Fund executives say it will take more than just investing acumen to fix the problem
Severely underfunded public defined benefit plans will have to try a bit of everything to shrink liabilities, from benefit cuts to contribution hikes to accelerated payments, and paying more attention to costs overall.
According to Pensions & Investments' analysis of funds' annual report data, the average funding ratio of the 100 largest public pension plans dipped slightly in fiscal year 2011, to 73.64%, with unfunded liabilities increasing 4.1% from the previous year. One positive note, however, comes from Wilshire Associates' annual measurement of 102 systems' 2011 actuarial data, which showed pension assets growing faster, at 16.4%, than liabilities, which grew at 3.3%.
Wilshire attributed the latest asset growth to strong global equity performance, along with more moves into other non-traditional assets.
“There has definitely been over time a move into a larger number of asset classes, and more diversification into global,” said Wilshire Associates Managing Director Steven J. Foresti in Los Angeles.
But he and other public plan experts caution that investing is not the solution to plan underfunding, especially for the many plans that are still writing down investment losses that occurred in the recession. “It would take some really attractive returns short term to invest your way out, and one of those routes requires taking more risks,” Mr. Foresti said.
Meredith Williams, executive director of the National Council on Teacher Retirement and former executive director at the $38.2 billion Public Employees' Retirement Association of Colorado, has seen “some pretty exotic modeling” of various scenarios as public plans start to think about risk management. He is also hearing more debate over active vs. passive management. “Maybe you can beat the market short term, but can we consistently beat the market over the longer term? The fee structure is so attractive on the passive side, and technology has made the passive portfolio so cost-efficient.”
David Driscoll, a principal with Buck Consultants, Boston, agrees that in the public arena, “people are looking around for ways to save.”
“One way to do that is to spend less money on the management of the fund. It's certainly going to result in more attention to benchmarks. They look for ways to boost returns, and we do see more and more funds talking about index funds,” Mr. Driscoll said. While he thinks active managers will be popular as long as the results are good, “they're under tremendous pressure to prove that they add value. There isn't a lot of money on the budget to absorb bad experiences.”
The public sector does have some breathing room for addressing underfunding problems because of the funds' long-term horizons. “It took years to get in that hole, and it's probably going to take years to get out,” said Mr. Williams. “The first thing you do is stop the bleeding,” starting with more realistic benefit promises for new hires, then existing employees, and even retirees, if necessary, he said.
Disconnecting benefit promises from actuarial calculations got the Teachers' Retirement System of Louisiana, Baton Rouge, so far behind that in 1989, the state created a schedule to pay off its unfunded pension liability by 2029. Like a mortgage, the initial payments have gone more toward slowing the growth of the liability, but within a year from now, TRSL should be making bigger inroads in the liability itself, said Chief Investment Officer Philip Griffith. In years when the $13.7 billion plan falls short of its 8% rate of return target, employer contributions are raised to make up any shortfall in the payment to the fund. “We have a plan. We don't adjust the portfolio for the funding status,” said Mr. Griffith, a sentiment echoed by many other administrators.
The $8.8 billion Louisiana State Employees' Retirement System, also in Baton Rouge, has a similar plan, with payments and a recent market return of 24% bumping the funded ratio to 57.6% in fiscal 2011 from 56% in 2010.
For addressing unfunded liabilities from the past, a lot depends on a plan sponsor's ability — or willingness — to make contributions toward present liabilities, let alone past-due amounts. Four of every 10 plans in the National Association of State Retirement Administrators 2010 public funds survey received less than 90% of required contributions. According to State Budget Solutions, a non-profit organization advocating state budget reform, only four of the 15 states with the largest liabilities — New York, Florida, Wisconsin and Georgia — consistently make their annual required contribution, and only two states, Delaware and South Dakota, fully fund their plans every year.
Officials at the New Hampshire Retirement System, Concord, which was 57.41% funded at the end of FY 2011, recently got out of “the hole we were in” by legislating an end to long amortization periods that delayed funding decisions indefinitely, according to spokesman Marty Karlon. The New Hampshire fund hopes to add $3 billion over 20 years from employer cost cuts, he said. Rhode Island officials are also projecting a $3 billion drop in unfunded liability through some recent reforms.
Sometimes it has to get worse first. That was certainly true in Florida, where chronically underfunded pension plans were closed in 1970 to create the current $125.8 billion Florida Retirement System, Tallahassee, while a constitutional amendment was passed to promote responsible funding. It took 20 years of extra contributions to make up the deficit, but the system weathered the 2008 crisis in much better shape than previous market downturns, said Florida State Board of Administration spokesman Dennis MacKee. After partial funding payments in the past two years, FSBA administrator and CIO Ashbel C. Williams, Jr. is now asking state officials “to consider more robust funding” of the unfunded liability , and to revisit lowering the assumed rate of return to 7.25% from the current 7.5%, Mr. MacKee said.
For well-funded plans, it's all about discipline. Kevin Murray, New York State executive deputy comptroller, credits the $150.6 billion New York State Common Retirement Fund's consistently high funding levels, including 94.34% in fiscal 2011, to the state's conservative cost calculations and a longstanding habit of making full contributions. “That has made a big difference,” said Mr. Murray. “We were above 100% funded when the market (downturn) hit, which gave us a cushion. If you stick to the discipline, you will be able to recover.”
Mr. Murray understands the temptation in well-funded states to hold back pension payments, “but once you zero something out, it's very hard to get it back in the budget,” he said.
David Craik, executive director of the $7 billion Delaware Public Employees' Retirement System, Dover, agreed. His board in 2002 had the Legislature add a 2% floor to employer contributions, after they had dipped to zero when the system was “too well funded.” For the system that was 90.8% funded in 2011, “probably the biggest thing is that state has consistently paid 100% of its ARC,” said Mr. Craik. It also helps that the system is in the top quartile on investment returns, and the state tweaks benefit levels and increases contributions to stay on track.
“Part of the formula is having good habits and not changing them,” said Janet Cowell, state treasurer and sole trustee of the $74.5 billion North Carolina Retirement Systems, Raleigh. “If you get off the path, then you're in the wilderness.” The North Carolina pension fund has exceeded 100% funding at times, and the state missed making its full contribution only once in 70 years. Ms. Cowell also credits her status as an elected official for added accountability. “It sets the tone,” she said.
That will be helpful when legislators convene to figure out next year's pension funding and related issues, including a more diversified investment strategy for a portfolio with a large fixed-income component, “as opposed to putting more taxpayer money into the system,” Ms. Cowell said. “Even for well-funded plans, there are a lot of conversations.”
Perhaps the biggest challenge is in Illinois, with a combined unfunded liability of $83 billion for the $36 billion Illinois Teachers' Retirement System, Springfield, the $13 billion Illinois State Universities Retirement System, Champaign; and three systems with combined assets of $10.3 billion overseen by the Chicago-based Illinois State Board of Investment. Gov. Pat Quinn has committed $5.2 billion to the five systems this fiscal year, which represents 15% of the state's general revenue spending. But he also put legislators on notice that “everything is on the table” to reach a goal of 100% funding by 2042, including benefit reductions, contribution increases from both employees and employers, and a 30-year funding payment plan, said spokeswoman Kelly Kraft.
“It all comes down to political will,” said Hank Kim, executive director of the National Conference on Public Employee Retirement Systems, Washington. “I think over the next 12 to 18 months, you'll see that sink in.”
This article originally appeared in the October 1, 2012 print issue as, "Solving the underfunding crisis".