Wisconsin Pension Official Details State's Approach to Weathering Market Volatility

In fiscal year 2020, America’s state public pension systems collectively met a crucial benchmark for minimum pension contributions for the first time since 2001. The discipline shown by states and plan administrators over the last decade to meet or exceed annual contribution targets has set the stage for improved long-term fiscal sustainability for state pension plans.

To maintain this trajectory, state policymakers must continue to make scheduled contributions, which in turn requires a plan to address future fiscal uncertainty from volatile investment markets. Some state pension systems have maintained high funded ratios at predictable costs over the past 20 years in part because they have strategies—including policies that target debt reduction while sharing gains and losses with workers and retirees—to mitigate cost increases during economic downturns.

Courtesy of John Voelker

Three states in particular—Wisconsin, Tennessee, and South Dakota—have delivered stability and sustainability through the economic ups and downs of the last two decades. And although these states’ plans rely on different benefit designs, they share several exemplary characteristics, including a path to retirement security for all workers within clearly defined cost targets, a plan for managing risk, and a commitment to ensuring that policies are transparent and clearly communicated to stakeholders.

To better understand the factors that contribute to these pension systems’ success, The Pew Charitable Trusts conducted a series of interviews with representatives from these states, including the following conversation with John Voelker, Secretary of the Wisconsin Department of Employee Trusts Funds (ETF), the agency that administers the Wisconsin Retirement System (WRS).

The interview has been edited for length and clarity.

Q. What are the Wisconsin Retirement System cost and retirement security goals?

A: By statute, the WRS must fulfill its benefit commitments to its members at the lowest possible cost—and the trust fund may not be used for any other purpose. These common-sense principles have served the WRS well; in its latest brief on state retirement systems, the National Association of State Retirement Administrators listed Wisconsin as the third-lowest-cost state in terms of contributions to pension as a percentage of all state spending at 2.12%.

Q. That’s nothing new, is it? The WRS has been a strong performer for decades.

A: You could go back to 1945, in fact, to understand the roots of the WRS. That’s when the state legislature established a joint committee to look at “the pension and retirement plans and laws of this state." The committee’s report in 1947 laid the groundwork for pension administration and governance for Wisconsin public employees.

Q. Since you’re giving us the history here, another landmark moment came in 1975. Can you tell us more about that?

A: Legislation that passed in 1975 consolidated pension fund systems for Wisconsin teachers, state workers, and local employees, excluding the city and county of Milwaukee and a few smaller funds. By the time that legislation was fully implemented in 1982, approximately 90% of all Wisconsin public employees became participants under WRS—making ours one of the largest state pension funds in the nation.

Q. Fast-forward another 15 years to an important court decision in 1997.

A: Yes, that’s when the Wisconsin Supreme Court upheld the principle that a plan’s contributed funds and earnings may only be used for the benefit of the plan’s beneficiaries.

Q. Today, what plan features do you think are most important for achieving WRS’ goals?

A: We strive to maintain stability and predictability in contribution rates. One way we do that is by spreading the cost of accumulated gains and losses over five years, which phases in the impacts of short-term investment experience.

We also frequently evaluate actual plan experience and adjust actuarial assumptions when necessary. We carry out annual actuarial valuations, as well as an actuarial experience study at least every three years—and we use the results to adjust, if necessary, our rate assumptions. We periodically examine long-term costs via a 50-year projection study, and again we make adjustments if necessary. Finally, we conduct stress testing biennially to assist in evaluating risk.

In addition, WRS has provisions in place to ensure that all employer contributions are remitted to the Department of Employee Trust Funds (ETF) on schedule; state law allows for a reduction in state aid to WRS employers if contributions are not paid.

Q. Like other top performers, WRS has paired a strong funding policy with a way to share risk and gains. Can you say a little about that?

A: WRS distributes risks and gains among employers, employees, and retirees. Risk is shared between the employers and employees by having both split the total cost of contributions. Risk is shared with retirees through the dividend feature, which allows for annual adjustments of retirees’ benefits based on the funding level of the system. That means that retirees see an increase if investment returns and actuarial conditions show that there are sufficient assets to pay for it. It’s a dividend that goes up if investments exceed expectations.

