They just won't stop stretching the projections. Politicians and pension trustees keep ignoring market reality and clinging to unrealistic investment return projections — despite their pension professionals' advice. Last week it was Los Angeles Mayor Antonio Villaraigosa, who told his city's pension trustees to stop thinking about a quarter-point reduction in their actuarial investment-return assumptions. A reduction from 8 to 7.75 percent would mean a $50 million hit to his budget. This spring it was the giant CalPERS state pension board trustees, who ignored their own actuary and refused to cut their investment assumption from 7.75 to 7.5 percent . The higher rate of return appeased local employers, but even their own investment officer has admitted they will be unlikely to achieve that number. Although some pension plans are laudably trimming back their expectations to be more realistic--and the national averages have declined--there are plenty of holdouts.
As I explained earlier in a January column, we've entered a new world in which traditional assumptions about investment returns can't be used, if only because the interest rate on bonds is now much lower than historical norms. That one factor alone should result in lower expectations. Then we have to deal with the slower global growth that results from the hangover of excessive debts accumulated by consumers and governments in the past two decades-- which impairs today's corporate earnings trajectory. Even though the long-term (30-year) results of investments during malaise periods like this are historically favorable, the 10-year outlook that aligns with many public pension liabilities is obviously gloomier today than a decade ago. Retirees will probably no longer be around and the youngest baby boomers will be drawing pensions before we see those rosier historical returns.
GASB's brilliant proposal. For those looking for a better way to drive the projections process, the Governmental Accounting Standards Board (GASB) is now building a helpful foundation. Its proposed new pension accounting rules will require annual disclosure of a pension fund's asset mix and its expected rate of investment return by asset class (stocks, bonds, international, real estate, etc.). That way, investors and the public can see exactly how the pension trustees came up with their numbers. It won't take a genius to see that the trustees are stretching their numbers and their noses if they project bond returns of 5 or 6 percent when government paper is yielding 3 percent. Those who disingenuously forecast strong double-digit compounded returns for any type of asset in the next decade will have skeptics and second-guessing lawyers asking what they were thinking.
This alone won't stop the pension-Pinocchios from stretching the numbers to unrealistic levels and taking more risks than their portfolios should really accept. But such practices then will make them sitting ducks for lawsuits attacking them and their professional advisors for fiduciary negligence. Many investment consultants will be much more guarded in their projections as they become visible in public. Smart trustees will require documentation by an expert to protect them from hind-sighted fiduciary lawsuits if things work out as badly as they have in the past decade.
GASB's proposed rules won't be adopted officially until next year and will likely take effect in 2012-13. But they will force pension trustees to demand better data and put it out in public for everybody to see - including anybody who wants to second-guess them in the future. I predict we'll see a half-point drop in average assumed returns by 2014. By then many plans will also have to take into account their unfunded liabilities in setting their even-lower actuarial discount rates. That means higher and higher contribution rates for employers, and even more pressure on budgets from 2013 through 2015 and beyond.