In December 2008, the National Association of State Retirement Administrators (NASRA) and the National Council on Teacher Retirement (NCTR) released an issue brief titled Market Declines and Public Pensions.
The issue brief describes the effects of the current financial crisis on public pension plans. NASRA and NCTR explain that the financing objective of most governmental plans is to establish contribution rates that remain relatively level as a percentage of payroll over the long term. This promotes intergenerational equity by allocating the costs evenly across different generations of taxpayers.
Asset smoothing is essential to this strategy. Most public pension plans use actuarial smoothing to phase in investment gains and losses, typically over five years, which reduces the effects of shorter term financial market volatility. The brief indicates that due to actuarial smoothing (and other factors such as the timing of actuarial calculations and market gains and losses), the recent market decline will be recognized in government contribution rates more gradually than it would be otherwise. In this regard, asset smoothing acts as a form of financial shock absorber.
The issue brief also discusses public pension plans’ prior experience with market turmoil. Although the scopeand suddenness of the recent market decline may be unprecedented, the brief points out public pension plans have survived major market downturns in the past. Even taking into account the 1987 market crash, the 1990-91 recession, the bursting of the dot-com bubble, 9/11 and other events, through 2007 median public pension fund investment returns have been positive in 22 of the past 25 years. The brief notes “[e]ach time investment markets have declined, diversified and disciplined investors, including public pension funds, have been rewarded for their patient, long-term positions with strong subsequent investment returns.”
In conclusion, the brief emphasizes that governmental plans with longterm, prudent investment strategies and funding mechanisms will not only have the liquidity to pay promised benefits in the short term, but also to accumulate assets and continue paying benefits responsibly over the long term.