In December I posted links to the PERS 2017 financial reports here. Today I look at downside risks.
Here are the two pages I focus on, which are pages 58-59 of the Comprehensive Report:
These pages show PERS has a funding ratio of 61.49%. That means Mississippi is scheduled to pay only 61.49% of promised benefits. That’s scary.
The official PERS party line is that we should not worry about it, because the shortfall will be offset by investment gains in the stock market. PERS allocates 63% of its investment portfolio to the stock market.
The bottom of the second page shows net pension liability at a 1% increase and decrease from the assumption of a 7.75% annual return in investment earnings. Unhelpfully, the report does not provide the funding ratio, just the raw numbers.
But I did the math (warning: I’m a history major) and these are the funding ratios:
- 6.75% annual investment earnings- 49.5%
- 7.75% annual investment earnings- 61.49%
- 8.75% annual investment earnings- 71.5%
These numbers tell us two things. First, it will be hard to invest our way out of this mess. Second, the downside risks of earning less than assumed are catastrophic.
The 61.49% funding ratio translates to a shortfall of $16.6 billion dollars. Earn 1% less, and the shortfall goes up to around $22 billion. Remember that there is no guarantee of 6.75%.
This isn’t in the report, but I wanted to know the funding ratio if the stock market drops 50%–like it did in 1999 and 2008. If that happens, the value of PERS’ $16.5 billion in stocks drops to $8.25 billion. How would that impact the funding ratio?
By my calculations, a 50% drop in the stock market would drop PERS’ funding ratio to around 42.4%. Something around $25 billion.
Forecasts for realistic investment rates of return in the investment markets for the next 10 years are sub-6.75%. Earnings of 10%-plus to dig out of this mess will not happen unless something weird happens to the world economy.
Put it all together and the inescapable conclusion is the downside risks of PERS’ funding shortfalls are much greater than the possibility of rolling Yahtzee in the investment markets. You will not hear this from PERS leadership. You should. But you won’t.
A bunch of disclaimers go with this. Again, I’m not a mathematician. It’s not my job to conduct this analysis. It wasn’t easy and I’ve spent more time than I anticipated. Still, I could be making mistakes. If this interests you, do your own analysis and let me know what you come up with.
If the stock market drops 50%, the losses may be offset by gains in the bond portfolio. My guess, however, is any gains in the bond portfolio will be offset by losses in the real estate and private equity portfolio.
PERS is priced for perfection. It will take better than perfection for PERS to solve its funding problems without government intervention. If that sounds impossible, it probably is. The 2018 legislative session is winding down. Another year where the legislature ignored the PERS crisis. Not good, but unsurprising.