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Special Report: Public 100

Dip in funded status not a good omen

Alicia Munnell said public plans haven’t seen much improvement in their funded status.

Even with increase in contributions, ever-rising liabilities paint picture of a dismal future

The average funding ratio of the 100 largest U.S. public pension plans dropped slightly in fiscal year 2016, following two years of increases.

The average funding ratio of the 100 public pension plans that Pensions & Investments tracks dropped to 74.99% for fiscal year 2016 from 75.19% the prior year. Still, the ratio was higher than the 73.13% average in fiscal year 2013, which was the lowest since P&I started tracking the data 10 years ago.

The slip came in a tepid year for returns, as the median one-year return among plans that disclosed investment performance for fiscal 2016 was 1.3%. That, combined with employer and employee contributions, was not enough to overcome the continuing rise in pension liabilities.

In aggregate, the top 100 plans had unfunded liabilities of $942.9 billion as of their most recently available actuarial valuation date, compared with $723.6 billion the year before. Total actuarial assets had risen to $2.83 trillion from $2.19 trillion, but the rise in actuarial liabilities matched the rise in assets, rising to $3.77 trillion from $2.92 trillion.

In fiscal 2016, employee and employer contributions totaled $140.1 billion, up 17.5% from the previous year. Employer contributions for 2016 totaled $100 billion, up 15.8% from the previous year, while employee contributions for 2016 totaled $40.1 billion, up 22%.

The increase in contributions is a good sign, experts say, but given the dip in average funding ratio, it still is not enough and more contributions are needed.

Alicia Munnell, director of the Center for Retirement Research at Boston College, said its research shows plans have not been progressing as they should for the past 15 years in terms of funded status improvement.

"What we basically came down to is the fact (pension plans) all have low returns over this period since 2000 and also they're basically looking at the wrong annually required contribution that's not rigorous enough. They're not paying all of that. That's the general problem."

"If we have another financial correction, which we're inevitably going to do, they're at risk at seeing a significant downgrade in their funded status," Ms. Munnell said.

Didn't happen overnight

Jay V. Kloepfer, an executive vice president and the director of capital markets research at Callan Associates Inc. in San Francisco, said decades of insufficient contributions by public plan sponsors have led to the funding problems more than any return shortfalls.

"It's not enough contributions. That's it. There are no other factors," Mr. Kloepfer said.

For fiscal year 2006, the year P&I began collecting funding data on public pension plans, the average funding ratio was 85.6%. The ratio hit its peak at 86.8% in fiscal year 2007. By fiscal year 2010, after the worst of the financial crisis was over, the average funding ratio was 78.1%.

"It's obviously been a very difficult environment post-global financial crisis, where funding ratios took a pretty substantial hit," said Steven J. Foresti, chief investment officer at Wilshire Consulting in Santa Monica, Calif., in a telephone interview. "Then you look at market returns, they've been strong in the last handful of years, (but) liabilities continue to grow at the actuarially assumed rate at a median 7.5%."

"Even if you assume contributions are essentially going to match new benefits that are accrued, and you look at the asset returns, (you need) compounding returns above that 7.5% to make up ground," Mr. Foresti said.

"If you're sitting there at 70% funded today, and again I'm just going to assume contributions and new benefits vet each other out, if you think about fully funded from returns only, over the next 10 years it would require a compounding return of 11.5%," Mr. Foresti said.

Recent history shows that kind of return is not realistic. According to P&I's data, the median 10-year compound annualized return among plans that disclosed investment performance was 5.7%. The median annualized return over the five-year period was 7.3%.

"Over 20 years, (the return required) would be 9.4%. Over 30 years, it would take 8.8%," Mr. Foresti said. "It's difficult to expect returns to be the complete answer. It's very likely going to be contributions above and beyond what they expected a decade ago, and that's where the potential tension comes on."

Plan sponsors need to contribute more to their plans to meet their obligations, those interviewed for this story said. Many recognize that fact. Implementing the decision, however, is another matter entirely, the experts said.

