FPPTA’s Advisory Board and Education Committee. Notwithstanding the foregoing, AndCo, FPPTA, Foster & Foster, Ryan ALM and Aon Hewitt are not affiliated entities.