Milliman Study: Public Pension Plans See 4Q Funded Ratio Decline

Investment income of $11 billion was overshadowed by outflows of $26 billion.

By Poonka Thangavelu

Public pension funds for the most part remained underfunded in the fourth quarter of 2016, according to a study by Milliman, with their funded ratios dipping to 70.1% in the fourth quarter, from 71% in the third. Milliman finds that the funding status of the 100-largest US public pension funds declined $54 billion over this period, while their deficit rose from $1.338 trillion to $1.392 trillion.

Although these plans enjoyed average investment returns of 0.45% for the fourth quarter, making for investment income of about $11 billion, their outflows of about $26 billion overshadowed this income, as the benefits they paid outpaced the contributions made.

The fortunes of the pension funds varied, with 25 plans at a funded ratio of less than 60% (four of these pension funds were dangerously underfunded, with a funded ratio less than 30%) and 65 pensions at a funded ratio of 60% to 90%. Ten of the plans enjoyed a funded ratio higher than 90%.

Becky Sielman, a Windsor, Conn.-based consulting actuary for Milliman, said, “Besides the significant investment losses in the financial crisis, another significant headwind for funded ratios is that public plan sponsors have been steadily lowering the interest rate assumptions. And that causes the liabilities to go up and therefore causes the funded ratio to fall. Both of these contribute to the funded ratio we see today.”

While corporate pension plans tend to tie their interest rate assumptions to current market rates on high-quality bonds, these public pension funds’ interest rate assumptions, which they don’t change on an annual basis, are based on the expected long-term returns on their portfolios, which have been decreasing.

The underperformance of individual funds may also occur if the plan sponsor hasn’t been making sufficient contributions to the fund for an extended period,, or perhaps because the plan has granted benefit improvements that have not yet been funded.  The public pension plans that are flush with funds, have been conservative over the years. The New York State Teachers’ Retirement System, for instance, enjoys a funded ratio of 110.5%, according to Milliman.

John Cardillo, a spokesperson for the plan, points out that critical to this success is the uninterrupted flow of employer and employee contributions to the plan over its history. “This has allowed us to remain committed to a disciplined, risk-controlled investment approach that focuses on thoughtful diversification of assets across a broad spectrum of capital market segments,” Cardillo said. Moreover, the plan has decreased its costs by managing a big part of its investments in-house.

Sielman noted that these pension plan-funded ratios go through ups and downs, and one that is underfunded today might have been well-funded 10 years ago. “It is difficult to make broad generalizations about these plans. Each one is a very different story and where they are today is a function of what’s happened over decades,” she said.

She expects that if investments earn the rates expected by these pension funds in the long term and plan sponsors make the contributions that their actuaries recommend, and if there are no major improvements that aren’t funded immediately, the contributions by the plans “should be sufficient in the fullness of time to bring each plan to a fully-funded position.”

The study’s methodology was based on the pension plans’ financial reporting information disclosed in the plan sponsors’ Comprehensive Annual Financial Reports, which reflect measurement dates ranging from June 30, 2014 to December 31, 2015. It was calculated against market performance and the Standard & Poor’s 500 index, and assumed plans rebalanced to keep the same allocations. This is Milliman’s first year presenting quarterly updates, and there is not yet a margin of error.