Top of the pension class
Size doesn’t matter. It’s how you are allowed, expected and required to manage
Published January 1, 2011 | January 2011 issue
If pensions were a dating game, some plans might go unnoticed. They live modestly. They don’t buy on impulse. They pay their bills religiously. They prefer safety over risk. They probably wear tan sweater vests.
Yet in the pension world, this modesty would be the envy of plans across the country. While pension plans are almost universally underfunded at the moment, some plans have weathered the storm better than others.
In the district, two plans at opposite ends of the spectrum stand out: the Wisconsin Retirement System, with $80 billion in assets, and the city of Sioux Falls, S.D., which sponsors two separate plans for general workers and firefighters, and has assets of about $350 million.
In each case, these pensions are hard-wired to keep fiduciary responsibilities front and center. They offer modest benefits and make required contributions that keep the actuaries happy; each has a more conservative investment expectation than its peers and a few unique wrinkles to protect members and taxpayers from catastrophic events.
Meet the contestants
In Sioux Falls, the city’s latest full-year estimate put the funded ratio at about 87 percent for the two plans. While that leaves some room for improvement, the city beats the pants off most locally sponsored plans. In Minneapolis, none of the city’s three sponsored plans is above 80 percent, and its largest plan (MERF, for general employees) is 56 percent funded, has unfunded liabilities of $700 million and has recently been consolidated with a state plan. In Fargo, N.D., city-sponsored pensions for general workers and firefighters are a combined 61 percent funded.
Tom Huber, Sioux Falls assistant director of finance, outlined a number of reasons why the city has managed to keep its pension upright. For starters, the city is required by state law to make full, actuarially based contributions. Unlike most plans, large or small, “when times were good, the city and pension board did not increase benefits,” said Huber, adding there have been “no major changes” in the plan in at least 15 years.
Huber also noted that the city budgets very conservatively and “faces its liabilities straight up”—an approach the rating agency Moody’s noted in a credit rating when the city was looking to raise money in the bond market, he added. The city amortizes its unfunded liabilities over just 14 years—about half of the amortization period for most plans. The city even started funding retiree health care before the term OPEB (other post-employment benefits) became a common part of the pension lingo. Though it only partially funds this retiree obligation, its commitment to date far exceeds that of most local plans.
“The pension board takes its fiduciary role very seriously,” Huber said. “The key is to fund [pensions] before they become a crisis, so you’re managing from a position of strength.”
That doesn’t mean things are perfect. Like elsewhere, rising pension costs are putting pressure on the budget, and the city is studying its options, including the possibility of having new employees join the statewide system. It’s all part of a continual process of trying to predict the future, said Huber.
Some people call that guesswork, but the plan has been a decent soothsayer. In 2007—“before the downfall,” according to Huber—the city took the prescient action of lowering its investment benchmark from 8 percent to 7.75 percent. “We got out ahead” of the market collapse, he said, because the board felt at the time that it would be increasingly difficult to consistently achieve an 8 percent return.
David, meet Goliath
The Wisconsin Retirement System (WRS) has experienced some of the same hard knocks as other plans, including a 26 percent investment decline during the financial market collapse.
Yet the plan is nearly 100 percent funded. (A technical caveat: Its high funding ratio is due partly to the fact that it uses a different method (frozen entry age) to calculate liabilities than the one used by most plans (entry age normal), according to Dave Stella, secretary of the Wisconsin Department of Employee Trust Funds, which administers the plan. Regardless, using the EAN method, the fund would have been 88 percent funded in 2009, still close to tops in the district.)
That funding stability comes from a couple of sources. The plan has the lowest multiplier of any plan in the district (at 1.6 percent per year of employment), and the average pension today runs to $1,900 a month—decent, but hardly rich.
Arguably more important is the plan’s system of governance. Stella said most pension plans are very cognizant of long-term sustainability, but often have to deal with elected bodies that have very different perspectives on funding responsibilities and plan health. So WRS has features that give it special, independent authority to enforce its fiduciary responsibilities.
For example, the system is legally required to make all actuarially required contributions, according to Stella, and it carries an enforcement stick just in case. If participating local governments choose not to fork over their calculated amounts, the plan can simply grab it out of that locale’s state aid. WRS also has the authority to increase employer and employee contributions without legislative approval. It did so recently, increasing both rates by 0.6 percent.
To Stella, the formula for relative stability is simple. “Governance structures are very important to success,” said Stella. “Who are the fiduciaries, and do they have the authority to act? I haven’t seen anyone go as far as Wisconsin has.”
In fact, WRS has one wrinkle regarding investment performance that might be unique across the entire country. The plan has a 7.8 percent return assumption—roughly in the lowest third of large plans nationwide. The plan pays ad hoc annual dividends based on investment performance, but makes no guarantee on future adjustments.
In fact, the only guaranteed portion of a retiree’s annuity is the original amount calculated at retirement. That allows WRS to claw back previous post-retirement annuity increases when investment returns fall. It had never used such authority until 2010, when it instituted its first ever “negative dividend” of 2.1 percent (and importantly, there have been no legal challenges). Retirees who voluntarily invested in a smaller, variable fund—which took a 39 percent clobbering—also took much larger hits to their monthly checks.
A white paper by Stella and Keith Bozarth, head of the State of Wisconsin Investment Board, which manages the plan’s assets, sums up the rationale. Because investment risk and reward is shared widely, rather than focused solely on the employer, the consequences of volatile returns are also viewed differently. Conventional wisdom says employers are best able to bear the investment risk and reward over time and absorb fluctuating results. “The equation has been changed with the WRS, and the interests of the employers, employees and retirees are aligned with respect to the volatility of investment returns. As volatility increases, all three groups share the potential downside result.”
In an interview, Bozarth said changing medium and long-term economic expectations have convinced the system to consider what he called “alternative portfolios,” including lower return assumptions. One reason is the uncertain economic environment for investments; low interest rates translate into return on cash of “virtually zero percent,” Bozarth said. To make up for that, other assets have to assume more risk, and “targeting that level of return may require taking on an undesirable level of risk.”
And this mentality holds despite the fact that WRS’s most recent full-year return was 22 percent. Said Bozarth, “We probably have a higher aversion to volatility than some plans do.”