The board that oversees Oregon’s Public Employees Retirement System (PERS) voted Friday to reduce the expected return assumption for the plan from 7.5% to 7.2%. The new rate assumption will take effect in 2019.
Why is the Expected Return Assumption so Important?
In a pension system, future payments are a liability of the fund. The fund must cover those future payments with current assets, plus future returns. The difference between the future liabilities and the assets plus expected returns is referred to as ‘unfunded pension liability’. If you cut the assumption for future returns, the unfunded liability of the plan increases.
Additional Discussion on Rate Assumptions
Oregon PERs board considered a number of inputs in making its decision. The citizen panel that oversees PERs, The Oregon Investment Counsel, recently adopted an internal estimate of 7.1%. This rate was adopted based on consideration of four outside consultants. Milliman, Inc., Oregon PERs actuary, has projected that PERs will generate 6.7% return over the next twenty years. According to the Oregonian, ‘The board was clearly motivated to lower the rate after its actuary Milliman, Inc. urged it to go to at least 7.25 percent. Had the board not acted, Milliman said it would have flagged the state’s refusal to adopt a more realistic earnings assumption in its next report card on PERS.’
According to the National Association of State Retirement Administrators, the median assumed return rate in use as of February 2017 was 7.5%. California PERs has recently announced they will reduce their assumed rate of return to 7% over the next three years.
What Returns has PERs Achieved Historically?
According to data presented by Callan and Associates to the Oregon PERs board, the fund has averaged 5.5% return over the past 10 years (through March 2017). The median fund tracked by Callan returned 5.65% over the same period.
What is the Unfunded Liability for Oregon PERs?
Based on the current previous assumption of 7.5%, Oregon PERs had an unfunded liability of $22 billion. With the new assumed return rate, the unfunded liability jumps almost 10% to $24.1 billion.
What Happens Now?
Employers must make up the difference. State and municipal government pays in a contribution to cover pension benefits that accrue each year. In addition, they pay in a surcharge to help reduce the total deficit. The PERs board does not require full payment. They set a rate ‘collar’ to limit impact on budgets in the short. As a result of the rate ‘collar’, unfunded pension liability continues to increase.
According to the Oregonian, given the current deficit, employers PERs contributions should have gone up $2.4 billion for the two-year period beginning in July. Instead, employers are only being asked to make up $885 million. This new assumed rate change will only make things more difficult.
What is the Legislature Doing?
The Oregon legislature did not address PERs reform this session. Governor Kate Brown established an expert panel to address pension costs this Spring. The panel is expected to report back November 1st. She asked that the panel focus in three areas: 1) sell off state assets (excluding forest and parks), 2) requiree employees to contribute a larger share of their pension accounts, and 3) hire more internal staff so outside consultant costs can be reduced.