An analysis of North Carolina’s Teachers’ and State Employees’ Retirement System (TSERS) says that despite it being one of the best funded systems in the country, it has several weaknesses, such as overly optimistic return assumptions that “could jeopardize its fiscal health in the long run.”
Although North Carolina TSERS is nearly 90% funded at a time when the average public pension plan is only 72.6% funded, North Carolina-based nonprofit think tank the John Locke Foundation says there is cause for concern as the system’s funded ratio has been on the decline for 20 years and today has $9.64 billion in unfunded pension liabilities.
The foundation said its analysis of the causes of the growing unfunded liabilities found that underperforming investment returns are the main culprit of the growing pension debt and that the plan’s investment returns assumptions are overly optimistic.
“Although TSERS has made some changes to its assumed rate of return over the past years, it still remains too high,” the report said. “Moreover, in order to achieve the target assumed rate of return, TSERS is likely to have to introduce even more risk—and therefore greater uncertainty and potential volatility— to the plan.”
The report said that added uncertainty leads to higher fluctuations in both funded ratio and employer contributions.
The analysis credited TSERS with showing fiscal prudence by using an actuarially determined contribution policy, however, it said that if the assumptions that go into calculating employer contributions are incorrect, then paying the annual actuarial bill in full will not lead to full funding.
“Other than lowering the target rate of return, TSERS should consider changing the discount rate,” the report said. “Inaccurate use of discount rate leads to an underestimated level of liability, which leads to lower than needed employer contributions. This can have detrimental consequences for the plan going forward.”
In addition to employing more conservative assumptions, the report suggested TSERS should look into introducing retirement plan choices that include a risk-managed defined benefit pension, cash balance plan, or defined contribution retirement plan that will further reduce the risk of underfunding.
“In order to keep providing competitive benefits for existing and future employees,” the report said, “it needs to consider incremental changes to the plan today that will pay off greatly in the future by preserving benefits and ensuring fiscal sustainability in the long run.”
The analysis found that TSERS is unlikely to reach its assumed long-term average investment return of 7.0%, which could lead to increases in employer contributions in the near future. And even if the plan does meet the target assumed rate of return on average, it said the timing of the returns could negatively affect the plan’s fiscal outlook.
It also found that the plan’s portfolio includes high-risk assets that it says are prone to volatility, which make the investment returns less predictable.
“Marginal improvements to the existing TSERS benefit system can pay off greatly in the future and ensure the system stays on solid financial footing for the long term,” the report said. “Better risk management and more realistic plan assumptions can help ensure the state delivers the promised retirement benefits to its employees.”