U.S. stock rally strengthens state pensions

Pension Industry Updates

A record rally for U.S. stocks generated the best annual investment returns for public pension plans in more than three decades, easing funding pressures in the U.S. public pension system.

According to Pew Charitable Trusts, a Washington-based think tank, public pension plans averaged 25% returns on investment in the year ending June 30, increasing the assets of the US public pension system. from over $ 0.5 billion to $ 3.87 billion.

Greg Mennis, director of Pew, said the “once-in-a-generation” returns had taken the aggregate funding position – assets to liabilities – for U.S. state pension plans to 84 percent, its highest level. since the end of 2007/08 financial crisis.

The gap between assets held by U.S. state pension plans and their liabilities is expected to narrow to $ 740 billion at the end of June, the first time it has fallen below $ 1 billion since 2014.

Still, Anthony Randazzo, executive director of the Equable Institute, a New York-based nonprofit think tank, said the funded position of U.S. state pension plans was “still well below” what ‘they should aim.

“Getting up to 80% funding is great compared to recent history, but there are a lot of clouds ahead,” Randazzo said. “No one thinks that public pension plans will generate such high returns on a consistent basis, which means there is a warning here. States cannot invest to get out of this mess.

“Public pension funds have performed exceptionally well, with some posting their best annual performance in their history,” noted Thomas Aaron, senior credit manager at rating agency Moody’s, “but we still see fairly widespread risks. “.

Moody’s uses a discount rate – based on high-quality corporate bond yields – of less than 3% to assess the liabilities of public pension funds, suggesting that the funding gap still exceeds $ 4 billion.

Public pension funds use their own measures of expected annual returns of around 7% on average as the discount rate, which significantly reduces the value of future liabilities.

“Most public pension funds still have large allocations to stocks and bonds to meet their average yield requirement of 7%,” Aaron said. “The high-yield nature of public pension investments carries significant volatility risk and it wouldn’t take a repeat of the 2007/08 financial crisis to wipe out much of the returns. “

Pew collected data from 230 public pension plans representing about four-fifths of the workforce in the public pension system. Only partial data was available for 2020, which Pew used for his projections for public pension systems. These estimates were reviewed by officials working on the plans.

An average annual increase in contributions of 8 percent over the past decade has also helped improve the funded status of the public pension system. Yet most public plans pay more in benefits than they receive.

To assess the risk of a public pension fund running out of money, Pew measures operating cash flow as a percentage of assets. Public pension plans in Colorado, Ohio, Oregon, New Jersey and Rhode Island were paying 5% of their assets no later than 2017. Pew sees this threshold as a harbinger of the future financial viability of a plan.

But the increase in dues and other policy changes have meant that all 50 states have paid less than 5% of their assets in the past year.

The coronavirus pandemic has highlighted the “volatility and uncertainty“facing US state pension plans,” Mennis said, adding that it was essential to introduce stress tests and provisions to share losses between workers and retirees to ensure future retirement promises could be kept.

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