Many elected officials overseeing public employee pension funds have received the message that pension obligations must be funded annually.
They have realized anything less than the annual required contribution simply makes the funding needed in future years that much larger, and that, in turn, squeezes other vital parts of public-sector budgets such as education, police and fire. It also passes on to future taxpayers at least part of the cost of pensions being paid out for services provided by public employees today or in the past.
Unfortunately for those officials, the task of paying down the unfunded liabilities is not getting easier. As reported in a special report in this issue, the average funding ratio of the 100 largest public pension plans declined more in fiscal 2017 than in fiscal 2016.
The fiscal 2017 funding ratio, at 71.9%, is the lowest since 2005, the first year for which Pensions & Investments has such data, and dropped despite strong investment returns in fiscal 2017. In this year's special report, P&I found the median fund returned 13.22% compared with 1.25% in fiscal 2016. The five-year returns at the end of fiscal 2017 were also strong at an annualized 9.1%, compared with 7.29% at the end of the previous fiscal year.
The decline in funding ratio occurred despite the fact that 92% of state and local officials have been paying more of their required minimum contributions into the funds than in previous years. The trouble is, liabilities grew at a faster pace than assets in fiscal year 2017.
One reason is many public employee funds have reduced their annual investment return assumptions to more reasonable levels. According to P&I's data, the average assumption for the 100 largest plans was 7.29% in fiscal year 2017, down from 7.53% the prior year.
Many analysts believe the stock market return over the next five years will be much lower than it has been for the past five years. Public officials working with public pension funds appear to have accepted this prognosis.
The change in interest rate assumptions will make the task of raising the funded status of the public funds more difficult for state and local officials because it will increase the required annual contribution.
At least part of the unfunded liabilities in some states and cities arose because in the past officials agreed that investment returns above assumed rates could be used to increase pensions for retirees, or to reduce employee contributions. The officials forgot that good one-year investment returns do not guarantee returns the following years will be positive, and that negative returns could wipe out the one-year gains, so the increased benefits would deepen the unfunded liabilities.
This must not be allowed to happen again. Elected officials must resist pressure to increase pension benefits after short-term investment gains. They must remain committed to increasing the funded status of public employee pension plans across the country. They must never again shortchange the funding of those plans or approve unfunded benefit increases.
Restoring many public employee pension plans to health will take time. Tough decisions will be required — new revenues might be needed, or benefits might have to be frozen or even reduced. But they must not waver.
