Yesterday the Pension Funding Council met and agreed to make changes to the economic assumptions of state retirement systems, including lowering the investment return assumption from 8 percent to 7.9 percent for the 2013–15 biennium. Additional reductions in later biennia were not agreed to at this time.
At the end of August, the Office of the State Actuary had released reports on the financial condition and long-term economic assumptions of the state’s retirement systems. The actuary is required to make these reports to the Pension Funding Council every two years.
The actuary notes in an introductory letter that since his last report on August 31, 2009,
the funded status for all plans improved due to subsequent investment performance, funding, and benefit changes during the 2011 Legislative Session. However, looking forward, we still expect contribution requirements to increase as the plans fully recover from the effects of past funding shortfalls and the 2008-2009 drop in funded status. In addition, current and potential litigation would change the financial condition of the affected retirement systems should the court order reinstatement of recently repealed benefits.
(And indeed, on October 11, the Washington State Federation of State Employees filed suit over the repeal of certain automatic cost-of-living adjustments for PERS 1 and TRS 1 that was enacted this year. The actuary’s report shows what the impact on the general fund-state would be if both gain sharing and this COLA are reinstated by the courts: Employer contributions to PERS, TRS, SERS, and PSERS would have to increase by $639.7 million in 2013-15.)
The actuary recommended decreasing the inflation assumption from 3.5 percent to 3 percent; decreasing the annual investment return assumption from 8 percent to 7.5 percent; and decreasing the general salary growth assumption from 4 percent to 3.75 percent. The actuary would phase in the investment return assumption decrease over 10 years by 10 basis points per biennium (7.9 percent in 2013-15, 7.8 percent in 2015-17, etc). Such a phase-in would reduce the budgetary impact in 2013-15. With the phase-in, GFS spending on contributions would increase by $27.4 million in 2013-15 (as opposed to $261.6 million if the rate dropped to 7.5 percent in 2013–15).
According to the actuary’s report, “lowering the rate of return assumption will increase affordability risk (less affordable) . . . due to increased contribution requirements in the short-term.” That said, “contribution rates become less volatile under the recommended 7.50 percent assumption than under the current prescribed 8.00 percent return assumption.” Also, “Lowering the rate of return assumption will decrease ‘pay-go’ and ‘low funded status’ risks” because there will be more assets on hand.
In our April 20 brief, Reforming Public Pensions, we looked at Washington’s pension situation and discussed the rate of return assumption issue. Assuming high rates of return means that states can keep contribution rates lower, because investment returns are expected to cover more of the costs. Many economists argue that rate of return assumptions should be much lower than the national average 8 percent.
Washington Research Council 