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Special Report: The P&I Public 100

Gap between haves, have-nots is growing

Average funding ratio of top 100 public plans slips still lower

Jean-Pierre Aubry sees a growing separation of three levels of pension funding among public plans.

Updated with corrections

The gap between well-funded and struggling public pension plans grew wider in fiscal 2017, despite higher investment returns and more contributions.

The average funding ratio of the 100 largest U.S. public pension systems slipped to 71.6% in fiscal year 2017, the lowest since 2005, the first year Pensions & Investments tracked such data. That compares with 73.99% in fiscal year 2016 and 75.19% the prior year. The drop came despite noticeably better returns among plans that disclosed investment performance, with a median 13.15% return for fiscal 2017, compared to 1.25% in fiscal 2016. Five-year annualized returns were also up in 2017, at 9%, compared to 7.29% the previous year, while 10-year returns of 5.51% came close to the 5.7% notched in fiscal 2016.

Some of the funded status decline was due to a downward trend for investment return assumptions. According to P&I's data, the aggregate return assumption was 7.29%, ranging from 5.25% for the $12 billion Kentucky Retirement Systems, Frankfort, to 8.5% for the $21.1 billion Teachers Retirement Association of Minnesota, St. Paul. The previous year, the aggregate assumed rate of return was 7.53%. For fiscal year 2010, it was 7.9%.

(All asset sizes in this story are based on the most recent actuarial valuation figure.)

"You are definitely seeing more downward pressure on the expected rate of return. Some of that comes from the reality of what expected returns are. It becomes a much easier pill to swallow," said Timothy F. McCusker, partner and chief investment officer of NEPC LLC, Boston. Kevin Leonard, partner and team leader for NEPC's public fund consulting practice, does not expect that trend to reverse, given public funds' long-term liabilities. "I think what we've seen in the public fund world is an acknowledgment of what the professionals are telling them. We are all telling the same thing," Mr. Leonard said.

Growing disparity

To Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College, the bigger story behind the fiscal 2017 numbers is the growing disparity in plan funding since 2001. "The funded ratio has been basically flat since 2012. What is interesting to us is that the average hides a lot of variation now," he said. The top third funds are funded around 90%, the middle third around 70% and the bottom third average 55%, he added.

"The universe of pension plan funding is trifurcating. You are seeing an increasing separation of plans in the public space. It's a combination of contributions and returns," said Mr. Aubry.

Contributions were up as well, driven entirely on the employee side. In fiscal 2017, employee and employer contributions totaled $143.9 billion, up 1.37% from the previous year. Employer contributions for 2017 dipped 1.8% from the previous year, to $99.4 billion, while employee contributions rose 9.27%, to $44.5 billion. It was still the second-highest total employer contribution since P&I has been collecting the data.

A Center for State and Local Government Excellence survey found that 17% of governments made changes to the contribution levels, plan structures or eligibility requirements in 2017, in keeping with a trend that started in 2008. The most common change has been to increase contributions, with 11% doing so for new hires and 9% for existing workers.

"I think the contribution story is relevant today," said Mr. Leonard of NEPC. "It's the historical lack of (employer) contributions, not the recent contributions. In today's age with that being so much on the front lines, most of the clients are meeting the required contribution," he said.

In fiscal 2017, total actuarial assets rose 2.85% to $3 trillion from $2.925 trillion, while actuarial liabilities hit $4.201 trillion in fiscal 2017, up 6.3% from $3.953 trillion the year before.

In aggregate, the top 100 plans had unfunded liabilities of $1.193 trillion as of their most recently available actuarial valuation date, up 16.1% from $1.028 trillion the year before.

A report from the Center for Retirement Research at Boston College coming out in October on 180 plans in a public plans database shows rough aggregate funding ratios in fiscal years 2016 and 2017 of 72%, and a steady funding level between 71% and 73% since 2012. The public plans database is produced by the Center for Retirement Research in partnership with the Center for State and Local Government Excellence and the National Associate of State Retirement Administrators.

Contributions matter

The center's 2017 study of funding levels, covering 95% of public plan assets and participants in the U.S., shows that 92% of state and local pension plans have been paying more of their required contributions relative to recent years.

"You're seeing an increased effort on the part of plan sponsors to pay more of their required contributions," said Joshua Franzel, president and CEO of the Center for State and Local Government Excellence in Washington. "There has been an upward trend in recent years. To their credit, they are making a concerted effort. They are still making up for losses a decade ago."

Keith Brainard, research director at the National Association of State Retirement Administrators in Georgetown, Texas, said his members also are seeing plans institute more conservative actuarial assumptions while making progress on paying down their unfunded liabilities. They are using tactics such as using shorter amortization periods that might increase the cost but pays down the unfunded liability quicker, Mr. Brainard said.

"I think the focus has shifted toward reducing unfunded liability, even it increases costs short term," he said. "I think a stigma has developed for plan sponsors that are not paying their full contributions. We are seeing a lot more attention being paid.

"A funding ratio is the most recognized and referred to indicator of a pension plan's condition, but it's only one. You have to look at a number of factors, including the size of the unfunded liabilities relative to the plan sponsor's ability to service that," said Mr. Brainard, who agreed that "there is more disparity between haves and have nots. Most public pension plans are in reasonably good shape," he said.

Best funded

Among P&I's universe of the largest 100 public pension systems, some of the best-funded plans are the $7.4 billion District of Columbia Retirement Board, with a funding ratio of 105.2%; the $107 billion New York State Teachers' Retirement System, Albany, 97.9%; the $44.2 billion Tennessee Consolidated Retirement System, Nashville, at 96.2%; and the $9.6 billion Oklahoma Public Employees Retirement System, Oklahoma City, at 95%.

At the bottom of the list are state and municipal plans in Illinois, including the three plans overseen by the $17.6 billion Illinois State Board of Investment and the Chicago Municipal Employees' Annuity and Benefit Fund. 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 14.9%, 35.6% and 35.5%, respectively, as of June 30, 2017, the most recent data available. The $4.5 billion Chicago Municipal Employees' Annuity and Benefit Fund had a funding ratio of 27.4% as of Dec. 31, 2017.

Some of the largest funding ratio gains in fiscal year 2017 were 9.1 percentage points by the $19.2 billion Louisiana Teachers' Retirement System, Baton Rouge, to 64.55%, and 12.9 percentage points by the $14.2 billion Minnesota State Retirement System, St. Paul, to 60.4%.