The state pension plans that 12 percent of South Carolina residents are counting on gained $1.2 billion in the 2018 financial year, but they need $25.47 billion more to be fully funded.
South Carolina's pension funds added billions to the bottom line over the past two years but also paid higher fees and produced lower investment returns than most other large public pension funds.
“It’s our job, ultimately, to earn a rate of return that makes our plan work, not to beat our peers," said Mike Hitchcock, CEO of South Carolina's Retirement Systems Investment Commission.
Although the state's main pension fund has just 54 cents for every dollar needed to pay future benefits, retirees aren't at risk of missing pension checks. The pension system has more than $31 billion invested and gets millions in contributions yearly from workers and the state and local governments that employ them.
The impact of being quite underfunded is that taxpayers, through the governments they finance, are paying increasing amounts of money to shore up the pension system. Those amounts are due to rise for years to come.
"We were able to absorb the increase this year," said Don Kennedy, the Charleston County School District's chief financial officer. "Through 2022 we won't be able to sustain that."
Contribution rates the district and other branches of government pay are set to rise 1 percentage point each year through at least 2022. That may not sound like a lot, but this year's increase will cost the school district $2.4 million (in a $507 million operating budget).
Kennedy said he'll be recommending tax increases and expense cuts in upcoming budgets.
The Charleston and Berkeley county school districts, University of South Carolina, and Medical University of South Carolina are among the 10 largest contributors to the pension funds. The state government is the largest.
At MUSC, this year's mandatory increase in pension contributions added up to $7.1 million for the university and hospital system, spokeswoman Heather Woolwine said.
"It’s reasonable to say that we are looking at the entire operating budget for ways to absorb these increases in the employer contribution on both the university and clinical sides of our house," she said.
The ever-growing demand for funding is not because pension benefits are lavish — more than half the 142,652 retirees in the S.C. Retirement System collect monthly benefits of $1,500 or less, and more than a third get no more than $1,000.
The problem is, the pension funds pay out more in retirement benefits each year than they take in from employers and employees. That means the pension fund only grows or and gets closer to being fully funded when investments do well enough to cover the benefit gap, with money left over to invest.
That gap has been shrinking because of mandatory contribution rate increases every year since 2011 and government workers hired in recent years receive less generous pension plans.
“I think we are really starting to see the impact of the pension reform bill," Hitchcock said. "I don’t think we can overstate the positive impact that bill has had on the fund."
The S.C. Retirement System has gained billions in assets but at the same time has become less fully funded with each passing year. The plan was nearly 68 percent funded in mid-2009 during the Great Recession; despite investment gains since then, the plan was just 54 percent funded as of June 30.
“It’s among the bottom third of plans," said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College. The center curates a database of large public pension plans.
During a lengthy interview, Hitchcock suggested several times that South Carolina should not be judged by the performance of other comparable pension plans.
“When it comes to earning a return that makes the plan work, we’re seeing progress," he said. "When it comes to beating every other plan out there, that’s not the goal."
This year, for every $1,000 paid to a school teacher, a school district would contribute $145.60 to the state's main pension fund, and the teacher would contribute $90. For employees, the mandatory contributions amount to roughly a month's pay each year. That rate is now capped, but the rate for employers continues to rise.
By 2022, a school district's contribution rate will be $185.60 per $1,000. Multiply that across a school district's payroll and every 1 percentage-point increase in the contribution rate can cost millions of dollars — the same cost as giving all those employees a 1 percent raise.
Lagging, not leading
South Carolina's pension fund has not only seen investment performance that trails its peers but also has continued to pay some of the highest fees for investment expenses and management.
In November, Pew Charitable Trusts published a tool to track public pensions in 50 states. In that ranking, which used fiscal year 2016 data, South Carolina had the second-highest external management fees compared with total investments.
“We have tried to focus on lowering fees," Hitchcock said. “You also don’t want to do that to the point where it compromises your ability to earn a return."
The high fees are partly due to earlier decisions to pursue costly alternative investments, such as hedge funds, with the goal of higher investment returns. That began more than a decade ago after South Carolina voters approved a constitutional amendment to allow such investments.
“One thing that is intriguing to me is that the asset shift was so dramatic, and the fee rate is out of this world compared to any other pension plan I see," said Aubry, the Boston College researcher. “It’s hard to understand why, unless they think most other plans are doing it wrong."
Aubry looked up the average investment returns for 124 pension funds with fiscal years that end in June, including South Carolina's. He said that from 2007 through 2017 the S.C. Retirement System ranked 113th, with all but 11 of the other plans seeing higher investment gains.
About 591,000 people are counting on the state's pension plans for current or future retirement benefits. That's more than one out of nine South Carolina residents.
Some are current retirees while others are working for the state, local municipalities, school districts and public universities. They include teachers, police officers, judges and university administrators.
One positive reason the pensions appear increasingly underfunded is that the state has adopted more conservative, realistic assumptions about its investments.
Since 2000, the state's pension plans have failed to meet annual goals for investment performance as often as they've met or exceeded them. Despite that, as recently as 2009, South Carolina assumed against all evidence that its pension fund could make an 8 percent return on its investments year after year.
Assuming such a high rate of return makes a pension plan appear better funded. Lowering the assumed rate of return makes a plan appear less fully funded.
In 2012, as part of a pension reform package, South Carolina's assumed rate of return was dropped to 7.5 percent and a multi-year increase in required contributions began. More recently, the assumption was dropped again, to a 7.25 percent rate.
Both changes made the pensions appear more poorly funded for the long term because the long-term finances depend on investment gains. If the state changed its investment assumption to 6.25 percent yearly gains, the pension system's underfunded amount would jump by almost $7 billion more, according to RSIC's financial reports.
Most recently, in the year ending June 2018, South Carolina's pension funds saw a 7.82 percent gain on investments, after fees, beating the goal.
The state's financial year ends June 30. Since then, financial markets have become volatile, with U.S. stocks plunging in December then rebounding sharply in January.
“We didn’t sit on our hands during that time," said Geoffrey Berg, RSIC's chief investment officer. "We did make a meaningful — I think it was on the 21st of December — addition to the equities in our portfolio."
Inevitably, at some point there will be a downturn in financial markets that will once again challenge the pension funds.
“We are doing a number of things in recognition that the risks are rising," said Berg. “I am not convinced, however, that a recession is imminent."
Contribution rates for the two largest pension funds are not allowed to decrease unless those plans are at least 85 percent funded. The RSIC remains confident that fully funding the pensions remains possible, but in the short term, there are clouds on the horizon.
"It is inevitable that growth will eventually slow and equity markets pull back," Frank E. Benham, investment consultant to the S.C. Retirement System Investment Commission said in the RSIC's annual report, "but the question is when."