Weak investment returns amid market volatility will likely undo the funding improvements US public pensions made in 2013 and 2014, according to Moody’s.
The ratings agency reported that unfunded pension liabilities increased by roughly 17% in fiscal year 2015 as public pensions failed to meet expected rates of return. With recent market volatility dampening the performance of US pension funds, Moody’s predicted a further decrease in funding levels in 2016.
“We project unfunded pension liabilities on a reported basis will grow by at least 10% in fiscal 2016 even under our most optimistic return scenario,” said Moody’s analyst Thomas Aaron.
Though expected returns for public pensions are typically around 7.5% annually, in the first half of fiscal 2016 several large public pensions reported negative returns, according to Moody’s. This, combined with stock market trends since 2015, suggests “investment returns will fall short of assumed targets.”
“Should markets not recover sharply in the next several months, fiscal 2016 will mark the second consecutive year of investment performance below assumed rated for US public plans, following strong returns in 2013 and 2014,” Moody’s said.
2014 had been the “best year for state pensions since the recession,” according to Loop Capital Markets, with median funding levels increasing to 71.5%.
But in Moody’s most optimistic scenario for 2016, in which public pensions achieve average returns of 5%, net liabilities are projected to increase by 10%. In the rating agency’s most pessimistic scenario—where funds lose 10% on average—unfunded liabilities could jump by 59%.
These declines in funding levels are exacerbated by insufficient government contributions. Moody’s reported that less than half of the 56 plans in their sample received enough contributions to cover service and net liability interest costs in 2015—and no positive change is expected in 2016.
“Plans receiving weaker contributions will experience growing net liabilities even if investment performance meets assumptions,” Moody’s said.