State Pension Fund Falling Short of Benchmark Return

A report by the same consultant that the U.S. Treasury tapped to help oversee its bailout fund for banks says that the North Carolina pension fund has an expected long-term return of 6.7 percent, below the level the state has been predicting.

North Carolina uses an investment return rate of 7.25 percent when calculating how much the state needs to contribute to the Teachers’ and State Employees’ Retirement System each year, even though its average annual return for the last 10 years is less than half that — about 3.4 percent, according to the latest annual report.

The difference means that North Carolina could potentially face a shortfall of billions of dollars, which may require higher contributions from taxpayers or lower benefits to retirees.

More than 800,000 current and retired public employees are members of TSERS.

Edward Siedle, a former attorney with the U.S. Securities and Exchange Commission, noted that the expected rate of return for famed investor Warren Buffett’s Berkshire Hathaway Inc. is 6.9 percent.

“How can a group of lug nuts dramatically outperform the best investor in the world?” asked Siedle, the president of Benchmark Financial Services in Ocean Ridge, Fla. “I would never claim to outperform Warren Buffett. For them to claim that is, in my opinion, the height of stupidity or arrogance. If they’re wrong, which is likely, the repercussions are enormous for North Carolina taxpayers.”

Heather Franco, a spokeswoman for State Treasurer Janet Cowell, said the 6.7 percent figure in the report by Ennis, Knupp & Associates is based on achieving benchmarks and doesn’t account for outperforming those targets.

“The investment staff periodically review asset allocation strategy with the goal of meeting or exceeding the 7.25 percent return,” Franco said. “Staff are currently performing such an asset allocation study to determine how our investment strategy might be altered in the current investment environment.”

North Carolina actually is more conservative in its assumptions than many public pension plans. The median rate of return for 125 plans in a survey sponsored by the National Association of State Retirement Administrators and the National Council on Teacher Retirement is 8 percent. The rates range from 6 percent in Minneapolis to 8.5 percent for funds such as the Missouri State Employees and Houston Firefighters.

“Almost every public pension in the country has this type of mismatch,” said Chris Tobe, a trustee for Kentucky Retirement Systems. “North Carolina is probably better than average.”

The General Assembly passed a law last year designed to boost returns by adding investments like junk bonds and commodities to the state pension portfolio.

“It’s my hope that we will at least have a fighting chance,” Cowell said last year.
The Ennis, Knupp report said the changes to the pension account for about 3 percent of the portfolio.

“The inclusion of the inflation and credit portfolios will impact the expected risk and return of the portfolio, but only to a small degree given their relatively small allocations,” the report said.

A report last year by Barclays Global Investors, which assumed a rate of 6.92 percent, said the state may have to contribute $3.3 billion more to the pension fund if it didn’t increase returns.

Cowell said last year that she planned to ask the General Assembly for an additional $329 million in pension contributions during the 2010-2011 fiscal year.

Ed Macheski, a retired New York money manager and Alamance County resident who has been critical of the pension system, said Cowell should change the rate the state uses uses in calculating annual contributions to the pension.

“I think the treasurer would be more responsible to put in a realistic rate of return and let the chips fall where they may,” he said. “Otherwise, they underfund the pension.”

The state treasurer’s latest annual report said the pension is 99.3 percent funded, down from being fully funded the previous year.

“Even if we achieve investment target returns as the economy recovers, it is very likely that the funding status will continue to decline as losses from the 2008 downturn are distributed over the next several years,” the report states.

The State Employees Association of North Carolina has criticized the contributions the state has made to the pension system. For years the state’s contributions have been modest because of high investment earnings. In 2003, the state didn’t contribute at all, and in 2004 the state contributed an extra 0.22 percent of employee pay.

Ardis Watkins, the legislative affairs director for SEANC, said she didn’t expect the General Assembly to contribute enough to make up the funding gap. “It’s clear that’s not going to happen,” Watkins said. “We don’t have that kind of money. We have great concern about the fact that the system wasn’t funded adequately, and now we’re seeing the after effects of that.”

Sarah Okeson is a contributor to Carolina Journal.