Investment Losses and Local Government and Banking & Finance and State Government and Retirement Benefits and Public Pensions and Government & Economic Development

Government pension performance stings cities

September 17, 2011

The pension fund that holds benefits for public employees has seen improved investment returns over the last two years, but the hammering it took during the depths of the recession continues to deal a blow to cities, counties and other employers.

Units of government that contribute to the plan will see an average 11-percent increase in their contribution rates next year.

Indianapolis saw among the biggest jumps—43 percent, from 5.25 percent of employee salaries to 7.5 percent. Marion County’s rate rose 19 percent, from 6.75 percent to 8 percent.

Combined, that will add about $4 million in costs to the city-county’s roughly $1 billion budget next year. The higher costs add to the challenge Indianapolis and other cities face at a time property tax and income tax revenues are tight.

“It’s one of the bigger drivers of additional costs,” said Jeff Spalding, Indianapolis’ controller.

The Public Employees Retirement Fund, or PERF, covers some workers in city and county government, the state, and public universities, but excludes firefighters, police officers and teachers, who are covered by separate funds. Employers make contributions into the system, based on factors such as the age and salary levels of their employees, and the returns the state receives on those contributions.

The fund’s value plummeted 40 percent from its recent peak of $16.7 billion in October 2007 to its low of $10 billion in February 2009. Since then, improved performance and the continued influx of employer contributions has pushed the fund up more than 50 percent, to $15 billion.

Stronger performance has helped offset what would have been more dramatic contribution rate hikes for employers. But because the steep losses in 2008 are spread out over contribution rates for four years, their effects will continue to hit local government units next year and into 2013, said Steve Russo, executive director of the Indiana Public Retirement System, which manages PERF and other retirement funds.

However, provided the upward trend continues, Russo said, rates could begin to decline starting in 2014.

Plenty of company

Indiana is far from the only state that took a hit on its pension investments.

U.S. pension plans lost a median of about 25 percent in 2008, according to Wilshire Trust Universe Comparison Service, a Santa Monica, Calif.-based firm that benchmarks institutional investments, and gained about 20 percent in 2009. By comparison, Indiana’s 2008 loss of 27 percent was deeper, but its 2009 gain of 27 percent was higher.

PERF’s one-year return as of June 30 was 19 percent, which is below the Wilshire median of 21 percent.

Russo attributes improvement to a rebound in stocks and other assets.

“As things have recovered, every [investment category] seems to be doing well,” Russo said.

Indiana is among many states that have upped employer contributions, said Josh Franzel, vice president of research for the Center for State and Local Government Excellence, a nonpartisan group that tracks public pensions.

pension feversAccording to the group’s database, which covers about 85 percent of U.S. pension dollars, funding for pension contributions grew from 6.4 percent of payroll costs in 2001 to 13.5 percent in 2010.

A survey the group conducted this spring found 30 percent of governments are experiencing changes to benefits that include higher employer costs and larger employee contributions.

Central Indiana cities such as Greenwood, Brownsburg, Shelbyville and Danville saw increases in their contribution rates ranging from 13 percent to 26 percent. The state of Indiana’s rate rose about 23 percent.

The $4 million more Indianapolis will pay might seem modest but it’s hitting when the city is requiring departments to cut $20 million and is borrowing money from its downtown tax-increment financing to close a budget gap of $64 million.

“There are some mayors who are really strapped,” said Craig Hartzer, a former executive director of PERF who now serves as a clinical professor of public management at IUPUI. “It’s an extra budgetary pressure at a time when money is tight.”

Changing the mix?

Indiana has invested more of its pension dollars outside of stocks and bonds over the last decade. Domestic and international equities and fixed-income investments still constitute more than 70 percent of its portfolio, but the remainder is in areas such as private equity, hedge funds, real estate and commodities.

By comparison, about 5 percent of PERF dollars were in so-called alternative investments in the early 2000s.

Lynn Turner, a former chief accountant for the Securities and Exchange Commission who is now managing director at the California-based consulting firm LitiNomics, said funds across the country have delved more heavily into alternative investments.

According to a November 2010 Public Fund Survey prepared by the National Association of State Retirement Administrators, the average fund had about 80 percent of its assets in bonds and equities, with the remaining 20 percent in cash and alternative investments.

Indiana’s percentage, Turner said, is “at the high end of the range,” but because it also contains inflation-resilient investments such as commodities, it doesn’t cause him initial concern.

“The real question becomes, did the pension fund pick those alternatives that got them better returns?” Turner said. “Or did they just throw money at alternatives and hope they ended well?”

In the fiscal year that ended June 30, PERF’s returns on private-equity investments were about 17.9 percent, while real estate and commodities were 24.5 percent, and hedge funds were 9.5 percent. Equities returned 32 percent.

PERF employs consultants who use computer models to simulate risk and return of investment choices. Those simulations help dictate where PERF invests the money. The pension also employs 105 money managers to oversee where money is invested day to day. Annual fees for those consultants and managers total $102.7 million for the $15 billion fund.

Russo said the objective is to hit PERF’s projected average annual returns of 7 percent without too much fluctuation.

This year, the fund is launching a study to see how the pension allocates its assets.

While Russo said he doesn’t anticipate a “radical departure” from the current breakdown, it’s too soon to say whether PERF will shift its asset allocations.

The pension expects to decide on the changes by the end of this year.•

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