Thanks to the lingering impact of sharp market declines in 2008 and early 2009, many cash-strapped U.S. public pension plan sponsors could face liquidity problems in the future as they struggle to pay higher annual required contributions both to improve funding ratios and to make benefit payments.
The aggregate public pension plan funding level dropped to 80% for the fiscal year ended June 30, 2009, the most recent year for which data are available, from 85% a year earlier, according to the National Association of State Retirement Administrators, Baton Rouge, La.
Those higher unfunded liabilities — as well as a widespread move this year to lower investment return assumptions — mean annual required contributions (the cost of benefits accrued in the current year plus the money needed to amortize unfunded liabilities) will be significantly higher in coming years for many public funds, said Keith Brainard, research director at NASRA.
More and more states are not keeping pace with their annual required contribution payments, according to an analysis of state pension fund annual report data by investment bank Loop Capital Markets LLC, Chicago.
For the fiscal year ended June 30, 2009, Loop researchers found that 26 states did not contribute their full payments, compared with 23 states a year earlier.
Loop also found that 20 states did not meet their minimum contribution level for three consecutive years through June 30, 2009, including Illinois, Iowa, Kentucky, Maryland, Minnesota, New Jersey, Ohio and Pennsylvania.
NASRA data support Loop Capital's finding that a broad swath of U.S. public plans are not receiving full annual funding from their sponsors.
NASRA's analysis of its public fund survey also includes city, county and other municipal defined benefit plans and found that the average payment received by the 99 plans in its survey was 88% of the annual required contribution amount in fiscal 2009, the same as a year earlier. But that number masks the fact that 40% of the plans in NASRA's survey “continue to receive less than 90% of their full required contribution,” the analysis said.
By not meeting the minimum contribution rate in 2009, state governments in Colorado and Kentucky deprived their public pension plans of the money needed to pay that year's accrued benefits, requiring the plans to sell assets. Earlier this year, the Illinois Legislature did not meet a number of monthly pension payments to the state's five public pension plans, also necessitating a sale of assets to meet benefit payments (Pensions & Investments, Sept. 20).
Many state and local funds — especially in the Northeast and Midwest — are mature pension plans. As retiree numbers rise, benefit payments often outpace the combined contribution from employers and employees, NASRA's Mr. Brainard noted in an interview from his Georgetown, Texas, office.
“When all else is equal, more mature plans and those experiencing contribution deficits will have more challenges going forward,” Mr. Brainard said.
To alleviate or at least forestall those future challenges, many state, county, city and municipal plan sponsors made changes this year to improve the funding status and to reduce the required employer contribution, ranging from reducing benefits, increasing employee contributions, freezing defined benefit plans and moving to defined contribution or hybrid plans. (See related story).
Among states, 19 (or 38%) have sought to reduce their pension liabilities this year by reducing benefits or increasing employee contributions, according to a brief published in November by The Pew Center on the States, Washington. That compares with 11 in 2009 and eight in 2008.
Seven both reduced benefits and increased employee contributions: Colorado; Minnesota; Iowa; Missouri; Mississippi; Vermont; and Virginia.
Minnesota, Colorado and South Dakota are plaintiffs in class-action suits filed on behalf of plan participants angry about changes to cost-of-living adjustments brought about by pension reforms (P&I, Oct. 4).
“All these states have acknowledged that the costs they face for these benefits (including retiree health benefits) have diverged from what they have been willing or able to pay and have started to take the steps to bring them back in line,” according to the Pew Center brief.
Such moves might well prevent future benefit shortfalls, said Christopher J. Mier, managing director and head of Loop's analytical services group.
“There are too many variables and too much time to be able to accurately predict which plans will have problems down the road. Any one of these states has plenty of time to improve the funded status of its plans, change benefit levels, increase employee contributions, move to a (defined contribution) plan, etc.,” Mr. Mier said.
“There's this continuing drone ... about the potential for disaster with these public plans. People tend to approach these problems with public plans as though the outcome is pre-ordained, but (it isn't). There are so many ways to address these problems,” Mr. Mier added.
“Studies that say that public pension plans are heading toward insolvency are overhyped,” agreed Mr. Brainard, noting he believes that “June 30, 2009, market values of many pension plans are artificially low.”
Gains from markets that have recovered since hitting their lows in March 2009 likely will result in much healthier pension fund balances as of June 30, 2010, the NASRA report said. But because most public pension plans employ a five-year smoothing period that phases in investment losses and gains, the report said losses incurred in 2008 and 2009 won't be completely incorporated until 2013.