US State Pension System Deficit Hits Record High in 2016

Report suggests states assume annual returns of 6.5% for the next decade.

An analysis by Pew Charitable Trusts reveals that the US state public pension system funding deficit was at an all-time high of $1.4 trillion in 2016, rising nearly $300 billion from 2015.

With an average funded ratio of 66%, the funds have amassed $4 trillion in pension liabilities and have only $2.6 trillion in assets to cover them. According to the report, the widespread shortfall comes from a combination of poor investment returns, lackluster state contributions to the state systems, and a reduction in the assumed rate of returns that drove the overall liability $138 billion higher.

“The gap between returns on safe investments and state pension plan investment assumptions was the highest in decades,” the report read, noting that even if assumptions were met, the gap would still have seen a $13 billion increase. “All of these measures show that plans are more vulnerable to volatility than in the recent past, which could have an adverse impact on funds in the future.”

Among the worst-funded were Kentucky, New Jersey, Illinois, Connecticut, and Colorado — each with a funded ratio below 50%. Only four states — New York, Wisconsin, South Dakota, and Tennessee — have a funded ratio of 90% and above. Eight are above 80%.

Pew noted that last year’s strong returns should decrease the unfunded liabilities, providing a brighter outlook for the short term. The data research firm reported that since 1990, public pensions have increased their allocations to riskier investments such as equities, hedge funds, real estate, and commodities by more than 30%.

Although these continued allocations have yielded high rewards, especially over the past several years, the report stressed that the risks involved could spell doom in an economic downturn.

The firm’s analysis suggested that states assume annual returns of 6.5% for at least the next 10 years, with 5% returns or lower as a strong possibility over the next 20 years.

Pew also advised policymakers to curb costs and to use stress tests to see how the funds would cope with a financial emergency, as well as to better measure cash flow to avoid problems.

“As well-funded states have shown, combining strong contribution policies with a focus on managing risk and avoiding unfunded benefit increases can help states offer secure retirement benefits in a sustainable and affordable way,” the report said. “The data, however, show that most states are falling short of this standard.”

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