Yesterday’s meeting of the Ohio Retirement Study Council (ORSC) provided further evidence for what we’ve been arguing for quite some time: Ohio’s pension funds’ investment assumptions are set unrealistically high.  And now that returns are falling far short of their goals, Ohio taxpayers are ultimately stuck with the tab.

From Gongwer News Service, here’s the breakdown of each pension fund’s returns over the past decade:

As seen above, pension investment returns over the past ten years have fallen considerably shorter than their assumed rates of return—not the mention the very poor performance over the past six months.  While a strong 2010 buoyed the three-year average return, this temporary growth was unable to close funding gaps.

Weak returns have profound implications.  Public pension funds rely on investment returns to fund over two-thirds of retiree benefits, so when returns fall short, liabilities balloon rapidly.

Current unfunded liabilities for Ohio’s pension funds total nearly $72 billion.  As returns continue to fall short, this number will only grow.  And because of the defined-benefit structure, it is ultimately the taxpayer who is responsible for making sure that shortfalls are closed and benefits are paid.

The main issue with setting investment assumptions is risk.  While keeping the assumed return rate high helps improve the fiscal health of the pension fund (at least on paper) it does expose taxpayer dollars to greater risk.  Lowering assumptions weakens fund health, but it does better protect taxpayer investment.

Many public pension administrators are willing keep their investment assumptions high, citing average 30-year returns of around 8.0 percent.  But is the past truly prologue?  What’s important is not the boom years of the 1990s which inflated 30-year investment returns; what’s truly important is what’s to come in future decades.

A growing number of experts have serious doubts about pension funds achieving 8.0+ percent returns in years to come and the amount of risk that such an investment strategy requires.  For instance, private-sector defined-benefit plans use an average investment assumption of only 5.22 percent.

As a representative from Milliman Consultants (independent actuarial firm) noted yesterday at the ORSC meeting, “There are serious questions about whether 8.0 percent is the right number.”  Assumptions of 7.75 percent are already considered aggressive for the industry.

As we’ve stated, Ohio’s public pension plans should set investment assumptions at rates that reflect realistic expectations so that taxpayer dollars are not exposed to unnecessary risk.  If that means that pension fund health declines, at least taxpayers will have an understanding of the true depth of the problem and be less exposed to market volatility.  Additionally, we support further reforms that transition away from defined-benefit plans into defined-contribution systems.  Such a transition would be more fiscally responsible to taxpayers while still providing reasonable retirement benefits to our former government employees.