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State officials in charge of overseeing pensions and health plans for more than 49,000 government retirees are hoping their combined $20 billion in investments can get back on track as the coronavirus scrambles the state’s budget priorities and sends the global economy reeling.

The retirement funds lost millions in March, but recovered most of that after markets swung up in April. But even with that immediate threat over, the retirement funds still face a cloudy horizon.

“There’s still a lot of uncertainty. There are a lot of things that we don’t know, like how the economy is going to look after the health crisis ends,” said Kuan Yuan, investment officer at the Employee Union Health Benefit Trust Fund. 

What damage, if any, has been done to the investment portfolios won’t be fully apparent until financial reports come out later this year. Things could be worse, officials said, if the funds didn’t take steps in the last three years to mitigate risky investments.

Like the coronavirus, it’s not known how long the stock market will take to recover, and it’s not clear how much money state and county governments will have available to pay down Hawaii’s $26.5 billion shortfall in future retirement benefits.

Shrinking that shortfall, known as the state’s unfunded liability, depends on two factors — investment portfolios consistently turning profits, and government employers continuing to make contributions.

“Does it create concern? I’d say yes,” Thomas Williams, the Employee Retirement System director, said of the economic situation.

“But I’m concerned about our plan even in good times. It’s the long term we need to focus on. I look at it daily, monthly. The comfort comes looking at it over time.”

Paying Off Liabilities

Both the pension fund and the health plan have a ways to go before they pay off their billions in unfunded liabilities.

Hawaii’s public pension system has a funding shortfall of about $14 billion worth of future payments to government retirees. It’s not expected to cover that funding gap until at least 2045.

The state health plan is in slightly worse shape, with estimated unfunded liabilities of $12.4 billion. The plan isn’t expected to fund all of its future liabilities until at least 2050.

However, any scenario in which the funds reach solvency — when assets are greater than liabilities — also requires billions of dollars in contributions from government employers. That requires tax revenues.

In fiscal year 2021, which begins July 1, the state is expected to pay out about $1 billion to the ERS and another $840 million to the EUTF. 

Those payments — along with others for Medicaid, social security, and debt payments — take up about half the state’s general fund, which is being hammered by the economic slowdown brought on by COVID-19.

Heads of public labor unions have suggested Gov. David Ige forego those contributions to reduce pay cuts for public workers. Ige said the state needs to shave $1.5 billion off its budget in the next 18 months.

When asked in April if he would dig into those contributions for the retirement system, Ige deflected, saying his administration is considering all options.

Wes Machida, a current ERS trustee and former state budget chief under Ige, said there’s always a concern when state revenues are taking a hit since contributions are needed for the fund to be sustainable.

It’s possible that Hawaii could lose a substantial amount of those general fund revenues. But the public may not get a glimpse into how much the state has to spend in the next few fiscal years until the meets later this month to set projections for tax collections.

Williams said losing out on those contributions would mean the fund needs to sell some of its investments to make up for the loss in cash.

“We need those contributions to be made,” he said. “It’s vital and necessary to achieve full funding in the time we need.”

It would also hit the EUTF hard. Government employers for years shortchanged payments to the health plan, which contributed to its ballooning unfunded liabilities.

A required those employers to pay their full share by 2019. Derek Mizuno, the EUTF administrator, said that if the state and counties go back to paying only the premium on those health plans, the date when the plan reaches full funding would continue to get pushed back.

If that happens, the state, and taxpayers, could end up paying more over time to cover the funding gap.

Protecting The Funds

Both the pensions and health plan portfolios are expected to return 7% annually, meaning the $17.4 billion ERS portfolio should return at least $1.2 billion next year. That doesn’t always happen.

Both funds surpassed their goals in 2018. But last year, the pension fund returned 5.7%, while the health plan ended last fiscal year at 4.5%. While it hasn’t happened yet, consistently missing investment goals can also drive up the state’s unfunded liabilities.

The funds have had a roller coaster ride in the first few months of 2020.

The ERS’s portfolio went from being up 5% in January, to down 9.5% in March, to back in the positive in April. It was a similar story for the health plan, which saw its investment portfolio lose $323 million between December 2019 and the end of March only to gain most of that back through April.

In the short term, public retirement plans nationwide have been after years of relying on risky investments to fund growing retirement costs.

The situation could be much worse here in Hawaii, according to retirement officials, if both plans did not start moving more money into a class of assets designed to protect against economic downturns.

There are different names for those assets — the ERS calls them “Crisis Risk Offset” and the EUTF says it’s the “diversifying strategy.” But at their core, those investments act as a counterweight to higher risk investments, going up when the rest of the market goes down. 

The ERS invests about 20% of its portfolio, or around $3.4 billion, in the CRO, as it’s called. The health plan allocates a higher percentage, about 28% of its portfolio, or $971 million, in those assets.

A portion of that is invested in government bonds, which are typically seen as stable investments even as the economy shrinks.

“When there’s a big downturn and people are in a panic, that’s one of the first places they go to,” said Mizuno, the EUTF administrator. “It’s viewed as our safe haven.” 

Machida, who’s also a former ERS director, credits those CRO investments with helping to diversify the fund’s portfolio and shield it against downturns in the economy.

The ERS had been tinkering with those investments about six years ago and seriously started funding it three years ago, Williams, the ERS director, said. 

Since 2017, the ERS has increased its CRO investments from 9% of the total fund to the current 20%.

The EUTF began funding that strategy around the same time. The health plan shares the same investment consultant as the ERS.

And those strategies seem to be working, too. On one day in early April, for example, the CRO class was outperforming the rest of the portfolio by 25%, Williams said. For the EUTF, its similar assets returned about 11.3%.

“We knew our biggest risk was in fund depletion,” Williams said. “We needed to protect against that.”