Maryland’s $20B pension punt

Originally published in The Daily Record

Jeff Hooke Apr 7, 2017

Maryland’s legislative session is about to conclude full of sound and fury but signifying nothing on Maryland’s largest fiscal crisis: the state pension system’s $20 billion shortfall.

More than 400,000 current and retired state employees depend on the Maryland State Retirement and Pension System for a secure retirement. Yet Maryland lawmakers passed no substantive legislation this session to shore up the system’s finances. Pension fund members can be forgiven for wondering whether their nest egg will be there when they need it most.

Maryland legislators aren’t the only ones ducking the issue. When the board of the pension system met in February, the lengthy agenda failed to mention that investment returns for 2016 were 1.5 percent below the average of similar funds, suggesting an income shortfall of $600 million, an amount equal to Maryland’s annual tax revenue from gambling.

This was not a one-year blip. The fund has averaged returns of 4.85 percent over the past 10 years, well below its annual goal of 7.55 percent. The returns fell into the bottom 10 percent of the fund’s peer group over that same time period, implying an opportunity cost of about $400 million per year or $4 billion overall.

To close this gap, tough policy choices lay ahead for Maryland leaders. The most commonly discussed options are lowering retirement benefits for state employees, requiring higher contributions from current employees, raising taxes on Maryland families and employers, or pushing a combination of the three.

We recommend a fourth option: Reduce or eliminate the estimated $500 million the pension system pays each year to its active money managers. Next, shift most of the fund’s assets to passive, low-cost index funds designed for institutions. Maryland’s pension fund investment managers have consistently promised, yet failed to deliver, investment returns that match investment benchmarks, let alone surpass them. Academic studies show that since 2006, professional managers at mutual funds, private equity funds and hedge funds routinely underperformed either the broad stock market or the relevant bond benchmark.

The exact amount of fees Maryland’s pension fund pays may never be known because the board has never requested a full accounting. Nonetheless, a reasonable estimate for the last two fiscal years is $900 million given that New Jersey, a larger fund with similar assets, spent $1.4 billion in fees amidst full disclosure.

Maryland, like many states, passed laws that keep most money management fee arrangements secret. In fact, the financial industry’s influence is so pervasive that the Municipal Accounting Standards Board, which sets standards for state and local government accounting, allows states to ignore most private equity and hedge fund fees for record-keeping purposes.

We encourage Maryland’s pension fund to emulate Nevada, where a bipartisan coalition of policymakers jettisoned its complex pension fund portfolio and adopted a low-cost blended index whose returns historically have beaten the 50 state averages.

This pension crisis is national in scope. The Pew Center on the States estimates that the nation’s state-run retirement systems have a $968 billion shortfall. The question is not whether Maryland’s pension system is in trouble. The question is how much longer policymakers will punt on making tough but necessary reforms to ensure state workers have the secure retirement they were promised.

Jeff Hooke is a finance lecturer at Johns Hopkins Carey Business School and a senior fellow at the Maryland Public Policy Institute. He can be reached at