Report: Despite Market Rebounds, States Won't Be Able to Pay Pension Benefits

(March 8, 2011) — According to a Wilshire report, state plans will fall short of assumed returns in the next decade.

Its paper, titled “2011 Wilshire Report on State Retirement Systems: Funding Levels and Asset Allocations,” the Santa Monica, California-based consulting firm noted that 99% of the state retirement systems are underfunded based on fiscal year-end market value of assets. Using their current asset class performance projections and the last reported asset mixes for the 126 state retirement systems studied, Wilshire calculated a median projected plan return of 6.5%, significantly below the median actuarial long-term assumed rate of 8%. Following these assumptions, none of the 126 plans’ projected long-term returns exceeded the median assumed rate of return. The report clarified that “Wilshire return assumptions represent beta only, with no projection of alpha from active management.”

The consultant firm’s long-term expected annualized returns over the next 10 years ranked private equity as the best-performing asset class at a projected 9.7%. Following private equity, Wilshire calculated 7.25% each for domestic equity and non-U.S. equity, 5.5% for real estate, 3.75% for US bonds and 3.4% for non-U.S. bonds.

Meanwhile, funding for US state pension plans improved in 2010 as the economy rebounded from the recession, with the ratio of assets to liabilities of US state retirement systems rising to 69% in fiscal 2010 from 65% the previous year. “This improvement in funding ratio reflects the US. economy’s ongoing recovery from the global market dislocation events of 2007 and 2008, and the resultant recession that economists declared ended in June 2009,” said the report. “The redeployment of assets over the past decade out of US public markets and into offshore and alternative assets has caused the average state pension plan to move towards a slightly higher expected return and slightly lower risk profile along the efficient frontier,” the report noted. “Increased allocations to real estate and private equity from 2005 to 2010 provided notably lower risk expectations for the average state plan.”

According to the report, the average asset allocation for the 126 systems last year was 31.1% in U.S. equity, down from 44% in 2005, the latest data available; 17.5% in non-U.S. equity, up from 15%; 6.2% in real estate, up from 4.2%; 8.8% in private equity, up from 4.4%; 27% in U.S. fixed income, down from 28.6%; 1.5% in non-U.S. fixed income, up from 1.2%; and 7.9% in other asset classes, including hedge funds, up from 2.6%.