Lessons From Well-Funded Public Retirement Plans for Managing Crises

Representatives of three well-funded pension plans shared information about their contribution rate, assumed return rate and COLA strategies.

In a webinar, Dan Doonan, executive director of the National Institute on Retirement Security (NIRS) revealed features of six public pension plans the institute analyzed that remained well-funded despite the 2008/2009 financial crisis.

The first two features of the well-funded plans are employer contributions that pay the full amount of the actuarial required contribution (ARC) and that maintain stability in the contribution rate over time, that is, at least equal the normal cost; and employee contributions to help share in the cost of the plan.

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Tom Lee, executive director of the New York State Teachers’ Retirement System shared with webinar attendees the sources of income for the system over a 30-year period. Eighty-four percent of income came from investment income, 14% from employer contributions and 2% from employee contributions. During that 30-year period, from 1990 to 2020, the system generated $187.2 billion in investment income, $30 billion from employer contributions and $4.5 billion from member contributions. The system paid $126.8 billion in benefits. “This is how a plan should work,” Lee stated.

He said the two largest statewide plans in New York, the teachers’ fund and the New York State Common Retirement Fund, are very well-funded, at over 90%. “We take great efforts to communicate the value of the pension fund and the importance of employers making contributions,” Lee said.

He noted that the New York legislature enacted a provision that allows school boards to set aside unspent dollars into a pension reserve fund in the event of rate increases in the future. With the effect of the COVID-19 crisis, returns will probably be in the low single digits, he said, and that will put pressure on contribution rates.

Bob Conlin, secretary of the Wisconsin Department of Employee Trust Funds, said virtually every school district and municipality participates in Wisconsin’s state plan, with the exception of Milwaukee. The system has 180,000 retirees, 250,000 active employees and the rest are vested, terminated employees. He says the plan’s funded ratio has remained solid over time.

Until 2010, the system had mandatory employee contributions, which some employers picked up, but now, the legislation requires that employees and employers share in contributions. Conlin said this helps employers. The contribution rates for calendar year 2021 will remain flat, and investment returns in 2019 were good, so this should help employers manage the current crisis, he added.

Lee said he thinks the biggest risk right now is to employer contributions. “We anticipate revenue losses in cities. In an environment where we have fiscal stress and rely on contributions to be successful, the ability for them to make those contributions will be the biggest risk,” he said.

Don Drum, executive director of the Public Employee Retirement System of Idaho (PERSI), noted that 2020 has been a roller-coaster ride as far as funded status. “We were 95% funded in February, by March 23, we were 70% funded and now we are 92% funded,” he told webinar attendees.          

“As we look forward, we are concerned about the revenue projections for employer members. Idaho was strong before COVID-19, so we think state revenues will be OK. They are projected to be down 5%,” Drum added. “Really, my concern is the impact to small employers in rural communities. As we work through this, we have to be well aware of what is happening with those employers.”

With PERSI, employers bear responsibility for 60% of contribution rates. After the Great Recession, PERSI implemented a 2.5% rate increase. “Employers tell us they will struggle with absorbing higher rates. The difference between now and the Great Recession is we are not sure employers are positioned to absorb rate increases if needed. We can see it being problematic if we have to propose rate increases,” Drum said.

Discount Rates and COLAs

Two other features of plans that remained well-funded despite the 2008/2009 financial crisis, according to NIRS research, were economic actuarial assumptions, including both the discount rate and inflation rate, that can reasonably be expected to be achieved long term; and cost of living adjustments (COLAs) that are granted responsibly, for example, through a quickly amortized ad hoc COLA, or a capped automatic COLA.

Conlin said that for the Wisconsin public retirement system, the discount rate, or assumed rate of return, is bifurcated—7% for active employees and 5% for retirees. “We think this is achievable long-term,” he said.

Conlin said the system has a variable COLA for retirees; if the assumed rate of return exceeds 5%, retirees receive a share of the excess, if the 5% rate is not met, Wisconsin can pull back or reduce previously granted COLAs. Conlin said the system had to do that for five years after the 2008/2009 recession. “We hope we don’t have to do that during this crisis, since the market rebound has been strong,” he said.

