The funded status of many state pension systems has stabilized, but volatile investment returns, historically low interest rates, rising contribution demands and demographic changes challenge the long-term sustainability of some pension funds, said a Fitch Ratings report released Tuesday.
On an actuarial value basis, the median funding ratio for state pension plans rose to 73.1% in 2015, up from 70.7% in 2014 and the 2012 post-recessionary low of 68.9%. On market value basis, however, the median funding ratio declined to 72.3% in 2015, down from 76.2% in 2014, driven by poor market performance in 2015. The median investment return was 0.3% in 2015, compared to 12% in 2014. Flat investment performance in 2016 will be a headwind for both ratios, Fitch said in the report.
Falling return assumptions are also slowing funding ratio improvement. “Because state and local defined benefit pensions use the investment return assumption as the discount rate for calculating the present value of future benefits, the lower investment return assumption (falling to a median 7.66% in 2015 from 7.97% in 2008) has pushed accrued liabilities higher,” the report said. Still, Fitch argues that these return assumptions are high in light of the low-inflation and low-interest-rate environment.
Another challenge for the state pension systems is the falling ratio of active workers to retirees (1.39 in 2015 vs. 1.85 in 2008). “Net cash outflows rise with longer life spans and (more retirees) and more assets must be invested in shorter duration, more liquid securities, making achievement of high investment return assumptions more unrealistic, particularly in systems with lower ratios of assets to liabilities,” the report warned.
Looking at state pension contributions, the report found that 66% of major state plans received 100% or more of their actuarially determined employer contributions in 2015, compared to 56% in 2014 and 44% in 2011, when strained budgets reduced pension funding. Even with this improvement, Fitch argued that “contribution practices in general remain a source of concern,” noting that many systems are bound by statutory caps on annual contributions or increases in contributions as a percentage of payroll. Rolling amortization practices in an environment of low investment returns can also lead to higher unfunded liabilities, the report said.
Looking at individual state’s pension burdens, Illinois ranked the worst, with outstanding direct debt and unfunded pension liabilities amounting to 22.9% of personal income in Illinois compared to a median 5.1% for all states and 0.6% for Nebraska, the least burdened state.