Q. Why have this shared-risk dividend instead of a cost-of-living adjustment (COLA)?

A: Funding a guaranteed COLA can be problematic in a market downturn. This policy, instead, allows for a reduced or suspended dividend to retirees—or even reductions in previously provided dividends—if that’s needed to preserve plan funding. The WRS’ post-retirement adjustments enable retirees to share gains and losses. But there’s also a guarantee that retirees will never receive less than their initial benefit. On average, this dividend process has stood up well over time, not only in maintaining full funding but also in mitigating the impacts of inflation on WRS retirees.

Q. Mitigating the impacts of inflation? How so?

A: Throughout its history, the WRS has successfully weathered a series of national economic crises. The WRS began in 1982, as the result of the merger of three previous state retirement systems, and it was a time of double-digit inflation and a recession. The next ten years included the “Black Monday” stock market crash of 1987 and the savings and loan crisis, in which about a third of the savings and loan associations in the United States failed between 1986 and 1995. The 2000s opened with a recession and market volatility after the Sept. 11 attacks, and the decade wound down with the Great Recession of 2008 and 2009. While no one could have anticipated these events, the shared-risk structure of the WRS’ post-retirement adjustments put the WRS on better financial footing than if it had a guaranteed COLA.

Our experience with the WRS indicates that over the long term, the dividend approach is a robust method for staving off the effects of inflation on retirees. From 1983 to 2021, U.S. annual inflation averaged 2.7%. Over the same period, WRS annuity adjustments averaged 3.7%.

Q. What has this shared-risk approach meant for plan participants?

A: It requires clear communication with plan participants so that employees and retirees understand that there’s no guaranteed COLA and that there will be variability in the annuity adjustments—and possibly negative adjustments. But it’s important to remember that WRS retirees have a backstop to negative adjustments with the guaranteed minimum benefit, which ensures that a retiree’s annuity can’t be adjusted below the initial annuity amount that person was getting at the time of retirement.

Q. So WRS does a good job of achieving retirement readiness for career workers. But how do you provide a meaningful benefit to short-term and noncareer workers?

A: WRS-eligible employees contribute to the WRS during their working career, and their employer matches those contributions. Employees who have five years of WRS service become vested and receive the employer and employee contributions plus accumulated interest upon retirement. Short-term, nonvested employees forego the employer contributions; however, they receive their employee contributions plus interest. There is no penalty/fee for short-term employees to leave funds with us. In addition, the WRS calculates retiree benefits using two methods: a traditional formula calculation, based on final average earnings, service, and a formula factor; and a money purchase annuity calculation.

Q. How is this money purchase annuity calculated?

A: It’s based on employer and employee contributions and accumulated interest, with a factor based on age at retirement. The retiree gets the higher of the two calculations we do.

Q. Why is that?

A: It’s due to compounding of interest credited to contributions in the account. Assuming normal investment returns, a money purchase annuity can eventually surpass a formula annuity, which is based only on a limited number of years of creditable service and final average earnings that tend to be eroded by inflation when there is a gap between an employee’s separation date and retirement date.

Q. Can we go a little bit into the weeds here to talk about the roles of the State of Wisconsin Investment Board (SWIB) and Employee Trust Funds (ETF)?

A: ETF is responsible for plan administration and SWIB is responsible for investments. ETF collects amounts due to the plan (contributions, premiums, etc.), calculates and manages disbursement of benefit payments, and communicates with participating employees and employers. ETF establishes the controls, systems, and procedures necessary to ensure the appropriate administration and security of the trust.

The legislature wanted a separate professional investing organization for state funds, so it created SWIB to invest the trust fund monies of the benefit programs—and manage investments for a number of other state trusts as well.

Q. Do you find that the split responsibilities for investments and plan administration contribute to the WRS’ overall effective governance?

A: While SWIB and ETF have separate areas of focus, we maintain a close relationship by law and in practice. The separate responsibilities for investments and plan administration allow for better focus and development of expertise in each area: SWIB can focus on maximizing investment return and minimizing investment risk while ETF can collect contributions, calculate benefits, and respond to inquiries from participating employees and employers. This allows ETF to administer not only retirement benefits, but also health, disability, and life insurance as well.

By statute, the Wisconsin Retirement Board and the Teachers Retirement Board each select a member to the SWIB Board of Trustees. The ETF secretary has been elected to the SWIB Board of Trustees since the time ETF was created.