PHOENIX - Many of the largest state pension plans averaged less than 1% returns for the fiscal year ended June 30, most likely leading to a national trend of depressed funding ratios and increasing pressure on states to fund those pensions, S&P Global Ratings said Monday.
S&P crunched the numbers in its annual state pensions report, which confirmed the widely-held expectation that fiscal 2015 would turn out to be a tough investing year for most pension funds. In July, Moody's Investors Service had released a report citing poor returns from the California Public Employees' Retirement System, California State Teachers' Retirement System, and New York State Common Retirement Fund as signs that pressure is likely to mount on states and municipalities.
"After losses in 2008 and 2009, most U.S. state pension plans have not been able to recover to funded levels seen in the early 2000s," S&P said. "Investment returns in 2015 and 2016 are not going to make that path any easier."
The rating agency explained that short-term stock market volatility at the end of June 2015 related to stalled negotiations between Greece and its creditors and the Brexit vote fallout in June 2016 were two blows to market performance. Even after a month-end rally in June investment returns announced to date by many of the largest state plans still averaged less than 1% for the fiscal year. This level of returns, far below the 7.5% or more that many of the largest public pension funds continue to use as a baseline assumption, appears to have led to a near-unanimous decline in pension funding rations for the states.
S&P's report incorporated reported pension liabilities under the Governmental Accounting Standards Board (GASB) statements 67 and 68. Based on plan information reported through the end of fiscal 2015, the median funded ratio across state plans was 74.6% of the required level. The only state for which data was available that did not experience a decline from its fiscal year 2014 pension funding ratio was Alaska, which took what S&P characterized as an "extraordinary" step when it made a $3 billion contribution from its constitutional budget reserve fund to boost assets in its public employees retirement plan and its teachers plan. As such, Alaska saw a more than 10% improvement in its ratio. Oregon fell by more than 10%, the most among the states, a reflection of the Oregon Supreme Court's decision to overturn a significant feature of the state's 2013 pension reform legislation.
"Reported pension liabilities are estimates of a long-term liability that need to be managed over time to avoid significant future costs and credit pressure," S&P said. The takeaway, the report said, is that overly optimistic investment return assumptions and bad market performance will ultimately force states to spend more money to keep their pension funds solvent, a future concern.
"Given the long-term nature of the obligations and their payout, most state pension funding policies stress a long-term view of funding estimated liabilities and smoothing market performance over several years," the report said. "As a result, the full impact of market losses will not be reflected immediately in states' required pension contributions but will gradually increase as annual market fluctuations are phased in to avoid year-to-year budget shocks. Nevertheless, a trend of lackluster investment returns, together with forecasts of lower expected market returns over the next 10 years, has brought on renewed calls from some financial economists for lower rate of return and discount rate assumptions. When public pension plans assume a lower rate of return, all else being equal, governments must dedicate a greater proportion of their revenue to pension contributions to meet the higher estimated pension liability. Continued trends of slow revenue growth, growing liabilities, and higher future pension contribution costs could amplify an already constrained budget environment for many states."
