Despite nearly a decade of sustained economic growth and stock market gains, not all state-sponsored pension plans have been able to recover from the Great Recession. In fact, The Pew Charitable Trusts’ most recent analysis of publicly reported data shows that the disparity between well-funded and fiscally strained state retirement systems has never been greater.
Looking ahead, an economic downturn is inevitable. Further, a sustained period of low growth could also have a substantial impact on many pension fund balance sheets—and, in turn, on state budgets. To address such concerns, leaders in the field agree that more robust risk reporting is necessary to help key decision-makers—including legislators, budget officials, and plan fiduciaries—navigate economic cycles.
In July, the John F. Kennedy School of Government at Harvard University released a report detailing the proceedings of a conference last September that brought together more than 40 industry experts, government officials, academics, and other stakeholders. Organizers planned the conference, “Better Measurements: Risk Reporting for Public Pension Plans,”with the goal of identifying core measures and metrics that should be included in a comprehensive approach to risk reporting.
Participants addressed ways to better measure, report, and manage pension plan risk in ways that support planning and decision-making by fiduciaries and policymakers. While opinions varied, common themes and recommendations emerged. As a starting point, conferees largely agreed that initial improvements should focus on measuring investment risk—the potential that investment returns will be lower than expected—as well as contribution risk, the potential that future taxpayer contributions will need to increase.
With those two measures in mind, Pew representatives presented a proposed foundation for pension risk reporting. The final version of Pew’s five-point framework, published in November, incorporates feedback from attendees and has been endorsed by the conference organizers. It is designed to help officials understand how pension investment risk could strain government budgets, evaluate the impact of contribution risk on pension system solvency, qualify the range of likely costs for current benefits, and assess the effect of market volatility on expected employer contributions.
The framework builds on recommendations made in a 2014 report by the Blue Ribbon Panel on Public Pension Plan Funding, commissioned by the Society of Actuaries, as well as on established and proposed government accounting and actuarial standards.
Notably, the Pew proposal emphasizes stress testing, a financial analysis that can assess how pension funds would fare during a financial crisis or a period of lower economic growth. Stress testing looks at a range of potential economic scenarios, both positive and negative. The results can then help policymakers plan for market downturns, examine the need for making full actuarially recommended payments, improve budgetary planning, and evaluate proposed retirement plan changes.
The discussion at the Kennedy School was not just an academic exercise. Nationwide, efforts to bring more transparency to the real costs of pension investments and ensure the availability of tools to measure and manage financial market risks are gaining traction.
Ten states now require some measure of routine financial risk analysis and risk reporting for their public worker retirement funds. The assessments are designed to inform a broader audience, including state officials and legislators with budget decision and planning responsibilities. In the last two years, Colorado, Connecticut, Hawaii, Indiana, Maryland, Montana, New Jersey, and Virginia have adopted the practice. Others are considering legislative proposals.
While there’s no one-size-fits-all solution to public pension funding challenges, experts agree that policymakers need tools that help them understand how financial market volatility and shifts in the broader economic landscape can affect their retirement plans. Stress testing can help states better prepare the pension systems for their workers and retirees for all cycles of the economy.
Susan Banta is director of research and Fatima Yousofi is an officer with The Pew Charitable Trusts’ public sector retirement systems project.