This is the seventh column in a series presenting findings and conclusions of Nevada’s 2016 Popular Annual Financial Report (PAFR), posted at controller.nv.gov. Here, we address the Nevada Public Employee Retirement System (PERS).
PERS runs a defined-benefit (DB) retirement funding program for state and local employees. In a retirement program, people put some of their current income into a fund that is invested for maximum risk-adjusted growth of the principal so that after their working/contributing years, they may draw retirement income from it.
A weakness of DB plans is that participants and the agents who govern the plan can socialize the risks of their investment decisions to taxpayers and to today’s early-career participants who have no role in managing those risks and thus no opportunity to be fairly protected.
So, DB retirement programs inherently raise the following profound public-policy questions:
What investment management policies and practices are followed?
What expected rate of return on future investments — or discount rate (DR) for future liabilities — is used in setting contribution and draw levels?
What lengths of working and thus contributory participation time are assumed, in addition to the other estimates used?
PERS leads the nation and is doing the important things right in investment management. In investing, one cannot expect to beat the market by consistently scoring higher-than-market-average returns – and one can lose a lot by trying. Hence, one should seek essentially to reap market-average returns and keep investment-management costs as low as possible. This is known as index-based management. PERS has done the best job of implementing index-based management on reasonable asset allocations and has realized greater returns than much larger public pensions elsewhere.
Determining the DR is highly controversial. The proper fiduciary method to set the DR is to soberly assess expected net rates of return on the investments and use that rate to determine the probabilities that the fund will be able to cover various future payout levels. Then, contribution requirements and benefit levels can be determined to satisfy the level of certainty of coverage chosen by the board overseeing the plan.
Thus, the DR question is: What are the reasonably expected returns? For decades, public-sector plans have assumed returns around eight percent, although some plans have adjusted downward slightly in recent years. Our analysis in the PAFR shows economic growth rates and thus investment returns are highly likely to be much lower than historic levels for the foreseeable future. Our conclusion is that a DR of 5 percent, net of fees and costs, is the most reasonable.
Turning to the final matter, expected life length has been climbing in the US for decades, and health status has been improving at every age, but these factors have not been reasonably reflected in the reference working lives and retirement terms assumed by pension funds, Social Security, etc. In short, today most working lives assumed in public pension plans, including PERS, mean that retirement benefits maximum levels are reached after 30 years of employment and often available at a mid-fifties retirement age.
Thus, many public employees get market-level pay for 30 years of service (with Nevada local government employees getting even higher pay), followed by retirement draws of 30 years that are noticeably better than the retirement draws generally available in private employment. Thus, they get a much better deal than the private-sector taxpayers who support them.
The basic duty owed by all public officials – from governors, controllers and legislators to all public employees in policy-related positions — is a duty to voters, taxpayers and the broad public interest. However, they often view taxpayers and early-career retirement plan participants as mainly deep pockets to allow the politicians and bureaucrats to better serve the interests of retirees and late-career plan participants.
So, reforms should be evaluated mainly on whether they avoid socializing risks of DB pensions to taxpayers and early-career plan participants.
Ron Knecht is Nevada’s elected controller and Geoffrey Lawrence is assistant controller.
