Wednesday, June 27, 2012

Illinois Public Pension Rate of Return Assumptiom to be Cut

Illinois Pension Fund May Cut Return Target has the breaking news:

"The Illinois Teachers' Retirement System's top official said the pension fund might lower its annual-return target, now among the highest in the U.S.

"My guess is that it comes down," Richard Ingram, executive director of the $31 billion pension fund, said in an interview with The Wall Street Journal. "We are not immune from financial reality. We are looking at the same numbers as everyone else."
[image] Illinois TRS
Richard Ingram

The Illinois Teachers' Retirement System provides pensions to 101,000 retired public-school employees in Illinois. Its current 8.5% assumed rate of return has been in place for 25 years.

Lowering the annual-return target could increase the pension fund's liabilities by billions of dollars even as Illinois is struggling to keep up with current pension payments, which have soared.

But the cloudy near-term outlook for returns on the pension fund's investments makes it likely that actuaries will recommend a cut in the annual-return target, he said. "It's an unforgiving equation," he said.

The pension fund's board could vote on the move in August.

The Illinois Teachers' Retirement System was 46% funded as of June 30, 2011, meaning its assets as of that date covered just 46 cents of every $1 in future liabilities. State pension funds in Illinois are among the lowest-funded in the U.S.

Public-pension funds across the U.S. are under scrutiny for using assumptions that some critics say are too optimistic. Pension funds also use their assumed rates of return to calculate the present value of their future obligations. The higher the so-called discount rate, the lower the liabilities are.

But some large public-pension funds are capitulating to the grim realities of slow economic growth and volatile markets.

Earlier this month, New Jersey officials approved lowering the assumed rates of return at the state's pension funds to 7.95% from 8.25%, according to a spokesman for New Jersey's treasury office."

My Take

The pathetic  funding level of Illinois pensions for its teachers will look even worse sometime soon, according to the report.

In simple language, a lower expected return means a greater future liability. If I owe $1 in ten years and expect to earn zero, I'd have to fund that $1 now. However, if I expect to earn 7% annually, I'd only be required to set aside 50 cents now in order to have $1 ten years from now. That's the rule of 72 at work. Thus, 7% x 10 years = an approximate doubling of the initial amount invested.

In any case, it appears that Illinois actuaries will "urge" the pension  fund to reduce its rate of return expectations which in turn will mean its unfunded liability increases. It's simple accounting or bookkeeping at work. Nothing else.

What really needs to happen is that sufficient money needs to put into the fund and then invested properly to achieve a solid rate of return over time.

Until now, there hasn't been enough money set aside. Changing the rate of return assumption won't change that. Nor will it change how well the investments do when the money has been contributed.

Here's the only rate of return equation that makes sense to me: Real funding level at any future point in time = real money contributed now + real investment return earned over time.

Thanks. Bob.

No comments:

Post a Comment