This year’s market downturn could end up being the death knell for struggling public pension plans which, after failing to replenish their funded levels in the decade since the financial crisis, might not survive to see the next decade.
“Given that the aggregate funded status of public plans has remained virtually unchanged since the last financial crisis, this downturn is a serious step backwards in their funding progress,” said a report from the Center for Retirement Research at Boston College and the Center for State and Local Government Excellence.
The report said that if the markets maintain their current level, most public pension plans will close out fiscal 2020 with negative annual investment returns, reduced asset values, lower funded ratios, and higher actuarial costs.
Although projections suggest that plan finances will continue to deteriorate in the aftermath of the downturn, the report says that plans “on the whole” should persevere and maintain sufficient assets from which to pay benefits. However, this does not include plans with extremely low funded ratios, some of which face an increased risk of depleting their assets and the high cost of “pay-go funding” if they do, the report said.
To determine how plans might manage in the wake of the downturn, the report used projections from 2020 to 2025 under two possible market scenarios. The first scenario assumes markets remain at current levels until June 2021 and then steadily climb to their previous peak by 2023. And, from that point on, plans would achieve their assumed rate of return of approximately 7.2%. The second scenario assumes a more pessimistic forecast with markets remaining at current levels until June 2021 but taking longer to recover, with markets not reaching their previous peak until 2025.
Under the first scenario, the aggregate funded status of public plans would decline to 62.7% in 2025, and the actuarially determined contribution would rise to 25.1% of pay. But under the more pessimistic scenario, the funded ratio would fall to 55.5% while required contributions would surge to 29.1% of pay. Additionally, the average ratio of assets to benefits, which is a rough gauge for the health of a trust fund, would decline to 9.4 or 7.9 in 2025 from 11.6 in 2020. This means that, in 2025, public pensions would have assets equal to an estimated eight or nine years of benefits.
The report said plans can maintain asset levels if annual investment returns exceed their cash flow, and that the projections show that cash flows fall to negative 3.8% or negative 4.5% in 2025 from negative 3% of assets.
“Given these relatively attainable thresholds,” the report said, “no plans are projected to exhaust their trust fund within the next five years.”
However, remaining solvent over the next five years isn’t exactly reassuring for pension plans and their decades-long time horizons.
Under a slower market recovery, as in the case of the second scenario, the average estimated funded ratio for the 20 worst-funded plans in the report’s sample would be 38.3% in 2020, falling to 32.2% in 2025, according to the report. And six of the plans—Charleston (West Virginia) Fire, Dallas Police and Fire, Chicago Municipal, Chicago Police, Chicago Teachers, and New Jersey Teachers—would see their funded ratios dwindle to 25% or less.
The average funded ratio for the 20 worst-funded plans is projected to decline to 4.5 in 2025 from 5.9 in 2020, which means that in 2025 they will have assets equal to less than five years of benefits. And Chicago Municipal, Dallas Police and Fire, and New Jersey Teachers would see their asset-to-benefit ratios erode even further to less than two years of benefit payments by 2025.
“These sobering statistics highlight the precarious position of the worst-off plans,” the report said.