Special Report: Despite lowered target rates, Texas pension funds improve amortization period health

EXECUTIVE SUMMARY: When viewed in the aggregate and over time, Texas’ local pension funds have dramatically lowered their assumed rates of return for the last six years while also improving, by lowering, their pay-off periods for pension fund liabilities. The combination offers evidence that Texas pension systems are achieving stewardship goals for healthy defined benefit plans.

BACKGROUND: The Texas Association of Public Employee Retirement Systems conducts an annual survey of its 80+ members to understand and track portfolio asset allocations and other components of pension fund management. One component is the assumed rate of return, also known as the target or discount rate. The assumed rate is the future expected return on the fund’s assets. The accuracy of return assumptions has major effect on plans’ finances and the funding required[i] from both a city sponsor and its employees, to maintain a healthy pension system. If set too low, the assumed rate will cause a pension fund to overstate liabilities and costs, causing more money to be allocated to the pension fund in the near term, and undercharged in the long term. If set too high, the pension system will understate liabilities, thus causing the city to put less money into the pension fund.[ii]

TEXPERS also tracks Pension Review Board data which monitors the amortization period of 93 state and local pension funds.  The ‘am period’ is a concept similar to a pay-off amount for a mortgage: it compares the pension systems’ assets to the amount required for all present and future projected benefits to employees.

TEXPERS research indicates there is a 6-year trend of local pension systems achieving lower amortization periods. Texas Pension Review Board says that amortization periods are the single “most appropriate” measure of public retirement systems’ health.

POLITICAL CONTROVERSY: Opponents to defined benefit plans argue that the pension funds which have set their assumed rates at 8% or more mask the true amount of unfunded liabilities and cause the systems to take too much investment risk. The opponents say that lowering the assumed rates so as to help cities understand their true liabilities would cause them to abandon defined benefit plans in favor of defined contribution plans. They assert that all or most pension funds maintain an 8% or greater target rate but never offer empirical evidence about whether that is entirely factual.

TEXPERS ASSERTIONS:  TEXPERS asserts that greater understanding of two dynamics, of target rates and am periods, could support or dismiss the political controversy. In our view of surveys and PRB reports, the controversy can be dismissed through responses to the following questions:

  • What is the overall trend for assumed rates of return? Determining how many pension systems still maintain an 8% or greater rate and the overall trend for target rate increases or decreases could be helpful in gaining a higher level view.
  • What is the trend in amortization periods among Texas pension systems? By combining a trend analysis of amortization periods with similar trend analysis of assumed rates, the correlations would help clarify whether Texas pension systems are heading in the right direction.
Texas Local Public Employee Pensions Systems Have Reduced Their Assumed Rates of Return 
To determine how many pension systems have an 8% or greater assumed rate of return, TEXPERS examined surveys of its members in its yearly Asset Allocation report. Even though the survey is voluntary, and there are varying degrees of participation each year, it is safe to say that the systems have been lowering their assumed rates in the years 2011-2016.




These charts indicate that in number and percentage terms, most systems are working to lower their target rates below 8 percent. 

Texas Local Public Employee Pensions Systems Have Reduced Their Amortization Periods 
The 93 state and local pension funds which report financial statistics to the Texas Pension Review Board combined in 2016 to achieve continuing overall improvement to their amortization periods, according to a TEXPERS comparison of PRB data. The “am period” is the PRB’s single “most appropriate” measure of public retirement systems’ health.

The chart above indicates there are 37 pension systems in the Pension Review Board’s recommended amortization period of 0-25 years, which is two less than the 39 in September’s report. Even so, 37 is the second highest in the recommended category in the last seven years. The most substantial improvements in the 2016 period occurred in the five pension systems moving out of the >40<infinite category. While it is possible that one of those five moved into the infinite category, four others must have moved into the better category of >25<40 years. See the TEXPERS Am Period report here.

Summary:  In view of these charts and trend analysis, TEXPERS asserts that:
  • Texas state and local pension funds are reducing the target rates of return in line with experts’ recommendations for lowered investment returns.
  • The lowered expectations have not negatively affected pension systems’ ability to meet their obligations as evidenced by across-the-board improvements in amortization periods in the same period.
 
[i] “NASRA Issue Brief: Public Pension Plan Investment Return Assumptions.” Keith Brainard, Research Director, and Alex Brown, Research Manager. Updated February 2017, pg. 1.
[ii] Ibid.