Pensions: NJ raises assumed return, transfers management to beneficiaries

Alarm bells should be ringing with New Jersey increasing the assumed rate of return. This is especially true since they are the most underfunded system in the country. Moreover, letting beneficiaries control their own investments is a disaster waiting to happen. Watch them reach for risk and reach for yield.

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On Monday, the New Jersey Legislature passed a bill that allows public pension beneficiaries to control “how their retirement funds are invested and their levels of contributions and benefits”. That’s according to NJ.com.

Democrats sponsored the bill. But it had bipartisan support. The measure giving pension control to the police and firefighters passed the Senate by a 34-2 margin. It also passed the New Jersey Assembly by a 67-2 margin. But Democratic Governor Phil Murphy has concerns about the bill.

New Jersey most underfunded system in the US

While New Jersey controlled the public pensions, the state allowed funding to run down to 31% of expected benefits. That’s a 69% underfunding. And according to the ratings agency S&P Global Ratings, New Jersey’s pension funding ratio is the worst in the United States. On those terms, the police and fire system pension looks strong. It only has an underfunding of 35%.

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Right now, the state’s Division of Pensions and Benefits manages the funds. And the State Investment Council directs the investment of its money. But the State Policemen’s Benevolent Association told New Jersey On-Line, “we want to control our own destiny.” And State Senate President Stephen Sweeney, a Democrat and a sponsor of the bill, has endorsed these sentiments. He said that pension funds run by beneficiaries elsewhere have outperformed those run by governments.

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Meanwhile, earlier this month, New Jersey’s treasurer said she will increase the expected rate of return for the state’s public pension system from 7 to 7.5%. Later, she will lower the rate of return over time. The higher return rate assumption will mean  $238 million less that the state has to cough up to make up for underfunding shortfalls. It also means a temporary reprieve of more than $400 million for local governments. That’s according to the office of the Acting State Treasurer Elizabeth Maher Muoio.

New Jersey’s Accounting Dodge

Of course, most states are lowering their expected pension return rates. That’s because of lower interest rates and poor investment performance. So this temporary reprieve is just an accounting dodge that masks the true nature of New Jersey’s pension problem.

If you recall, last month  I mentioned that the nation’s biggest public pension fund, the California Public Employees’ Retirement System (CalPERS), voted in 2016 to decrease its assumed of return down to 7% by 2020. And many have criticized that assumption as  too optimistic.

So, the fact that New Jersey is increasing the assumed rate of return should send alarm bells ringing, especially since they are the most underfunded system in the country. Moreover, letting beneficiaries control investment is a disaster waiting to happen. Clearly they will take on risk and reach for yield to drive returns. And they are going to do so right at the tail end of a bull market. That ensures maximum losses when the cycle turns down.

Sorry to end on a sour note. But this will be a train wreck.

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