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.