Assumed average public pension rate of return hits 40-year low

According to the National Association of State Retirement Administrators, the average investment rate of return assumption for US public pension funds has fallen below 7.0%, the lowest level in more than 40 years.

Of the 131 funds measured by NASRA, more than half have lowered their return on investment assumption since fiscal 2020 as rising interest rates and other factors contributed to more volatile investment returns.

For the 30-year period ending in 2020, public pension funds accrued about $8.5 trillion in revenue, according to NASRA, of which $5.1 trillion, or 60%, came from revenue. shift. Employer contributions accounted for $2.4 trillion, or 28%, and employee contributions, $1 trillion, or 12%.

“The large portion of income from investment income reflects the important role it plays in funding public retirement benefits,” says a NASRA brief on the subject.

The NASRA report also notes that a difficult aspect of setting the investment return hypothesis that has emerged recently is a discrepancy between expected returns over the next five to 10 years and expected returns over the next few years. next 20 to 30 years. Because many short-term projections calculated recently are well below the long-term assumption that most plans use, according to NASRA, some pension funds are faced with the choice of maintaining a higher-than-expected return assumption at short term or reduce their return. assumption to reflect short-term expectations.

“If actual short-term investment returns turn out to be lower than historical norms, plans that maintain their long-term return assumption are likely to experience a steady increase in unfunded pension liabilities and corresponding costs,” the brief states. of NASRA. “Alternatively, plans that reduce their assumption in the face of reduced short-term projections will experience an immediate increase in unfunded liabilities and required costs.”

The investment return assumption used by public pension plans typically consists of two components: inflation and the incremental return above the assumed inflation rate, also known as the real rate of return. The sum of these components constitutes the nominal rate of return, which is the rate most often used.

The NASRA briefing note shows that although the average nominal return on public pension fund investments has declined, the average real rate of return has increased to 4.60% in FY2020 as the rate assumed average inflation fell faster.

According to the NASRA, one of the factors likely to contribute to the increase in the real rate of return is the higher allocation that public pension funds devote to alternative assets, in particular private stocks, which tend to have higher expected returns than other asset classes. At the end of the first quarter of the year, the Federal Reserve reported that public pension plan assets totaled $5.76 trillion, down 2.5% from $5.9 trillion in the previous quarter. and an increase of approximately $460 billion compared to the same quarter of the previous year, or 8.7%.

As the NASRA brief notes, actuarial assumptions fall into one of two main categories: demographic and economic. Demographic assumptions relate to factors such as changes in the number of active and retired plan members, as well as when members will retire and how long they will live after retirement. In the meantime, economic assumptions relate to factors such as the rate of wage growth and the expected future investment return on fund assets.

“Because investment income accounts for the majority of a typical public pension fund’s income, the accuracy of the return assumption has a major effect on a plan’s finances and actuarially funded level,” the report says. NASRA memory. “An assumption that is significantly wrong in either direction will result in a misallocation of resources and unfairly distribute costs across generations of taxpayers.”

Related stories:
North Carolina lowers assumed state pension rate of return to 6.5%

Record returns prompt NY to reduce alleged return rate to less than 6%

Funding of public pension plans increases in 2018, assumed rates of return fall

Tags: actuarial rate of return, assumed rate of return, investment return assumption, NASRA, National Association of State Retirement Administrators, public pension, public pension funds

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