Reduced stock holdings by tuition plan sought


The chairman of Maryland's prepaid tuition program will propose trimming the amount it is allowed to hold in stocks by about 15 percentage points - a reflection, he said, of demographics, not market losses last year that nearly wiped out the plan's actuarial surplus.

Chairman Edwin S. Crawford said he will recommend that the maximum that can be held in stocks be cut from the current 80 percent to about 65 percent at today's meeting of the Maryland Higher Education Investment Board. While policy permits up to 80 percent in stocks, the trust's target asset allocation for stocks this year is 70 percent.

"It's not a fear of the market place," Crawford said. Rather, he said, the trust is finding that the bulk of children enrolled in the plan are middle-school age and, therefore, will be paying tuition in five or eight years. Consequently, investments need to be less risky than if they were infants who wouldn't be going to college for 18 years.

The Maryland Prepaid College Trust, launched in 1998, allows parents and others to lock in future education costs at a Maryland public college based on current tuition rates. (The money also can be applied to private colleges or out-of-state institutions)

The trust has sold more than 11,500 tuition contracts and is in the midst of an enrollment period. Participation in the beginning fell far below expectations, but picked up steam after the state legislature in 2000 took steps to cover a shortfall if the trust couldn't meet future obligations.

The trust, nevertheless, is expected to generate earnings sufficient to meet its obligations, plan officials said.

The trust's board increased the portfolio's initial target stock allocation of 65 percent to 80 percent for the 2000 enrollment period, at the urging of former state treasurer and trust board member Richard N. Dixon. At the same time, it reduced the target allocation for bonds from 32 to 17 percent. Three percent was to be held in cash.

Crawford said he thought at the time that 80 percent was a bit aggressive. In practice, Crawford added, the portfolio hit 80 percent stocks only three times for a handful of days and usually hovered between 68 percent and 72 percent equities.

Some experts say having as much as 80 percent in stocks is more aggressive than usual for such plans or pensions. "The typical U.S. corporate pension fund, and these are the experts that do it with everybody's money, they're typically 50 to 60 percent equities and 40 to 50 percent fixed income," said Joel Morse, director of the Division of Economics, Finance and Management Science at the University of Baltimore.

Board member Karl Spain said that a 60 percent to 80 percent range for stocks was recommended by the plan's outside consultant, Watson Wyatt Investment Consulting, as having the highest probability to achieve the trust's long-term objectives.

Dixon, who also was the former head of the state's pension board, was criticized for holding too much of the pension fund's assets in stocks. He said he supported an allocation that permitted up to 80 percent in stocks - though it rarely reached that - because history shows equities provide the best return over the long haul. Despite a market downturn, the allocation is still a good one, he said.

"You don't look at what happens in the market one year or two years. When investing in the market you are doing it for long-term purposes," he said. "To look at what happens in one year is very misleading."

Like many individual investors' and pension funds, the prepaid trust took a hit in last year's stock market.

During its fiscal year that ended June 30, the trust's stock portfolio, invested in an S&P; 500 index fund managed by Vanguard, fell 14.7 percent, with the value falling $4.7 million, to $31 million, said Carol Kaiser, the trust's chief financial officer. The trust has yet to sell securities to pay for children's tuition, so any losses and gains are unrealized.

Overall, the portfolio, which included cash and a T. Rowe Price Associates bond fund, was down 8.7 percent, or $3.7 million, to $68.5 million, she said. For the first six months of the current fiscal year, the portfolio is up 0.45 percent.

The plan's goal is to earn a 7.65 percent average annual return.

Its actuarial surplus - the amount assets exceed future obligations - fell from $3.85 million the year before to $52,576 in fiscal 2001.

"It's clear that the situation deteriorated over the year, not surprising when you are invested that aggressively in stocks," said Thomas Lowman, an actuary with Bolton Offutt Donovan Inc., a pension consultant in Baltimore, who reviewed the trust's reports.

The trust, in fact, had a tentative actuarial deficit of $1.9 million before the board adjusted some assumptions that gave it a small actuarial surplus, according to minutes of its August meeting. The size of an actuarial surplus or deficit depends upon assumptions made, including the expected rate of tuition inflation and investment returns. Assumptions are reviewed annually with the plan's actuary, board members said.

According to the minutes, Spain "asked the board to discuss the ramifications of announcing the trust has a deficit. Mr. Crawford stated that he believed it would not [be] detrimental to announce an actuarial loss given the conservative long-term target investment rate and that the trust is a long-term investment. Ms. Kaiser stated that the board should realize that the financial statements would reflect actual loss, not actuarial loss. Therefore, any adjustments to try and minimize the actuarial loss will not negate the fact that the annual report will show the full financial statements of the trust."

Spain said that he had been concerned that the board was being far too conservative with its assumptions. For instance, he said, even though the trust sold 5,000-plus tuition contracts last year, more than doubling its total contracts in a single year, the assumption was that fewer contracts would be sold in the current enrollment period.

"Why predict you will do worse?" Spain said. "Perception-wise, it was negative to predict that the year after we did some 5,000-plus contracts, we're going to do 20 percent worse."

There's reason to believe more contracts will be sold now that the new federal tax law permits earnings to be withdrawn tax-free if the money is used for college, he said.

The board, after reviewing various scenarios with the actuary, revised two assumptions, including Spain's suggestion to increase the number of expected new tuition contracts - and hence payments into the trust - to 4,500 for the current enrollment period, up from 3,000.

Kaiser said changes were necessary last year because the old assumptions were unrealistic given that the plan more than doubled in size in a year, the federal tax law changed and a new state college savings plan was set to be launched.

Other changes were made in the past year. In the last few months of the fiscal year, the trust began to hold more incoming money in cash and added a small- to mid-cap fund and bond fund.

Kaiser said that the goal was always to add more investments once the trust reached a certain level of assets. The board also is expected today to discuss adding two more options, including a large-cap value fund and stable value fund.

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