The nation's largest public employee retirement system has just cut its long-term predictions of how much it expects to earn on its investments to 6.5 percent, raising a caution flag for Alaska, which still has expectations of 8 percent returns.
The assumed long-range investment returns are a key indicator of the financial health of the state retirement programs. Pick a number that is too high and the systems give a false image of financial strength. In addition, it could force a pattern of more aggressive and risky investments.
But pick a number that is too low and the systems require larger infusions of cash in the here and now.
It is generally easier to get agreement on optimistic numbers, especially when budgets are tight. The difficulty is that you never really know what returns will be until the future becomes the past.
While other states have trimmed back their long-term earnings estimates since 2008, Alaska is still using 8 percent as its target, which is on the high end of pension systems in the United States. As of the end of 2014, the national average was 7.69 percent. Some people argue the right number should be closer to 5 percent, while others say that is too pessimistic.
"Some critics of current public pension investment return assumption levels say that current low interest rates and volatile investment markets require public pension funds to take on excessive investment risk to achieve their assumption," the National Association of State Retirement Administrators said in May. "Because investment earnings account for a majority of revenue for a typical public pension fund, the accuracy of the assumption has a major effect on the plan's finances and actuarial funding level."
Reducing the long-term expectations on investment returns would increase the unfunded liability of the Alaska retirement systems by billions, which would add to the current budget pressures in the state.
It's an uncertain exercise for individuals to say how much their investments will earn in the future and it is far more complex for pension plans that cover tens of thousands of people. Small changes in assumptions about future performance can have a multibillion-dollar impact.
The debate over whether Alaska's 8 percent target is too high will intensify because of the action in California. The investment board there describes 6.5 percent -- to be reached over 20 years -- as a more prudent and realistic target than the 7.5 percent it had been using.
But California Gov. Jerry Brown says the new plan is irresponsible because of the slow pace in lowering expectations, a claim that the California Public Employees Retirement System denies. A more rapid reduction in investment return projections would have increased the strain on local governments, it said.
But Brown, expressing more caution than his state's retirement board, said the CalPERS plan is based on "unrealistic investment returns" and assumes an "unacceptable level of risk in the coming years."
Alaska Revenue Commissioner Randy Hoffbeck said the state retirement management board is likely to ask its advisors to provide some understanding of why CalPERS acted when the Alaska board meets Thursday and Friday in Anchorage.
Gary Bader, the chief state investment officer, said the earning assumption is based upon an expected real rate of return of 4.8 percent and inflation of 3.2 percent over the next 30 years. He said the retirement funds achieved the 8 percent rate over the five-year period ending Sept. 30.
"For the past five years the median public pension fund has returned 7.55 percent even though inflation has been minimal. If 8 percent turns out to be too high, then I suspect it will be because inflation and interest rates will have remained low," he said.
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