Can Investment Assumptions Worsen the State Pension Fund Crisis?

BY Diane Lincoln Estes  June 22, 2011 at 2:53 PM EDT

By Diane Lincoln Estes

Well, no. Investment assumptions themselves don’t worsen the crisis but as we explain in our story on Rhode Island on Wednesday’s broadcast, decisions about pension fund investment assumptions can mean higher taxes, lower pensions and bitter politics. Why? Because the lower the assumed rate of return, the greater the official underfunding of the retirement plan, the more that taxpayers or workers must contribute to make up the shortfall that would arise from a more sober assumption.

Map developed by Justin Myers.

In Rhode Island, the decision facing the retirement board was whether or not to lower the fund’s assumed rate of return from 8.25 percent to 7.5 percent. Public employees, already under fire nationwide for supposedly lavish retirement benefits, argued against lowering the assumption to 7.5 percent. The reason: dropping the rate of return assumption would mean the state having to come up with millions more a year to make up the difference. That would likely spur further taxpayer anger about public employees’ perceived generous benefits. In the end, a divided retirement board voted to lower the rate to 7.5 percent. The change goes into effect next summer.

So, what’s going on in other states? We’ve put together an interactive map, based on data from the Pew Center on the States showing how different investment assumptions affect pension funding across the country. Pew calculated each state’s funding level based on four investment return assumptions:

  1. Current Assumptions: Using the state’s own rate of return assumptions (as of February, 2009) for each of the state’s pension plans.
  2. 8 percent rate of return: More than half the plans use a rate of return assumption of 8 percent.
  3. 5.22 percent rate of return: Defined-benefit pension plans in the private sector use the interest rate for a high-end corporate bond, 5.22 percent as of March 2011.
  4. 4.38percent rate of return: Some experts suggest using a riskless rate–such as a rate based on a 30-year Treasury bond, 4.38 percent as of mid-March 2011.

Roll over the map and see how state funding levels vary depending on what the rate of return is. You can also pick the rate of return for all states at the top. For a particularly sobering view, click on 4.38 percent. The map turns completely orange and red which means that no state pension fund would be more than 70percent funded using the so-called “riskless rate” based on 30-year Treasury bond returns.