Markets give and markets take. Unfunded liabilities of public pension funds are projected to fall from $783 billion in 2021 to $1.3 trillion in 2022. This would mean that the funded ratio of public pensions would drop from 85% last year to 75% in 2022.
That’s according to the Reason Foundation, which predicts that after the 2021 market expansion helped pensions, the rather lackluster performance of markets this year could see an average rate of decline in government pension assets from 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 per year. compared to 2021.
“The nation’s largest public retirement system, the California Public Employees’ Retirement System [CalPERS], 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 the Reason Foundation’s Pension Integrity Project. “If CalPERS ROIs are minus 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. The pension cap 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 cites three reasons for the pension reform:
- Investment returns in 2021 will have a limited impact on funding long-term pension plans.
- Long-term returns are expected to remain low.
- 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 rocky decades for public pension funding. 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 public 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 researching the resilience of pension plans, Leonard Gilroy, vice president of the Reason Foundation, and Christensen state that pension plans must begin “to adopt assumed rates of return tied to short-term forecasts. and moving away from rates that are framed by long-term expectations — not because we don’t think the funds can do that, but because it’s a prudent way to build buffers against certain risks, especially when taxpayers are exposed to such significant financial risks associated with underfunded pensions.
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 will remain a problem as long as markets remain vulnerable to market shocks. Seeking ways to minimize risk with a view to investing for the long term (i.e. not counting on a good year) can make state systems more resilient to a future of unknowns.