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Despite modest gains in 2015, gap will raise public payroll costs in 2017-19.

Earnings on Oregon’s public-pension investments did relatively well in 2015 despite turbulent financial markets, but the pension system’s board was told Friday that the 2.1 percent gain was far short of its 7.75 percent assumed rate of return.

The gap in the unfunded liability for the Public Employees Retirement System now is projected to grow from $18 billion at the end of 2014 to $21 billion or $22 billion over the next few decades. Milliman, the actuarial consultant for PERS, will offer a more precise figure at the next PERS board meeting March 28.

PERS Board Chairman John Thomas says that means the 925 member agencies, covering 95 percent of Oregon’s public workers, can expect pension contribution rates to hit up to 30 percent of government payrolls by the 2021-23 budget cycle.

“The lower the expected return, the higher the contribution in the absence of any change in future benefits,” Thomas said.

“The funding issues are not necessarily going to be better at this time next year or two years from now… PERS employers should not be expecting a reduction in rates anytime in the near future — like the next 10 years.”

The PERS board on Nov. 29 released advisory rates for specific agencies for the 2017-19 budget cycle, based on 2014 data, but also factored in investment returns for part of 2015. Returns for 2014 also fell short of the assumed rate.

The board will set the actual rates in September, based on 2015 data.

“We had a bad year at a bad time,” said PERS board member Pat West.

Although the gap in projected liability will widen because of investment earnings off target, the biggest jump resulted from a 2015 decision by the Oregon Supreme Court. The justices ruled that lawmakers in 2013 had authority to pare annual cost-of-living increases to retirees, but those changes could not apply to benefits earned before 2013. The decision negated about $5 billion in projected savings from the system’s long-term liability.

Oregon PERS fund stood at $68.7 billion at the end of December. The Oregon State Treasury manages the fund, although the PERS board sets the assumed rate of return.

The PERS fund accounts for the largest chunk of the $90 billion invested by the treasury.

Modest gains

John Skjervem, the state’s chief investment officer, said that among public funds with at least $10 billion in total assets, Oregon’s PERS returns for 2015 stood at the 11th percentile. That means almost 90 percent of its peer funds did worse.

“Relative results were very good; absolute results were pretty modest compared with the assumed rate,” he said.

The PERS board has reset the assumed rate for 7.5 percent in each of the next two years, and systems in other states have done likewise.

Still, the gap compelled the PERS board to draw $280 million from a special fund to pay benefits to public retirees hired before 1996, when lawmakers severed a guaranteed linkage with the assumed rate of return. About $168 million remains in that fund.

That assumed rate is not used to credit benefits for those hired between 1996 and 2003, and the almost 100,000 current public workers hired after lawmakers overhauled the system in 2003. Their rates are just under 2 percent.

Although Oregon created its public-pension system in 1945, it was only in the 1970s that it began the kinds of investments that today account for almost 75 cents of every dollar paid out in benefits. Payroll contributions from state and local agencies make up most of the rest, and only about 5 percent comes from employees.

Skjervem said the mix of investments today is a lot more complex than even 20 years ago, when they were largely in fixed-income assets.

About 40 percent of Oregon’s current PERS portfolio is in U.S. stocks in large and small companies, 22 percent in equity outside the United States, and 12 percent in private equity. The rest is split between real estate and fixed assets.

“This is as aggressive as our portfolio can be and should be,” Skjervem said. “We cannot do any more.”

Oregon changes

Unlike California’s public-pension system, which has taken big steps recently to reduce its investments in private equity, Oregon has made smaller changes in its mix to minimize vulnerability in financial markets.

Oregon is paring its share of the PERS fund in private equity, which has offered solid returns but also comes with high management costs.

“We have been preparing for this for two years, not dramatically or capriciously, but deliberately,” Skjervem said. “It is not enough to insulate our portfolio from market vulnerabilities. We are return takers, not return makers.”

Skjervem likened the process to getting a rock band to play together.

While every financial sector wants the state to invest more money to maximize returns, he said, “to me, that’s like everybody in the band wanting to play lead guitar – and you can’t blame them, because the lead guitarist always gets the girls.”

“The cumulative effect of everybody playing lead guitar is that the music does not sound so great,” he added. “It takes a lot of discipline on a regular basis to keep everybody playing their roles, because we are inundated with opportunities to take risks.”

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