*****Source- American City and Town, Andy Castillo, First Published Jan 9, 2023
Coming off a strong 2021, the economy was hit hard last year, making it difficult for administrators to effectively manage retirement system and pension fund assets. The average funded status for the top state and local retirement systems dropped by a little more than 6 percent in 2022, according to a research brief from the nonprofit Equable Institute, “The State of Pensions 2022: Year End Update.”
“Fortunately, the investment losses in 2022 didn’t wipe out all the funded status gains from 2021. Unfortunately, the sharp losses this year have exposed—yet again—the lack of resilience plaguing many public pension plans,” the report reads. “Once all public pension plans release their 2022 data, we estimate that the combined funded status for the top state and local retirement systems will be 77.3%.”
Driven by poor investment returns, the pension funding shortfall increased nationally to $1.4 trillion during 2022 after dipping below $1 trillion in 2021. A pension’s funded ratio reflects its financial health. Pension plans with a funded ratio above at least 80% are considered healthy.
“Most state and municipal pension plans in the United States are distressed or fragile,” the report notes. A plan is considered “fragile” if its funded ratio is between 90% to 60%, and “distressed” if it’s below 60%. Washington, D.C. and Washington State topped all states with funded ratios of 103.4% and 102.9%, respectively. Kentucky and Illinois came in last, with funded ratios of 47.3% and 50%.
While analysts aren’t surprised by the findings of the report, given the volatility of 2021, Anthony Randazzo, executive director of Equable, said the second-half of the year didn’t play out exactly as expected.
“In the middle of 2022, we had seen about a fifth of the investment gains from 2021 get wiped out, and by the end of the year, it was half. That was maybe surprising in the sense that we had hoped investment returns would be stronger by the end of the year,” Randazzo said.
And because private equity returns “tend to get reported on a lag … it became clear that not all the pension plans were accounting for those losses in end-of-year reporting,” he continued. Because of that, some of last year’s losses will be reported in 2023.
In the decades leading up to the pandemic, the average funded ratio for public pensions trended as a whole downward, from 101.8% in 2001 to 72.2% in 2020, according to data from the MissionSquare Research Institute.
“Pension plans had a sharp decline around 2009 with the Great Recession, then they were flat, and relatively stagnant in the years after that,” said Randazzo. “What we’re seeing in the data of 2022 is a continuation of high volatility in the markets and how they’re affecting pension plans.”
In 2023, the outlook isn’t great. Indicators highlighted in the report suggest a continued decline. For example, the Federal Bank is expected to continue raising interest rates.
Given this, there are steps public organizations can take to reduce risk. Randazzo highlighted the success some states have achieved by “Walling off their existing liabilities,” he said, noting a step taken in 2018 by Michigan to pay down all existing pension plans under one schedule and create another, separate fund for all future plans.
The newly created plan is currently “the best funded plan in the nation,” and “The old one has systematically improved,” Randazzo said. Indiana did the same thing in the 1990s, and is consistently ranked among the top funded states.
States can also increase retirement contributions from employers and employees, although this approach has more implications to it: “Every time you raise the member contribution rates, that’s basically a pay cut against employees,” Randozza said.
The repercussions of poorly funded pension plans could further hamper an organizations ability to fund accounts by economic growth.
“Companies may or may not want to relocate to states with high unfunded liabilities,” Randozza said, as “That could lead to tax increases to pay them off.”