The San Diego County Pension fund continues to refuse to come to reality. When the board was faced with lowering expectations for investment returns to 8% from 8.25% they refused. You may wonder why this is a big deal?
The San Diego County Pension board and boards across the United States are using investment return assumptions that are unrealistic so that they don’t have to use current funds to make stable their pension funds that have overpromised and will underdeliver. This almost guarantees that at some point in the future San Diego will find itself in the same position as West Virginia – being forced to issue bonds to fund liabilities that cannot be met with current state revenues (they just issues $5.5 billion and now have one of the highest debt ratios in the country).
A typical pension plan has an allocation that is 60% stocks and 40% bonds, assuming this allocation will earn 8.25% going forward is absolutely ridiculous.
The Wall Street Journal asked several economists earlier this year what they thought future returns on the stock market would be after inflation – the most optimistic was 6.5%, if we assume only 3% inflation we would get about 9.5% for a total return on a portfolio fully invested in stocks. Since only 60% is invested in stocks we can assume that the portfolio will earn about 7.7% before fees and inflation – this is being optimistic. A reasonable assumption would be 7.5%, yet the board wouldn’t even consider lowering it to 8%. Clearly this board is not considering the long term best interest of the participants in the plan or the taxpayers of San Diego who will eventually be the ones making up the shortfall. This plan will continue to get worse and waiting a decade or two to fix it will hurt much worse than fixing it now.
There may be some pain to fix this pension now, but it is nothing compared to the pain that will be felt a decade from now. The board appears to looking at their own tenure and career in politics, not looking at the tough problems and finding solutions.
San Diego is not alone – this is a widespread problem and issuing bonds to fix the problem is not an acceptable solution.