“Having that risk-sharing throughout the system helps the fund and no party feels solely responsible for bearing hard times,” Conlin added.

He said communications that taxpayers, retirees, employees and employers all share in the success of the retirement system helps people understand the risk but be supportive because they also share in good times. “It is a cultural thing that has to be developed over time,” Conlin told webinar attendees.

Lee noted that the New York teachers’ system uses five-year smoothing (amortizing gains and losses over five years) which helps dampens volatility when large spikes in returns occur. The system’s COLA is on the first $18,000 in benefits and equals half of the consumer price index (CPI) increase, with a minimum of 1% not to exceed 3%. “It’s not generous. It does not cause a COLA increase to be compounded over time to result in impactful effects on the fund, so there would be no need for drastic adjustments,” he said.

Drum said PERSI has a mandatory 1% COLA, but it can give up to 100% of the CPI. “However, I don’t think we’ll be able to afford that going forward. I think our membership should expect to get the mandatory amount but not count on more,” he said.

Strategic Portfolio Allocations

All three state retirement system representatives said they have made no major changes to their portfolio allocations due to COVID-19.

“Our asset allocation is strategic and reviewed annually. We have 72% in equities, which has been a major contributor to growth in assets,” Lee said. “That’s not to say that volatility has not been there, but being longer-term investors, we can stay invested and not be forced sellers in downturns.” Lee added that sticking to targets and rebalancing when needed is beneficial to systems.

Conlin also said Wisconsin uses a strategic allocation. He noted, “We have parameters around allocations to give staff flexibility, so they made some tactical moves.”

Drum echoed the others’ thoughts. “Having long-term investment managers and strategically designing the asset allocation helps weather storms,” he said.

Benefit improvements such as multiplier increases that are actuarially valued before adoption, and properly funded upon adoption; and anti-spiking measures that ensure actuarial integrity and transparency complete the list of features of plans that remained well-funded despite the 2008/2009 financial crisis.

Alger Announces Move Into ETF Space

Both ETF products will be available in 2021.

Fred Alger Management LLC (Alger), a growth equity investment manager, has announced its plans to launch two actively managed exchange-traded funds (ETF): Alger 25 ETF and Alger Mid Cap 40 ETF, marking the firm’s entry into the ETF space.

Both vehicles will be focused, high-conviction strategies. The products are scheduled for availability in the first quarter of 2021.

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“We have seen increased demand for our focused strategies since we launched our first one in 2012. Having these strategies available as actively managed ETFs enables investors who prefer an ETF vehicle to access our investment capabilities,” says Dan Chung, CEO and chief investment officer (CIO) of Alger. “Alger has a proud, 56-year record of investing in change and innovation, and we believe the innovation of actively managed ETFs is something that will help to continue to propel our growth.”

Alger 25 ETF will be managed by Ankur Crawford, executive vice president and portfolio manager. She has been with the firm for over 16 years and currently co-manages more than $22 billion in the firm’s U.S. large cap growth equity strategies. This ETF will execute a strategy similar to the Alger 25 Fund, which launched in 2017, by investing in 25 high-conviction large cap growth equities in the technology, health care, consumer discretionary and industrials sectors.

Alger Mid Cap 40 ETF will be managed by Amy Y. Zhang, executive vice president and portfolio manager. The ETF will seek to invest in 40 high-conviction mid cap growth equities. Zhang has been with the firm since 2015 and manages several of Alger’s small and mid-cap strategies, including the Alger Small Cap Focus Fund, a five-star Morningstar rated fund.

Alger has licensed ActiveShares from Precidian Investments LLC, which enables the firm to deliver actively managed investment strategies in an ETF vehicle without disclosing holdings daily. The ETFs will be listed on the NYSE Arca Inc., which currently lists nearly 80% of all U.S. ETF assets under management.

Brown Brothers Harriman & Co. (BBH) will be the custodian, administrator and transfer agent of the funds. Alger and BBH have worked closely together for more than a decade. 

“After more than 10 years partnering with Alger, we are excited to now partner on its first actively managed ETF launch, which will continue to bring fresh investment solutions to the collective market,” says Ryan Sullivan, senior vice president and head of U.S. ETF Services at BBH.

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