SANTA MONICA, Calif. — Strong equity markets have helped narrow the gap between assets and liabilities of state defined benefit plans nationwide, but now is hardly the time to get comfortable, according to Julia Bonafede, senior managing partner at Wilshire Associates Inc., Santa Monica.
Wilshire released a report March 15 estimating state plans were 88% funded in 2006, up from 87% the year before.
“The markets are helping plans to catch up a little, but plan sponsors need to pay attention to three parts of the equation: assets; the growth in benefits; and contributions,” Ms. Bonafede said.
She explained that in the late 1990s, many states took “contribution holidays” while simultaneously increasing benefits. When the markets turned sour after the dot-com bust, funding ratios fell sharply — a rut most plans are still trying to crawl out of. However, because state defined benefit plans have very long investment horizons, focusing too much on the funded ratio can be misleading.
“You shouldn’t look at the health of pension plans as this finite number, unless it is dramatically low,” she said. “Funded ratio is a fluid number that will change.”
According to Wilshire’s 2007 report on state defined benefit plans, more than 51 of 64 plans were underfunded last year, compared with about 25 in 2000.
The firm gathered data from 125 plans for each year from 2000 to 2004, 108 plans in 2005, and 64 last year. For the 64 funds that reported data in 2006, pension assets climbed 8.4% to $850 billion, with liabilities increasing to $986.5 billion from $924.2 billion the year before.
Funded ratios for state funds fell precipitously between 2000 and 2002, and as they’ve slowly begun to improve, diversification has become a mantra. Ms. Bonafede said public funds are looking to generate returns wherever they can, and “some are taking on more risk than others because they feel the extra burden of their growth of liabilities.”
The report found that the average asset allocation for state pension plans is: 42.3% domestic equity; 17.1% international equity; 27.2% domestic bonds; 0.9% international bonds; 4.8% real estate; 4.4% private equity; and the rest in “other.”
Between 2001 and 2006, the asset class that saw the greatest change was international equity, with a 3.6 percentage point increase.
But it would be a mistake to depend entirely on investment returns to improve the health of pension plans.
“You can’t just invest your way (out of funding problems),” she said. “If you pay out more than you bring in, there’s only so much the markets can do to help you. You need to manage the risk within your portfolio.”
