Few people have as clear a perspective on the differences between public sector defined benefit pension plans in Canada and the U.S. as Paul Matson.
“I know the Canadian system,” said the executive director of the Arizona State Retirement System, during a session at the Canadian Investment Review‘s 2022 Investment Innovation Conference. “Before [the Alberta Investment Management Corp.] was AIMCo, I sat on [the] investment operations committee [of the Alberta Treasury]. In the late 90s, I was recruited to come to Arizona and create an internal investment division for the state of Arizona pension plan.”
In his work at the Arizona State Retirement System, Matson oversees the management of $50 billion of retirement savings on behalf of the plan’s 600,000 members. While it’s frequently described as a DB plan in the U.S., it would be defined as a hybrid plan north of the border. “What’s interesting to note here is that employees pay 50 per cent of all costs. . . . We’ve been that way since 1975, so we’re used to having contribution sensitivity on both sides.”
The 50/50 split between employer and employee contributions used to make the AZSRS stand out from its state retirement system peers. Until the 2008/09 financial crisis, most states covered 75 per cent of contributions. “Since then, there’s been an attempt to make risk sharing more equal,” he said. “The norm now is about one-third paid by the employee and two-thirds paid by the employer.”
The hybrid model wasn’t the only thing that Matson had to get used to when he moved to Arizona. He was surprised by the way actuaries measured the funded statuses of state retirement systems. “When financial accounting, they do a bunch of smoothing and amortization. . . . They’re focused on making sure you have relatively non-volatile contribution rates. . . . Coming down from Canada, I was shocked — if you’re a finance person, you want to un-smooth everything.”
This approach became problematic during the early 2000s, when these state pensions were often over-funded, he said, noting the boards, state governments or governors of state pension schemes would seek to spend excess funds. “If, half the time, you’re over-funded and, half the time, underfunded, . . . on average, you’re fully funded. But if you keep truncating the top every time you’re over-funded, then the math no longer works out.”
Today, the AZSRS’ solvency ratio stands at about 72 per cent. “As Canadians, you’re going to see that and say, ‘Oh my goodness, they’re low.’ These are average numbers in the U.S.”
According to Matson, state DB pension plans treat unfunded liabilities like a mortgage. “Could we pay the unfunded in a second? Absolutely — all we have to do is make our contribution rates 100 per cent of pay for seven months. . . . That’s not rational, in our minds. We can pay this off over 20 years . . . because we use layered actuarial amortization.”
The amortization of liabilities allows the AZSRS to adopt relatively aggressive asset allocations, he said, noting its portfolio is composed of 44 per cent public equities, 23 per cent private credit, 17 per cent real estate, 10 per cent private equities and six per cent interest rate sensitive treasury bills. “We’ve got about double the real estate allocation and hold a significantly higher amount of private credit.
“We think of risk as volatility of contribution rates to our employees and employers and our objective function is maximizing end-period wealth,” added Matson. “We’re liability-aware, but we’re not liability-driven.”