State pensions are in the dark, but red may be ahead

The funded status of state pension funds was strong at the end of 2021, but there could be challenges ahead, according to Wilshire. Despite their funded status in 2021 reaching a year-over-year growth rate not seen since 1990, for plan sponsors the market decline and volatility in 2022 will challenge state pension systems to maintain those levels.

The overall funded ratio of US state pension systems reached 83.3% in fiscal year 2021, an increase of 13.3 percentage points from the previous year, according to research by Wilshire. The report, “2022 Report on State Retirement Systems: Funding Levels and Asset Allocations,” reviewed the overall funded status and asset allocations for more than 100 US state-sponsored defined benefit retirement systems.

Ned McGuire, managing director of asset allocation at Wilshire, said the 13.3 percentage point increase, from 70%, is the biggest year-over-year increase since the company started. began compiling data on the government financing ratio in 1990. fell from 67.4% in 2016 to 70.5% in 2017, 71.9% in 2018 and 72.7% in 2019, before to drop slightly to 70.0% in 2020.

“State pension plans are much better funded than they were five or six years ago,” McGuire says. “Overall this means that required contributions may decrease, but it all depends, plan by plan, on how much future plan contributions may decrease over the next few years.”

Wilshire and McGuire note that for the research, data was collected in the first quarter of each calendar year to include the maximum number of reports possible with an assessment date of June 30 of the previous year.

Despite improvements in 2021, the approximate funded ratios of state pension systems have “actually slipped [in 2022] by 1.9 percentage points, from 83.3% to 81.4%, and this is largely due to the global fluctuations in equity values ​​that we experienced in the first quarter of this year,” adds McGuire. The research also points to falling inflation, interest rate hikes by the Federal Reserve, and geopolitical risks from Russia’s war on Ukraine.

McGuire adds that the Sisyphus task of state pension plans is exacerbated by market volatility. To remain viable for payouts to beneficiaries, a pension must match capital market return expectations.

“If you look at the capital market expectations across all sectors, they’re pretty subdued at this point, and being able to get the capital market return relative to what you’re assuming over the next few years could be difficult,” he says. “We have seen this challenge obviously in the short term, given the sharp drop in equity markets since the start of the year.”

Wilshire reports that in 2021, 30.8% of state pension plan assets were allocated to US equities; 22.6% to fixed income securities; 16.8% to non-US equities; 14.2% to real estate assets; 9.6% to private equity; and 6% to “other” asset classes, such as hedge funds and commodities. Wilshire estimates aggregate state pension fund assets grew to $3.96 trillion at the end of fiscal 2021, up more than 21% from $3.25 trillion in 2020 .

“Significant positive returns and contributions on investments drove asset values ​​to record highs for the third consecutive year and fifth consecutive annual increase,” the report said.

Wilshire also found that contributions increased asset value by 5% for the year, with nearly 30% coming from plan participants; investment income increased asset value by more than 27.6% for the year, the largest percentage increase ever; benefit payments are estimated to have reduced the value of assets by 8.1%; and other items are estimated to have decreased the value of the assets by 2.9%.

State pensions hold retirement assets for approximately 29 million American workers who have been promised retirement benefits. More than half of benefits depend on earnings from the nearly $4 trillion in assets held by the systems, says a Pew Research Center brief written by Susan Banta, project director for public sector pension systems.

Despite the improvement in the capitalization of public pension funds, storms could be on the horizon, as more than two-thirds of these assets are allocated to risky investments, she argues.

“Despite this recent recovery, pension fund returns have declined fairly steadily over this century, and a combination of trends suggest this will continue,” Banta writes. “With stock market valuations well above historical averages and the Congressional Budget Office predicting that real gross domestic product growth – a major driver of equity returns – will be weaker in coming years than in the fiscal 2021, future returns are expected to fall as equity prices adjust. Additionally, interest rates have reached historic lows, lowering return expectations for fixed-income investments, such as bonds. .

The Pew report, “State Public Pension Fund Returns Expected to Decline,” finds that in 2019, state pensions allocated 47% of assets to equities, 27% to alternatives, and 26% to fixed income and cash ; in 1999, 53% was allocated to equities, 18% to alternatives and 29% to fixed income and cash.

“With more than two-thirds of these assets allocated to risky investments – publicly traded stocks, also known as equities, and alternative vehicles including private equity, real estate and hedge funds – the ability of systems to meet their commitments depends largely on investments that are subject to stock market fluctuations,” writes Banta.

From 1990, in fact, the total allocations of public pension funds to “risky” assets – as Banta calls it – represented between 70 and 75% of investments. “After moving from relatively safe bonds to relatively risky stocks from the 1950s to the 1990s, pension funds have increasingly turned over the past 15 years to alternative assets to diversify their portfolios and achieve return objectives. “, she explains. “Investment in these vehicles has doubled since 2006, and in 2019 it represented about a quarter of total assets.”

Market volatility underscores the importance of managing pension plan risk and setting realistic return targets, Banta adds.

“Driven by the onset of the COVID-19 pandemic, the S&P 500 index fell 34% in February and March 2020, and the value of pension assets also fell,” she explains. “But in mid-2021, markets were soaring, generating a 21% budget return over two years for 2020-2021. In fiscal year 2021, government pension funds posted historical median returns of over 25%. »

However, Banta cautions against expecting annual returns close to 25%. Public pension funds assumed average returns of 6.99% in 2021, according to data released by the National Association of State Retirement Administrators in March.

Related stories:

Despite weak equity returns in April, higher discount rates have improved the funding of most pension plans

State pensions hit highest funded level in 13 years

State pension funding falls to lowest level in 30 years, says Wilshire

Tags: returns on investment, Pew Research, public pensions, Wilshire

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