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Why a Decade of Bull Markets Hasn’t Fixed Pension Funding

Public pension funds are in worse shape now than they were in 2008.

In 2008, the average U.S. pension fund had 83 percent of what it needed to make good on retirement benefit promises. As of the end of 2018, pensions had only 72 percent, according to Conning’s “State of the States” report released Wednesday.

“During the past decade, state pensions have had three main roadblocks to improving their funded status: restructuring, underperformance, and reduced contributions,” wrote the authors, who are members of asset manager Conning’s municipal research team.

Part of the problem for pensions’ funded status — the gap between assets and liabilities — has been restructuring. States have pushed out their amortization schedules — essentially calculating their liabilities over a longer period of time — and lowered the rates of return that they expect. Using more realistic expectations of what the market will contribute to their funds’ financial health is a positive move in the long term, but the changes have immediately increased those states’ pension liabilities.

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As an example, Conning cited the Texas Employees Retirement System. Decreasing the plan’s assumed rate of return from 5.36 percent to 4.36 percent — a single percentage point — would inflate liabilities by a whopping 30.3 percent. In contrast, a one percentage point increase in expected returns would cut liabilities by 26.9 percent.

Pensions have set unrealistically high return expectations for decades. On average, state pension plans have assumed a 7.6 percent return. The effects of underperforming that bogey are stunning. According to Conning, for instance, from 2015 to 2016, the average “unfunded actuarial accrued liability” grew by 12.7 percent. 

Though they needed to do the opposite, states with the worst-funded retirement systems consistently under-contributed to their plans over the last nine years. Connecticut was the only exception, according to the report. And states with financially healthy plans met or often exceeded their required annual contribution rate. 

Kentucky’s employee retirement system, “which has the lowest funded ratio of 16.3 percent, has only recently begun to make 100 percent of its required contributions,” Conning said. “Before 2015, contributions rarely accounted for more than 60 percent.”

In contrast, a Washington state police and fire pension plan contributed more than it needed every year between fiscal year 2008 and 2017. The plan’s funded ratio is 109 percent — the best ratio of any state. 

There is positive news from Conning. Forty-four states reported pension liabilities in 2018. Of those, 29 had reduced their unfunded balances since 2017. 

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