100 Largest Funds Cutting Assumptions

Funding levels improving, but market volatility left some scars.

The funding levels of the top 100 US pension plans have risen, but their assumed rates of return are shrinking.

The aggregate funding ratio of the sizable institutions sat at 72.1% by the end of the first half of 2018, with median assets totaling $3.67 trillion, according to Milliman’s latest public pension fund study, released Thursday. The plans are up by an estimated 1.3 percentage points from last year’s study, and 4.4 percentage points higher than the 2017 study.

Despite this good news, the average plan did not perform well in the first half of last year due to market volatility, compared to the year prior. For example, Q1 and Q2 2018 measured negative 0.75% and 0.70%, respectively, returns while 2017 reported 4.29% and 3.06% respective gains in the same period.

Liabilities have also climbed higher than $5 trillion, reports Milliman.

That said, the assumed rate of return for these pension plans has diminished. Since 2000, the average rate has fallen from 8.29% to 5.77%. Of the 100 plans involved in the study, 80 are assuming 7.5% returns and below. About 84 plans have lowered their assumption rates at least once during the surveys.

“We’re seeing that these plans have not really made much progress over the past four or five years in terms of funded ratios rising,” Rebecca Sielman, Milliman’s principal and consulting actuary told CIO, adding that the funding ratios have “bounced around a little bit in response to the investment market bouncing around” in 2018. “I think plans have faced a significant headwind, if you will, in terms of lower and lower interest rate assumptions, which have pushed up liabilities and therefore pulled down funded ratios.”

Milliman’s capital market assumption-based hypothetical asset allocation is 35% broad US equities, 15% foreign equities, 25% core fixed income, and 10% mortgages, and divides the remaining 15% evenly across real estate, high-yield bonds, and short-term investments. The plans were analyzed using a 2.5% interest rate.

Although funded ratio normally does not vary much by plan size, the 10 smallest plans are at the highest funding levels, averaging 81%. Additionally, the 10 smaller plans above that group experienced the opposite, at 55% funded, according to Sielman.

There is no correlation between either half of these 20 plans. Poor funded status has typically been a result of lackluster returns following the 2008 financial crisis and even weaker contributions paid from sponsors, which cause liabilities to surge.

“We still have significant unfunded liabilities in aggregate in what seems like a stagnant funded ratio in aggregate, but it’s really important to remember that the plans have been making a lot of progress in terms of lowering their interest rate assumptions to levels that are more appropriate given the long-term expected returns on their portfolios,” said Seilman. “That’s a painful process in terms of increasing liability and increasing contributions, but a necessary one.”

For these 100 massive plans, asset allocations remained essentially unchanged from 2017. The average 2018 portfolio held 48% in equities, 25% in private equity, real estate, and other investments; 23% fixed income; and 4% cash. The only differences from the year prior were fixed income (24%) and cash (4%).

“I’m sure that there have been smaller changes under the hood…but big picture we’re not seeing much change at all in the overall allocation,” Sielman said.

The study only measured the performance of the 100 largest public pension funds based on their most recent fiscal year ends.

Sielman stressed the importance of assumptions used for the lower return rates to calculate funding requirements being both strong and “not unduly ‘rose-colored.’”

“It’s important to have a solid basis for calculating liability so that we have a solid basis for funding the plans,” she said.

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