In July, the board for the Oregon Public Employee Pension System (PERs) cut return assumptions from 7.2% to 6.9%.  The 6.9% return assumption was well above that recommended by the investment consultants Meketa Investment Group and the actuary for PERs Millman.  Meketa recommended a 6.6% assumption while Millman recommended 6.27%.

According to NASRA, based on July data, the range of return assumptions for state pension systems ranges from 5.25% – 8.0%.  The median assumption is 7.0%.

Why does this matter?

Pensions make promised payments to retirees.  If investment returns are not sufficient to meet the commitments the pension is said to be ‘underfunded’.  The unfunded pension liability has to addressed or the pension becomes insolvent.  In Oregon, employers have to make up the shortfall in the pension by making additional payments over a ten-year period.  This extra expense comes out of the budgets and puts pressure on employers to cut staffing and/or reduce services.  For example, school districts may cut back on hiring teachers to help cover the cost of the extra pension payments.

Does the reduction in return assumptions reduce pension payments to retirees?

No, the pension obligations made to employees / retires is not reduced.  The shortfall has to be paid for through higher employer funding payments and/or higher taxes.

Why are the consultants recommending forward return assumptions be lowered?

Return estimates for bonds have come down as interest rates have been on a long term down trend.  In addition, recent Fed action in response to Covid included driving interest rates down even lower.  Stock returns are a function of growth and current prices.  Stock returns have been very strong as a result of government stimulus, and low interest rates drive asset prices up.  As a result, although returns have been good recently, the future returns are expected to be lower.

For more discussion on forward return estimates, this article from Charles Schwab may be of interest – ‘Why Market Returns May Be Lower’.  In the article, Schwab forecasted growth for US large cap stocks is expected to be 6.6%.

How big is the pension problem nationwide and where does Oregon fall?

Based on the most recent data from the American Legislative Exchange Council, the total unfunded pension liability in the US is $5 Trillion.  This comes to about $15,000 per person.  Oregon is in rough shape.  On a per capita basis, the unfunded pension liability in Oregon is ~$20,000 per capita.  This places Oregon in the bottom 20% of all states.

So, how big of a budget problem will it be for employers?

I did a quick calculation based on the most recent data available from Oregon on the unfunded pension liability found here,  Pension Summary UAL (oregon.gov).  Focusing just on the tier 1/tier 2 local school districts and state and local government the unfunded liability is 37.5%.  Roughly speaking, this is $20 B in shortfall.  The payroll that supports these programs is roughly $10 B.  If these entities had to pay back the shortfall over 10 years, it would cost over 20% of their budgets.  This calculation is based on the higher return assumptions.  With the lower return assumption the problem is even bigger.  These school districts and local governments are being dragged down by having to pay for pension plans that were promised to employees with return assumptions that were wildly off from reality.

Is my PERs pension safe?

So far, the courts in Oregon have demonstrated that they won’t allow the legislature to cut into the promises made.  All things being equal, cuts to services and possibly higher taxes to make up the unfunded pension liability seems much more likely than any direct impact to PERs retirees.  New hires don’t receive the same pensions, so gradually the situation should improve.

The PERs board took the easy route by adopting a return assumption that is higher than that recommended by their own consultants and actuaries.  Some say they are kicking the can down the road.  Others say they don’t want to put too much pressure on government and school budgets and so they want to ‘smooth’ the rates down.  It would be a very tough decision to make.  On the one hand, hoping for higher returns is wishful thinking.  On the other hand, driving government reimbursement rates up in the current environment would create more budget pain in the short term.  It would have been a very difficult decision to make.