"It's a long-term liability and elected officials get elected every two to four years, and it's easy to say, 'we'll deal with it later,'" Mr. Kloepfer said.

"We didn't arrive at this problem overnight. It's a long time coming. People all know it, but if you don't put the money in repeatedly for decades, it will catch up to you. So what they are doing is trying to come up with the money, but it's expensive," he said.

"There's a political challenge also as they've tried to manage the costs of liabilities. They've cut back to what they offer to newer employees, but it doesn't mean all those promises you made go away. They don't. There's tension, there's resentment (and) the taxpayers are wondering why they're paying for something now that was promised so long ago," Mr. Kloepfer said.

Mr. Foresti added: That contribution "from that sponsoring municipality or state, whatever that sponsoring organization is, that's usually competing against other budgeting priorities. That's clear where some of the tension comes from. And again, to do it right, it's going to take a mix of time and additional funds."

Ms. Munnell and Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research, said in the same interview they had separated the CRR's public plans database consisting of 170 state and local pension plans into three categories: Plans with funding ratios above 80%, between 60% and 80%, and below 60%.

"If you look at around 2000, they were all bunched around (100% funding ratio), and they all kind of splay out over a V shape over time, and the ones who are in this bottom group have been particularly bad at making contributions," Ms. Munnell said.

"Plans in the bottom category were paying about 60% of the appropriate amount, while groups in the top category were paying like 85% of the appropriate amount."

Taking additional risk

With public pension plans struggling to keep their funding ratios up in the face of lower-than-needed contributions, plans have taken on additional risk in an attempt to keep up with or surpass their assumed rates of returns, even as plans lower them.

The average assumed rate of return among P&I's public plan universe has gradually dropped to 7.54% for the most recent analysis from 7.96% for fiscal 2006, although doing so, again, brings up the necessity of higher contributions.

Public pension plans are "taking a lot more risk, so what used to be the standard portfolio 20 years ago was 60% in risky assets and 40% in not-risky assets or bonds. 60/40 is pretty unusual now for an open active plan. It sounds almost quaint," Mr. Kloepfer said.

"The sad fact is (if) you keep lowering your return assumption but you don't lower your required return to fund your plan you have to keep taking on more risk.

"You're not getting much out of bonds so you're pursuing more and more risk. If that 60% becomes 70(%) to 80(%) you have to diversify," Mr. Kloepfer said, adding many plans have increased their exposure to alternatives such as private equity, private debt, real estate and infrastructure in the effort to keep their returns up.

"It's going to (have to) be a combination of these asset returns and contributions," said Brian McDonnell, Boston-based global head of pensions at Cambridge Associates LLC. "A lot of municipalities and states are just in a fiscal situation where they're pretty constrained on what they can do on the contribution side, which puts a lot of pressure on the asset side to do the work."

"Whether it's embracing illiquidity, embracing alpha-seeking strategies that involve complexity but really help you bridge the gap between 5%, 6% (rate of return) and the 7.5% or 8% that you need, people are increasingly going to have to do that and use resources to identify those (opportunities)," Mr. McDonnell said.

Among the top 100 public pension plans, some of the best-funded plans are the $6.8 billion District of Columbia Retirement Board, with a funding ratio of 104.6%; the $5.1 billion Milwaukee City Employes' Retirement System, 96.7%; the $44 billion Tennessee Consolidated Retirement System, at 95.9%; and the $7 billion Missouri Local Government Employees Retirement System, Jefferson City, at 94.7%.

At the bottom of the list are state and municipal plans in Illinois, including the three plans overseen by the $16.6 billion Illinois State Board of Investment, Chicago. Those plans are the Illinois General Assembly Retirement System, the Illinois Judges' Retirement System and Illinois State Employees' Retirement System, which had funding ratios of 16%, 34.8% and 36.2%, respectively. Those numbers were as of June 30, 2015, the most recent data available. The $4.3 billion Chicago Municipal Annuity and Benefit Fund had a funding ratio of 30.5% as of Dec. 31, 2016.​