Christopher O’Dea writes in Investments & Pension Europe:
The dominant theme in the governance of US public pension funds these days is ‘investors, govern thine selves’. Many pension funds have invested in activist hedge funds or established their own corporate governance functions. These are designed to press corporate leaders and their boards to develop better strategies, improve execution and upgrade talent and technology to more effectively address an increasingly complex and volatile business environment. However, many US pension plans are in dire need of a governance overhaul themselves.
The challenges US pension trustees are grappling with today reflect the evolution of pension systems in the country, [pension consultant Rick] Funston says. “A good many of the pension systems, if not all of them, in fact, evolved from a sole fiduciary form of governance under treasurers and comptrollers, to independent fiduciary boards,” he says. But the question really is how independent are they? “In a number of cases,” he says, “legislatures still retain budgetary control, so a question remains how autonomous are the trustees, and how much freedom do they have to act, to do what they need to do in order to carry out their fiduciary duties.”
Systemic underfunding is the primary result of the governance gap. Since 2000, the study says, US public plans, in the aggregate, have gone from fully funded to 74% funded. In 2014, 63% of plans were less than 80% funded – the level deemed ‘at risk’ for private-employer pension plans under the Pension Protection Act – and 20% were less than 40% funded. To compensate, the study found, public pension plans have increased the risk profile of their investments. In 1952, public employee defined-benefit plans invested 96% of assets in cash and fixed-income investments; that percentage fell to 47% in 1992, to 27% percent in 2012, and to less than 19% in 2015.
The core issue is that “public pension plans make unreasonably high rate-of-return assumptions”, the study says. “The implied risk premium in state and local pension plans’ rate-of-return assumptions has grown from 30 basis points over 30-year Treasuries to 480 basis points today.” If public pension plans assumed a riskless rate of return, the study says, “state and municipal pension plans would be only 50% funded”.