The General Assembly is poised to give Treasurer Janet Cowell additional authority to invest state pension funds in assets that regularly have missed investment goals. Senate Bill 215 would allow the state treasurer to invest up to 10 percent of the retirement system funds in the “alternatives” class of investments. That class includes “limited partnerships, limited liability companies, or other limited liability investment vehicles that are not publicly traded.” Right now, Cowell can invest only 5 percent of retirement funds in that class.
The goal is not to put more money in low-performing investments, but to add more diversity to the state’s retirement portfolio, according to Shawn Wischmeier, chief investment officer under Cowell. “It kind of gets back to what your mother or grandmother told you,” Wischmeier said. “Don’t put all your eggs in one basket. So the key is to utilize different tools in very small amounts.”
But critics contend that the pension funds have been counting on unrealistic returns for years. Expanding the range of investments only would increase the risk of losses. Pension managers expect a 7.25 percent return on investments, but actual returns over the past 10 years have been closer to 5 percent. Reducing the expected rate of return would expose a heretofore hidden liability in the pension system; accounting for that liability would require the General Assembly to commit much larger contributions from taxpayers.
Most of the retirement system’s stock investments are made by outside money managers. The bill also would allow the treasurer to invest pension funds directly in such alternatives as long as they are managed by using a “published market benchmark index.”
The state’s retirement systems include several funds for a variety of public employees. The largest is the Teachers and State Employees Retirement System. It accounts for about 75 percent of the state’s retirement funds. The board of trustees for TSERS expects investments to return 7.25 percent. It also expects the state to contribute 6 percent of payroll every year to add to the fund. Employees contribute an additional 6 percent of their pay.
Cowell’s office releases quarterly reports on the investment returns of all the state’s retirement systems. As of December 31, 2010, she reported the total retirement system’s funds were worth $72.4 billion. The one-year returns looked good for traditional investment classes such as stocks, 15.24 percent, and bonds, 9.45 percent.
At 5.94 percent, the one-year returns don’t look so good for the alternatives. These are the investments Cowell wants additional authority to use.
While one-year returns beat the 7.25 percent goal, longer-term returns consistently have fallen short in nearly all asset classes. Combined 10-year returns on all assets were 4.99 percent. The alternatives lost 1.85 percent of their value over the 10 years ending December 31, 2010.
Sen. Ralph Hise, R-Mitchell, co-sponsored S.B. 215. He said he has not looked at the quarterly news releases from Cowell. However, he said the treasurer’s office provided information on investment returns while lobbying him to support the bill.
The perception of a lack of oversight has pension watchdogs like Ed Macheski disappointed in legislators. “How can these guys vote and make good decisions when I don’t think they’re sharpening their pencils and paying attention to business?” Macheski asked.
Macheski is a retired money manager from New York who at one time managed a significant portion of the New York State Teachers Retirement System. He acknowledged the obligation Cowell has to safeguard the retirement benefits promised to state employees.
“There’s a lot of pressure being put on the treasurer and her staff to generate very good performance, because they’re behind the eight-ball.”
The treasurer is playing catch-up for two reasons. First, the retirement funds haven’t met the 7.25 percent expected return over any lengthy period. And for the first time, the former Democratic leadership in the General Assembly failed to provide the state’s annual required contribution to TSERS this fiscal year.
Dealing with both problems would require the state to come up with large sums of cash. If the board of trustees lowered the expected rate of return even a fraction of a percentage point, it would have to acknowledge the unfunded liability created by investments that routinely have not met the 7.25 percent target. All actuarial calculations of the retirement system are done using the assumed 7.25 percent return rather than the real returns detailed in the treasurer’s news releases.
A smaller but no less significant liability was created when General Assembly Democrats did not pay the annual required contribution. In order to catch up, the forthcoming Republican budget would have to contribute at least $785 million to TSERS alone, according to the treasurer’s office. Gov. Bev Perdue’s budget proposal suggested contributing only $602 million.
“I’m definitely making the case and the argument as much as I can that we can’t continue to fail to fund it this year,” Hise said. “It just keeps making the problem worse and worse.”
Senate President Pro Tem Phil Berger, R-Rockingham, and Speaker of the House Thom Tillis, R-Mecklenburg, also have acknowledged a desire to fund the state’s annual required contribution fully.
S.B. 215 cleared its first committee vote March 31. An amendment by Sen. Richard Stevens, R-Wake, opened the door for Cowell to stop relying so heavily on outside money managers. It was adopted. Otherwise, the measure faced little debate. The Senate Finance Committee will consider it next.
Anthony Greco is an associate editor of Carolina Journal.