Unfunded Pension Liabilities Rise with Market Volatility

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Markets give and markets take. Unfunded liabilities of public pension funds are expected to fall from $783 billion in 2021 to $1.3 trillion in 2022. The funded ratio of public pensions would rise from 85% last year to 75% in 2022.

This is according to the Reason Foundation, which states that after the 2021 market expansion, pensions have helped; the rather lackluster performance of the markets this year could see an average rate of return on public pensions at -6%. If that were the case, the Reason Foundation estimates that some of the nation’s largest pension funds, California, New York, Texas, Ohio, Florida and Illinois, would see their unfunded pension liabilities increase by more than 20 billion dollars compared to 2021.

“The nation’s largest public retirement system, the California Public Employees’ Retirement System, provides a good example of the significant impact of a poor year of investment performance on unfunded liabilities, public employees, and taxpayers” , write Zachary Christensen and Jordan Campbell of Reason. Foundation Pension Integrity Project. “If CalPERS returns are -6% for 2022, the system’s unfunded liabilities will drop from $101 billion in 2021 to $159 billion.” That would equate to a debt burden of $4,057 for every Californian. Its capitalization rate would drop from 82.5% to 73.6% in 2022, and state employers would have less than three-quarters of the assets they need to pay the pensions already promised to workers.

The significant levels of volatility and funding challenges currently facing pension plans support the position of last year’s Pension Integrity Project that most state and local government pension plans still need to be reformed, despite strong returns on investment and funding improvements in 2021.

The Foundation set out three reasons for the pension reform, including:

  1. 2021 investment returns will have limited impact on funding long-term pension plans
  2. Long-term yields are expected to remain low
  3. Many plans remain vulnerable to increasingly volatile market outcomes

Additionally, the Foundation notes that many observers have mistaken a single good year of returns for a sign of stabilization in two bumpy decades for public pension funding. However, this year’s returns, along with growing signs of a possible recession, “support the belief that public pension systems should lower their return expectations and view investment markets as less predictable and more volatile.”

According to the Reason Foundation, one area where state pensions have failed is building resilient pension systems. It is no longer acceptable to accept the notion of “investing to get by” or “reverting to the mean”. In their commentary on Seeking Pension Resiliency, Leonard Gilroy, VP of Reason and Christensen, says pension plans need to start: “Adopting assumed rates of return tied to short-term forecasts and abandoning rates framed by forecasts long-term — not because we don’t. I don’t think the funds can achieve this, but because it is a prudent way of building up buffers against certain risks, especially when taxpayers are exposed to such significant financial risks associated with underfunded pensions.

Related: Wall Street secrets pit $75 billion pension plan against trustee to protect it

They add that this also means abandoning 30-year amortization periods to pay off future unfunded liabilities and limiting pension debt payments to shorter periods (15 years or less). This means using discount rates separate from assumed investment return rates to get a more realistic picture of the true liabilities that will be paid to beneficiaries no matter what happens in the market, and then budgeting for that much larger, but less risky. , Number.

Underfunded pension plans remain a problem and will continue to do so as markets remain volatile in the face of market shocks. Finding ways to minimize risk, with a long-term investment perspective (not relying on a good year), can make state systems more resilient to a future of unknowns.

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