The University of California Board of Regents is among a host of funds across the nation to lower the expected rate of return for the $70 billion pension plan to 6.75% from 7.25%, according to a Board of Regents report. One possible reason? Inflation
A falloff in expected returns is the result of lower inflation assumptions. The US annual inflation rate fell to 1.7% in August from 1.8% the month before. As a result, equity, fixed returns, salaries and COLA post-retirement increases are poised to be lower, too. When inflation falls, the level of benefits also falls and plans make downward adjustments.
The decline in expected rates of returns has been ongoing for almost two decades. The annual rate of return dropped from 8% in 2001 to around 7.2%. “What you’re seeing with California isn’t out of line with the general trend,” said Jean-Pierre Aubry, director of state and local research at the Center for Retirement Research at Boston College. “An assumed return of 6.75% would put California at the lowest.”
Segal Consulting recommended in July that UC reduce its expected rate of return to 7% after completing a study for the period of July 1, 2014, through June 30, 2018. A board committee asked for an alternative recommendation for a lower investment return assumption, along with a proposal to increase member contributions.
The expected cost savings for UC Investments over a decade is projected to be $2 million a year, according to the university press office. Since public plans are long-term investors and don’t react immediately to short-term financial changes, the expectations are reassessments of future returns across the board that reflect lower expectations for capital markets.
The assumed return used by the UCRP has been lower consistently than the average assumed over the period. “The common concern is that public plans are relying too much on optimistic investment return assumptions, leaving them at risk of higher-than-expected contributions if the returns that they assumed don’t materialize in reality,” said Aubry. “As such, it is likely to be viewed as a good thing that the UCRP plan is using a lower return assumption because the lower return assumption produces more realistic measures of the contributions that will be needed to meet benefit promises.”
The board directed the UC’s office of the president’s staff to model options for increasing member contribution rates for consideration at the upcoming November board meeting. UC Investments, the investment office overseeing the University of California’s $125 billion investment portfolio, hired Solovis to provide a technology platform to help the investment office with management of the portfolio. Aside from the pension plan, the portfolio includes the $25.6 billion defined contribution plan and the $13.4 billion endowment.