US Public Pension Funds Sensitive to Market Correction, per Fitch Report

U.S. public defined benefit pension plans are increasingly sensitive to market corrections and are at risk of cancelling out the progress made to stabilize funded ratios, according to a report from Fitch Ratings, which reviewed the audits of 100 of the largest state pension funds.

The funded status and returns of surveyed pension plans fluctuated over the past couple of years, according to Fitch. The value of assets managed by these funds increased by 24.4% in 2021, only to decline 7% the following year. In 2023, the value of these assets increased near or less than the average investment return assumption of 6.9%.

According to the Fitch report, the agency does not anticipate imminent market drawdowns similar to those of 2008, but any severe market correction would put pressure on the funded status of these public pension funds. Such a hypothetical drawdown scenario could then raise the need for increased contributions to the funds from government employers in a bid to stabilize these plans.

“We’re not suggesting that we expect a gigantic market correction at all,” says the report’s author, Douglas Offerman, senior director of public finance at Fitch Ratings. “But plans need to keep in mind that, should it happen, contributions would likely increase pretty substantially.”

The Fitch report noted that several public pension plans disclose the risk of asset underperformance that could lead to the need for increased contributions. One fund that makes such disclosure is the California Public Employees’ Retirement System, which estimated the chances of its plans falling below 50% funded status at 22.8% for its miscellaneous plans and 25.3% for its public safety plans.

Overall, state pension funds have taken several steps to mitigate the risk of a decline in asset value. CalPERS, for example, has reduced benefits for covered public employees that were hired recently, and it has lowered discount rates, but it is hard for any measure to have an immediate effect.

“You really can only change benefits for future employees,” Offerman says. “So you don’t necessarily get a big bump of corrective improvement from a benefit modification right away.”