ERS Board Lowers Assumed Rate of Return for Pension Fund

The Employees Retirement System (ERS) Board of Trustees lowered the assumed rate of return for the ERS pension fund to 7.5 percent at its Aug. 23 meeting. Previously, the assumed rate of return was 8 percent. The board also voted to revisit the assumed rate of return in two years, not waiting until the next review scheduled in four years by statute.

The decision was reached after months of discussion and analysis from ERS’ third-party actuaries. In July, actuaries had recommended lowering the return rate to no more than 7.25 percent.

An assumed rate of return is an actuarial assumption—in other words, a highly educated guess—about how investments will perform over the next 25 to 30 years. Actuaries use this economic assumption—along with demographic assumptions, such as mortality rates and the size of the workforce—to calculate how many years it will take a pension fund to pay off its current and future liabilities (the benefits promised to current annuitants and those still in the workforce). The unfunded liability period is a critical measure of a pension fund’s health.

The ERS pension fund’s FY 2016 actuarial valuation—or annual “check-up”—presented in December 2016 showed the pension fund to have a funding period of 35 years, down from infinite, following the 2015 implementation of 9.5 percent contribution rates for both the State and active employees. But that 35-year funding period was arrived at using the 8 percent return rate assumption, and the FY 2017 actuarial valuation, which the board will receive in December, will use the 7.5 percent return rate. Thus, the pension fund could once again show an infinite funding period.

This is concerning, but changing the return rate is not a problem in and of itself. Rather, it shines a light on an existing underlying problem: the fund’s $8 billion-plus unfunded liability. As board members discussed, they have a fiduciary responsibility to present an accurate picture of the pension fund’s health, and that health has suffered in what Board Chair Craig Hester called a “perfect storm”: legislative underfunding in 22 of the past 23 years, low interest rates set by the Federal Reserve, two recessions, two bear markets and more. The third-party actuaries hired by ERS to provide the actuarial valuation cautioned the board that not lowering the return rate or a delay in decreasing it could result in a “qualified” actuarial valuation in December, meaning the actuaries would be publicly disagreeing with the board’s assumption about future investment returns. Such disagreement could have detrimental ripple effects on the State’s overall financial health.

Lowering the assumed rate of return will not affect current annuity checks. It does make the likelihood of a 13th check or a cost-of-living adjustment for 20-year-plus retirees extremely low, as the board is only allowed to provide such a benefit increase when the fund is at and able to maintain actuarial soundness—a condition defined in statute as having a 31-year funding period. Retirees have not received a benefit increase since 2001.

The effects of lowering the return rate will be felt years down the road and depend on how the Legislature addresses the fund’s unfunded liability. Some interpret that the State has already reached its constitutional maximum contribution of 10 percent of payroll (9.5 percent from the State plus 0.5 percent from agencies), so increasing contributions is not a feasible option. Without improved investment returns, fewer potential paths of action exist, and benefit changes would be among them.

TPEA will continue emphasizing to the Legislature that:

  • The ERS pension fund is an essential tool for the State to recruit and retain a stable workforce;
  • The retirement benefits earned by current retirees and current active employees represent a financial obligation the State must meet;
  • State employees have been equal partners in funding the system; and
  • A delicate balance exists in state employee compensation. Those who dedicate their careers to public service do so with the understanding that a lower salary will be offset by superior health and retirement benefits.