John Dougall ran a nearly flawless campaign for state auditor last year. Building on his legislative reputation as a fiscal hawk, "Frugal Dougall" successfully argued that the constitutional role of state auditor required not just financial audits of state expenditures, but performance audits of state entities. Last week, the State Auditor's office issued its first performance audit, examining the Utah Retirement Systems' assumed investment rate of return. The audit is powerful in its implications and could have a significant, positive impact on the national pension reform debate.
The Utah Retirement Systems (URS) is, in my opinion, the best-run public pension system in the country. Executive Director Bob Newman, Chief Investment Officer Bruce Cundick and their staffs are the finest in the business. The organization exudes professionalism, competence and stability. When Utah leaders took up the issue of pension reform in 2010, URS helped the legislature objectively and thoroughly think through the detailed policy considerations. I have tremendous admiration and respect for the folks at URS.
Dougall's performance audit focuses on the difficulties in predicting how URS' pension investments will perform over the next 30 years. This is critically important to Utah taxpayers because of the structure of defined benefit pension plans for public employees. Every public employee hired before July 1, 2011 (the date Utah's pension reforms went into effect) and who meets basic employment hurdles is guaranteed a pension upon retirement. These pensions are funded by a combination of employer contributions into the pension system and the investment returns generated by the system. Pension plans have to estimate future investment returns to determine how much money they must collect now in contributions.
There is tremendous pressure in the pension industry to be overly optimistic about future investment returns. Most public sector pension plans in the country assume investment returns of around 8 percent. URS assumes a 7.5 percent rate of return, lower than 72 percent of public pension systems. While more conservative than most pension systems, Dougall's audit reveals that URS has just a 43 percent chance of meeting or exceeding investment returns of 7.5 percent. If URS misses the 7.5 percent target, Utah's pension system will fall further into the red and taxpayers will be forced to make up the difference with interest. The audit recommends a 0.25 percent reduction in the assumed return rate, acknowledging that such a reduction will require a $54 million increase in annual pension contributions.
As with every other pension system in the country, URS is caught between a rock and a hard place. Any attempt a pension system makes to reduce the assumed earnings rate requires an immediate increase in public spending, thereby impacting public policy. Pension systems are very reluctant to make such policy decisions unilaterally, and so investment return assumptions remain high when they should be declining.
Dougall's audit is the first of its kind in the country and is a valuable contribution to the pension reform debate. It persuasively demonstrates that pension funds have wide latitude in setting assumed investment returns, and that taxpayers are bearing significant financial risks if those return assumptions are unrealistically high. I believe the real power of the audit lies in the candid recognition that legislatures must take the lead to reduce pension risks.
Utah took the first major step in pension reform by moving to a defined contribution style system for new public employees in 2010. Those reforms capped Utah's legacy pension liabilities. The next step is to ensure that the pension system is appropriately funded. The Legislature should enable URS to lower its return assumptions by increasing pension contributions above what is currently requested.
Dan Liljenquist is a former state senator and U.S. Senate candidate.