WASHINGTON — State pension funding levels have probably hit their low point, and can begin a long, slow recovery, according to a report from Standard & Poor's.
The 50-state average funded ratio fell by 2 percentage points to 70.9% in 2012 from 72.9% in 2011, according to the rating agency's 2014 survey, released Wednesday. State pension investments performed poorly in 2008 and 2009, effects that will probably begin to be counteracted by much stronger market performance in 2013 and 2014, Standard & Poor's said. Investors expecting to see a quick turnaround for badly underfunded plans are likely to be disappointed, however.
"Although this is likely the low point, which is good news, we believe pension funded level recovery could be slow and uneven and sizable funding gaps will remain for most states," Standard & Poor's credit analyst John Sugden said. "While reform efforts continue, which will help over the long term, we see continued pressure related to market volatility, increased competition for limited state financial resources, and changes in actuarial assumptions."
The level to which pensions are funded and the extent to which those liabilities are disclosed to investors is a hot topic among market participants and regulators. Securities and Exchange Commission member Daniel Gallagher gave a speech last month calling for state and local governments to pin their assumptions about investment performance to a conservative rate such as the yield on Treasuries. They should then calculate and disclose a baseline plan contribution equal to the amount actuarially necessary to fully fund the plan, he suggested.
A number of state and local groups including the National Governors Association, the National League of Cities and the National Association of State Retirement Administrators took umbrage, telling Gallagher that they have already begun reforms and that any problems with pension funding or disclosure are with individual plans and not systemic. Those reforms are among several factors that Standard & Poor's said will affect pension numbers for years to come. An improving equities market is strengthening the economic outlook for states, and new Governmental Accounting Standards Board requirements will alter the way states calculate their liabilities.
"An equities market upturn and a strengthened budgetary position could contribute to states' improved funded levels and greater ability to fund actuarially required contributions," Sugden said.
While the average funded level is about 71%, the data shows a huge disparity between the best-funded state pension plans and the least-funded. The numbers compiled by Standard & Poor's show Wisconsin on top with 99.9% of its liability funded, while Illinois lags far behind with just 40%. Beside Wisconsin, only North Carolina, South Dakota, Washington, Tennessee and Oregon have more than 90% of their liabilities funded, according to the report.
Though the trend of declining ratios should be reversed in the near-term, other challenges remain, Standard & Poor's warned. While the National Council of State Legislatures has said all 50 states and Puerto Rico have undertaken some form of pension reform recently, such changes can be contentious politically and legally. Aging populations and the abilities of states to continue payouts remain "crucial concerns," the agency said.
"At some point investment markets are likely to cool down," the report says. "When they do, it will become more difficult for some states to improve or even maintain funded ratios. Funding policies that states put in place today and their ability to abide by these will largely determine how well prepared states will be to face additional downturns. In any event, however, our pension analysis will continue to consider a government's funding policy and discipline in our overall view of its credit quality."
