WASHINGTON — State and local contributions to pension plans and their level of funded ratios were down in 2011, but many governments enacted important reform measures to fix their pension problems, Loop Capital Markets found in its 10th annual Public Pension Funding Review.

However, employees and retirees are legally fighting these reforms in many states, posing concerns for investors, the firm warned.

“The legal process of reducing pension burdens will be a long one, that in many cases, will require large legal budgets and lengthy litigation,” Loop said in its report. “The postponement of reductions in pension costs due to litigation is a source of concern. Loss of one or more years of pension cost reductions has an unfavorable compounding effect.

“With different constitutional and statutory treatments in each state, the litigation battle is a house-by-house and block-by-block street fight,” Loop said. “Investors in state bonds will get accustomed to seeking a ‘win’ in one state and a ‘loss’ in another, potentially over the same issue.”

However, a number of states have made “notable progress” in reducing pension costs, the report said. “While these benefit cost reductions in most cases will take years to provide meaningful cost savings, we must remember that the liabilities also occur across a long spectrum of time,” it noted.

“There hasn’t been any material change in the [annual required contribution] levels or the funded ratios,” managing director Chris Mier said in an interview. “They are down a percent or two, but I don’t think that’s significant at all.”

“What analysts should be looking at is which states are getting the most dollar savings from the legislation they are passing” to lower their pensions costs, he said.

The report found that 32 states did not meet their annual required contribution levels for pension plans for fiscal 2011 and that 20 of them did not meet their ARC for plans during the entire 2007 to 2011 period.  That’s an increase from fiscal 2010, when 29 states did not meet their ARC levels, and fiscal 2009, when 27 states did not meet them.

“Resolution of the pension crisis will require that all states begin meeting 100% of their ARC reliably,” Loop said in the report. “Continued improvement in tax revenues at the state level should allow more states to swing into the ‘100% ARC compliance’ column as economic conditions improve.”

Funded ratios declined for almost all plans in 2011, the report said.

Of 149 state-level pension plans with funded ratios for 2011, the average funded ratio was 73%. Only 58 had ratios of 80% or above, the level considered acceptable. Similarly, of the 31 local-level plans with funded ratios for 2011, the average was 66%, and only 11 had ratios of 80% or above.

Of the 147 state-level plans and 29 local-level plans that had funded ratios for both 2011 and 2010, 69% of the state-level plans and 90% of the local-level plans were less funded than the previous year, the report said.

One of the trends in 2011 was weak investment performance, with returns generally coming in at low single-digit levels, Loop said.

For many years, state plans assumed investment returns of about 8%, which was about 5% over the 3% long-run real trend growth rate of the economy.  But the Congressional Budget Office is using a 2.75% long-term growth rate, suggesting returns rates of about 7.75% might be appropriate, according to the report.

“While 7.50% or 7.75% might seem optimistic given the current environment of slow growth and extremely low interest rates, it is primarily the monetary policy of the [Federal Reserve], which has distorted the financial markets, that accounts for that perception,” Loop said.

This year, about 60 state-level plans have decreased their long-term investment rate of return assumption an average of about 0.48%, compared to only 13 that reduced their assumed rate by about 0.38% last year, it said.

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