Typically, a financial adviser will tell investors that as they age and near retirement they should move assets into less-risky holdings. They might, for example, reallocate more money from volatile stocks to fixed-income bonds.
The same idea applies to pension funds. As a greater portion of members reach retirement age, more holdings should be shifted toward safer investments to guard against significant losses from market downturns.
But that's not what has happened. In fact, according to recent findings of a panel of experts commissioned by the Society of Actuaries, public employee pension plans across the nation have done just the opposite.
The plans are "maturing:" In 1993, 28 percent of participants in public pension plans had retired. By 2010, that had reached 39 percent. But the plans are taking greater risk, increasing assets in stocks and other volatile investments from 30 percent of holdings in 1984 to 73 percent in 2012.
As a result, the plans lost more in the Great Recession than they would have with a safer investment mix. And they're more vulnerable to downturns in the future. Moreover, those losses must be recouped from a relatively smaller payroll base.
That doesn't mean pension plans should invest solely in fixed-income bonds, says Bob Stein, panel chairman and retired global managing partner of actuarial services at Ernst & Young. But the 73 percent investment in volatile investments is too high.
"I think everybody would say the combination of growing maturity and increased risk is a dangerous combination. It makes it more difficult to recover from market distress," Stein said. "If there's a further downturn it will really be a problem."
Similar long-term trends of aging membership and increasingly risky investments have been seen at the public employee retirement systems for San Jose and Contra Costa and Alameda counties, as well as the California Public Employees' Retirement System, the nation's largest pension program.
It's an issue on the radar of Alan Milligan, CalPERS chief actuary since 2010. "I believe we have significantly more risk than we had 30 years ago," he said in an interview last week.
Milligan has spearheaded long-overdue reforms at CalPERS over the past three years. He persuaded the system board to change accounting practices, reduce assumptions about how much can be earned on investments and better account for increasing life expectancy of the population.
The issue of investment risk is now on his agenda, but it will take time to address, he said. "I think there's a lot of hard thinking that has to happen. I don't think that discussion is done."
Why would pension plans move to riskier holdings? Because investments in more volatile assets hold potential for greater returns. And the greater the expected future returns, the less money employers and employees must put into the system now.
But those riskier assets also carry a greater chance of investment losses. When that happens, funds that should already have been socked away must then be recouped. With a greater portion of the plan members already retired, those investment losses must be absorbed from current and future payrolls, either by workers or, usually, their employers, the taxpayers.
Investment of California public retirement funds in stocks was first permitted in 1974. Buried deep in a lengthy ballot measure on tax reforms that voters approved was a provision allowing moving up to 25 percent of pension holdings into equities. In 1984, voters approved a measure lifting the limit but requiring "prudent" investments.
In ballot arguments, backers of the measure spoke only of the upside potential, not the downside risk. They portrayed it as a tool to keep benefits up and costs down. But that's not how it has worked out in California, or across the nation.
Pension plans have experienced large investment losses and now must put more money into the system, notes Stein, the chairman of the actuarial society panel. "A strategy that was intended to reduce the pressure on contributions has had the reverse effect."