In September, the Select Committee on Pension Policy heard from the Office of the State Actuary (OSA) about its Report on Financial Condition and its recommendations on long-term economic assumptions. High investment returns in fiscal year 2021 mean that contribution rates will be lower than previously expected.

The 2021 Report on Financial Condition was released in August; because of timing, its contribution rate estimates do not take into account the investment returns experienced in FY 2021. The two presentations from OSA to the Select Committee on Pension Policy have the updated information (here and here).

Plan investment returns in FY 2021 were 28.68%—the highest annual increase since 1985. The state had assumed a return of 7.5%; so, according to OSA, the difference between assumed and actual returns amounts to about $22 billion in unexpected earnings. Of that, $2 billion–$3 billion will be recognized each year over an eight-year period.

This means that all open retirement plans are expected to be 100% funded (or more) by 2023. The unfunded actuarial accrued liability in the Public Employees’ Retirement System (PERS) plan 1 is expected to be paid off in 2025 (before the high FY 2021 returns, it was expected to be paid off in 2027).

The unfunded liability in the Teachers’ Retirement System (TRS) plan 1 is expected to be paid off in 2024 (before the high returns, it was expected to be paid off in 2026). As part of the 2021–23 operating budget, the Legislature appropriated $800 million from the general fund–state (GFS) to make a lump sum payment to reduce the TRS 1 unfunded liability. The payment is scheduled to be made on June 30, 2023. If that happens, and accounting for the high returns, the TRS 1 unfunded liability is expected to be paid off in 2023.

According to OSA, employer contribution rates for the state plans began to decline in 2021–23. For example, the employer contribution rate for PERS was 12.68% in 2019–21 and is 10.07% in 2021–23. With the FY 2021 returns, the rate is expected to drop to 4.38% in 2027–29. (Without the returns, it was expected to drop to 5.09%.) This does not mean that legislators aren’t making the necessary contributions; instead, lower contributions are required to maintain funded status. (A few reasons for that include: the unfunded liabilities in PERS 1 and TRS 1 are expected to be paid down and new hires are expected to cost less than current plan members.)

OSA expects the FY 2021 investment return to save the GFS $596 million in 2023–25 and $1.233 billion in 2025–27.

Meanwhile, OSA is recommending that the state reduce the general salary growth assumption from 3.5% to 3.25% and that the state reduce the investment rate of return assumption from 7.5% to 7.0%.

The 7.0% return assumption proposal reflects new capital market assumptions, and it would bring Washington more into line with peer retirement systems. This would be a continuation of a decade-long policy to lower the return assumption. In 2010, it was 8.0%. That was reduced in steps until it reached 7.4% for the Law Enforcement Officers’ and Fire Fighters’ Retirement System plan 2 and 7.5% for all other plans in 2017. As we discussed in a 2011 policy brief, the higher the investment rate assumption, the more the state is relying on future investment returns to cover benefits. Although this saves the state money in the near term, it does not properly reflect the level of risk and could result in less solvent plans over the long run.

If the state adopts the OSA recommendations, the assumption changes would increase GFS spending by $991 million in 2023–25 and $608 million in 2025–27. However, given the FY 2021 return, the net impact of adopting the recommendations would be to increase GFS spending by $395 million in 2023–25 and decrease GFS spending by $625 million in 2025–27.

The Pension Funding Council will meet to consider adopting the OSA economic assumption recommendations on Oct. 28.