Others Notice That A Long Bull Market Hasn't Improved Public Pension Fundedness
by meep
I knew you’d get there eventually, y’all!
I saw it both in the WSJ and Pensions&Investment news, and the WSJ piece is somewhat reasonable…. but the P&I bit is something else.
WALL STREET JOURNAL COVERAGE: JUST THE FACTS, MA’AM
I first saw it on WSJ: The Long Bull Market Has Failed to Fix Public Pensions
Maine’s public pension fund earned double-digit returns in six of the past nine years. Yet the Maine Public Employees Retirement System is still $2.9 billion short of what it needs to afford all future benefits to all retirees.
“If the market is doing better, where’s the money?” said one of these retirees, former game warden Daniel Tourtelotte.
The same pressures Maine faces are plaguing public retirement systems around the country. The pressures are coming from a slate of problems, and the longest bull market in U.S. history has failed to solve many of them.
There is a simple reason why pensions are in such rough shape: The amount owed to retirees is accelerating faster than assets on hand to pay those future obligations. Liabilities of major U.S. public pensions are up 64% since 2007 while assets are up 30%, according to the most recent data from Boston College’s Center for Retirement Research.
Fancy that.
I’m just going to pull out the reasons given, but there are problems with this explanation:
The Financial Crisis Happened
….
Governments Fell Behind on Their Payments
….
Deeper Pension Cuts Didn’t Materialize
….
People Got Older
….
The Future Looks Worse
So. Let us consider the various issues:
LIST OF EXCUSES WEARS VERY THIN
Financial crisis – okay, asset values dropped. But the whole point here is that there’s been a large recovery in asset values in A FRICKIN DECADE. And the funded status has not appreciably improved. In many cases, it continued to get worse after the market drop.
Fell behind in payments – holy crap, look. Many states and cities never made full pension contributions even before the crisis. As a deliberate choice. Now here’s the interesting thing – yes, contributions dropped when state revenues dropped during the recession. But what about all those boom years since then? Why couldn’t they make full or even higher payments? [this is rhetorical – I know there were other things they preferred to pay for.]
But here’s the bigger problem: even the ones supposedly making full payments fell behind. Remember Public Pensions: Why Do 100% Required Contribution Payers Have Decreasing Fundedness?
Here is the key graph:
So, all the plans in the Public Pensions Database did worse than the three subsets I picked:
- those who were fully- or over-funded in 2001
- 100% ARC payers
- the intersection of the above two groups
But notice those three groups ended up with medians about the same in 2016. And yes, below the mythical 80% level.
Deeper Pension Cuts Didn’t Materialize – as noted, various entities tried and were shot down by courts. That said, there have been a few places that cut pension benefits: Detroit, Rhode Island… yeah. Reality will always win.
People Got Older – are you kidding me? Just. Look. Yes, there has been mortality improvement, but nothing that was not foreseeable TWENTY YEARS AGO. But people thought it was okay to not incorporate future mortality improvements in valuation & funding, which few insurance companies would try.
The Future Looks Worse – Again, not necessarily a surprise. Look. People kept acting like the Boomer phenomenon would be sustainable in some way, ignoring that the Boomers did not have enough children, forget about grandchildren. Where did you think the equity growth was gonna come from? Pixie dust?
This is not something that “just happened”.
GRAPHICS: WHAT REALITY LOOKS LIKE
There were a couple of graphs that went along with this article.
Note: there are some of us who think the “risk-free” rate is quite a bit lower than 6% for valuation purposes (which is not the same as funding purposes… I think 6% for funding plans seems reasonable.)
Reading the footnotes, it sounds like unfunded obligations would be financed in a level $ amount over 30 years, but this is not totally clear to me.
PENSIONS AND INVESTMENTS COVERAGE
10-year equity rally isn’t enough to raise public plans’ funded status
U.S. public pension plans’ funded status dropped in the 10 years ended 2018, during a period when equities rallied, said Ashwin Alankar, portfolio manager and head of global asset allocation and risk management at Janus Henderson Investors at The Pension Bridge Annual conference in San Francisco.
…..
If pension plans haven’t been able to improve their funded status in an era of a rally in risky assets, “one potential solution is we can take more risk in our portfolios,” Mr. Alankar said.
(note: that wasn’t approval)
Yes, they’re not getting the returns they want, so let’s go to the casino!
sigh
Okay, guys. So. Let’s say you’re 80% funded. If we look at the history, we had a 36% drop in the S&P in 2008.
A recap of that, assuming no change in liabilities (which is not what happens, but let’s ignore that) – you have a new funded ratio of 64% * 80% = 51.2%.
Let me know how “safe” and “healthy” 80% fundedness is, eh?
And that’s just assuming regular market risk, and not the even riskier alternative asset classes.
Do I need to remind y’all how alternative assets can perform? Let me give you just three posts:
- Public Pensions and Alternative Assets: Dallas Shows How It Can End
- Which Public Pension Funds Have the Highest Holdings of Alternative Assets? Has It Paid Off?
- Alternative Assets and Pension Performance: A Dive into Data
Alternative assets are a great way to lose money faster, especially if you’re a pension fund driven by desperation.
