The Public Retirement System of Idaho (PERSI) reported a 1.62 percent return on its investments for the 2012 fiscal year, which ended on June 30. This represents a sharp drop from the 20.7 percent returns that PERSI reported for fiscal year 2011, and a figure well below the 7 percent net rate of return assumed by the actuarial formula used to determine how well funded PERSI is in comparison to expected future benefit payouts.
If the fiscal year had ended even a day sooner, the annual returns would have been closer to zero, because a full 1.58 percent of the year's gain came on June 30 after a last-minute market uptick. By midway through August, PERSI had gained another 2.4 percent in returns for the beginning of the 2013 fiscal year.
"As has been the case for the entire year, the markets were dominated by the twists and turns of three big macro issues (a stumbling but advancing US economy, European near-chaos, and China's successful attempt to slow growth to combat inflation, and current subsequent battle to prevent a 'hard landing') and generally supported by strong corporate earnings and balance sheets," wrote PERSI Chief Investment Officer Bob Maynard. "These same issues promise to be around for the start of the new fiscal year, along with the prospect of political confrontations, a 'fiscal cliff' at the end of this year, and the recent talk of a renewed stalemate on US debt ceilings."
Idaho, like many other states, has seen significant swings in its returns during recent years, from stark losses in 2008 and 2009 to higher-than-average gains in 2010 and 2011. The disparity between losses and gains is more apparent in Idaho, though, because PERSI does not average its returns over a period of years like most states do. Instead, Idaho's gains and losses are reported as they occur.
"PERSI is one of only two systems nationwide that does not smooth," a PERSI newsletter explained. "Smoothing is a process where unusually high or low returns in a given year are spread over a multi-year period to lower the volatility of the gains and losses from pension fund investment returns. PERSI uses a mark-to-market approach using the current fair market value of assets or liabilities. This gives PERSI a well-defined picture of returns in real time."
Still, the rate of return assumed by PERSI in its actuarial projections remains a pressing concern for critics who say that because public pension liabilities are guaranteed, and portfolio returns are not, plans like PERSI are far more underfunded than they may appear. After the 2012 fiscal year brought significantly lower returns than 2011, PERSI revised its assumed future returns in June from 7.75 percent gross to 7 percent net, PERSI Public Information Officer Patrice Perow said via email.
Don Drum, PERSI's executive director, emphasized in an email written prior to the release of 2012 return figures that he believes the long-term average is justified.
"We have averaged 8.31 percent annual returns in our 46-year existence," Drum said. "I am not sure why we should assume we can only earn 1.5 to 2 percent." The past fiscal year's lower returns have brought that average long-term figure lower, to 8.16 percent over a 47-year period, Perow said.
But Andrew Biggs, resident scholar at the American Enterprise Institute in Washington, D.C., pointed out that past fund performance is not an indicator for future success, and that there's more to the equation than averaging past returns over time.
"Both in economic theory and financial markets, the discount rate you use to value a liability is a function of the risk of the liability, not of any assets that might be used to fund the liability," Biggs said in an email to IdahoReporter.com. Although PERSI reported its funds were 90.2 percent funded for the 2011 fiscal year according to Governmental Accounting Standard Board (GASB) accounting methods, Biggs estimated that it was only 44 percent funded using fair market valuation, which takes into account both the risk of underperformance and the guaranteed payment of liabilities. It's too early to make a similar comparison between GASB and fair market valuation for the 2012 level of funding, but with returns that fall significantly below the assumed average, the funding level would be even lower than 44 percent.
If returns were to fall chronically below the assumed average well into the future, the guaranteed nature of fund liabilities would require greater taxpayer contributions into PERSI, although state statutes leave the specifics to the PERSI board.
"Idaho Statute 59-1322(5) states the Board must act if the amortization period for the Fund’s unfunded actuarial liability (UAL) exceeds 25 years," Perow said. "There is no language specifying what action must be taken. In 2009, the Board approved a contribution rate increase to be phased in over three years. Because of a strong recovery, the rate increases have been postponed twice. Currently, a 1.5 percent rate increase is slated to go into effect on July 1, 2013."
Drum said it's important to keep in mind that the 1.6 percent return reported for PERSI investments during the 2012 fiscal year is a preliminary figure that may change slightly after auditing.
"Our returns are not official until we receive and accept the annual actuarial valuation," Drum said. "We do our best to avoid confusion, which can occur when unaudited numbers are reported prior to the completion of the valuation." The official numbers will be presented to PERSI's board in September, subject to approval at a board meeting in October, and presented to the public in the 2012 annual report to be published in December. "The valuation numbers always are a little different than these posted numbers," Drum reiterated.