(I should look at what Calpers is up to.)
LIABILITY GROWTH DOESN’T CARE ABOUT ASSET GROWTH
Let’s go back to P&I article:
“Despite the rally, pension plans’ funded status did not improve” from 2008 to 2018, Mr. Alankar said. “Compounding matters is that liabilities have not let up,” he said.
….
During breaks, consultants and pension officials queried by Pensions & Investments attributed the failure of the bull market to help their funded status to employers failing to consistently make their actuarial contributions to the plans or pension fund being too risk adverse.
AYFKM.
Go and look at my graph above, re: 100% ARC payers. If you look at their asset allocations, I would not say they are risk-averse.
What is this crap.
In a separate panel, with Elizabeth T. Burton, CIO of $16.8 billion Hawaii Employees’ Retirement System, Honolulu; John Claisse, CEO at Albourne Partners; Ryan LaFond, deputy CIO of Algert Global; and R. Christian Wyatt, head of multistrategy research at Angelo, Gordon & Co., highlighted that while hedge funds have had a tough time lately, investors shouldn’t count the industry out.
“The hedge fund industry has plateaued, but the strategy has continued to expand,” Mr. Claisse said. “The outlook for hedge funds is quite positive with the exception of long/short strategies.”
Rapid advances in what used to be called “alternative data” that had helped long/short managers outperform are now widely available, Mr. Wyatt said.
….
Hawaii doesn’t invest in traditional hedge funds, said Ms. Burton, who until July had been managing director, quantitative strategies group at the $46.3 billion Maryland State Retirement & Pension System, Baltimore. “Not every hedge fund is the same,” she said.Ms. Burton added that hedge fund investments are “not going to work” for short-term investors.
“Performance has not been fantastic,” Ms. Burton said. However, “I can’t think of anything other than a Ponzi scheme” that never underperforms, she added.
At the Maryland pension fund, she said she was limited to not taking more than 0.2 beta in portfolio volatility.
She likened the limitation to parents giving their high school-age child a 10 p.m. curfew and locking the door “but the window is still open,” Ms. Burton said. “You can’t have rules. … You have to tie in incentives to make sure the manager has incentive to find the best fit.”
….
“I was forced to invest $1 billion in BlackRock (BLK) because I could not find” hedge funds in which she wanted to invest, Ms. Burton said.
“forced”?!
Forced, because you reaaaaally need the returns?
I’m sure the special market will give you what you need.
Okay, maybe not.
When asked for her favorite hedge fund strategy, she gave two: quantitative multistrategy managers to find uncorrelated investments and general partner stakes for the consistent coupon or income as well as for diversification.
“I would not have said this five years ago,” Ms. Burton said. “I miss the big macro giants of the 1990s. That’s why I got into this business…. I wanted to be a macro gunslinger.”
Um, well. Maybe that’s a good strategy. But, there’s a reason the macro of 20 years later is very different from the macro of the 90s.
I know I can give good quote to financial reporters (because I have no shame), but I’m generally giving quote re: something that’s not my actual job (like talking about actuarial professional groups.)
I mean, reporters out there, you can quote me, I love the life/annuity industry because I like thinking about death. (I wrote this in 6th grade, as an example).
But I’m not running a public pension fund talking about getting into very risky asset classes to try to support pension payment promises that are not supposed to be risky.
THERE IS NO MAGIC TO FILL THE HOLE
I am not afraid of risk, but I am the one who is not only making the risk decision but also having the brunt of the decision fall on.
If I’m working with respect to life insurance or annuities, I’m trying to match the asset risk to the liability risk. It’s supposed to be a low-risk promise, so I wouldn’t be throwing large amounts of the assets backing that promise into very high risk categories.
For annuities/life insurance, I have to cover the core promise, and I need to make sure that has assets matched to the promise — mostly bonds, so that’s expensive. But an insurance company is required to have additional funds on top of those covering the expected payouts. Maybe people will live a little bit longer. Maybe the benefit levels will be a little bit higher than we originally expected. So we have required capital for those extra risks.
But wait — there’s more!
Insurance companies have surplus beyond the required reserves (covering the core promise) and required risk capital (covering some adverse outcomes). The surplus isn’t required — it’s extra. So insurers can do the “weird stuff” for the surplus investment.
Okay, even so, it generally isn’t that weird. But insurers make a distinction between reserves+capital investments, and surplus strategies. You have more leeway for the surplus.
But pretty much none of the public pensions have any surplus.
When a public pension fund takes on additional risk, when it’s deeply underfunded, it might pay off for the taxpayers in reducing future contributions.
However, what has generally occurred is that these Hail Mary passes do not complete, and those trying to be “clever” end up having to go to the taxpayers to ask for even more money than if they had simply done appropriate asset-liability matching.
By trying to hide how expensive these promises actually are, a lucky few manage to get the jackpot, and most find that they’ll need even more money to fill the hole.
It’s one thing when you’re gambling with your own money.
But if it’s other people’s money?
If public market returns and “risk-free” returns don’t get you want you want, you are taking additional risks that impinge on taxpayers, public employees, and bondholders.
Did you ask them if they wanted to take that risk?
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