State pension plans' gain in funded ratios is offset by cuts in return expectations

WASHINGTON — The extended bull market in the U.S. has led to only modest gains in the funded ratios for many state pension plans because they are in the midst of a multiyear reduction in their expected rates of return.

The latest report by Wilshire Consulting released Monday found the aggregate funded ratio for 106 of the nation’s largest state retirement systems rose only by 1.7 percentage points in fiscal 2018 to 72.2%.

The findings marked a second consecutive year of improvement, though the funded ratio remained below the recent peak of 77% that Wilshire Consulting reported in 2014.

A few plans in states such as Illinois, Kentucky, Connecticut and New Jersey have funded ratios below 43% while the best funded plans are experiencing better-than-average returns.

The Center for Retirement Research at Boston College reports the Kentucky Employee Retirement System was only 15.8% funded in 2018 while in 2017 the Illinois State Employees Reirement System was 35.4% funded, the Connecticut State Employees Retirement System was 38.1% funded and the New Jersey Teachers plan was 42.1% funded.

“Today it appears the average is hiding more variation than it used to,” said Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College. “The better plans are improving and the worst plans are declining more rapidly. And so what looks like flat is kind of a dispersion.”

The 2018 asset values of state pension plans were driven upward by an 8.87% increase in investment income. Contributions increased asset value by 4.86% for the year with nearly 30% coming from plan participants.

But the funded status of many pension plans improved at a more modest rate because many have continued to lower their expected discount rate.

According to National Association of State Retirement Administrators, more than 30% of the 129 plans it monitors have reduced their assumed rate of return over the 12-month period ending in February 2019.

More than 90% have done so since fiscal year 2010, resulting in a decline in the average return assumption from 7.91% to 7.27%.

Wilshire's survey came up with an almost identical estimate, calculating the median at 7.25% and the overall range from 3.95% to 8%, “GASB 67/68 requires a downward adjustment to the discount rate based on a mandated projection methodology,” Wilshire said.

“It has been striking to see the number of plans that have reduced their return assumption,” said Keith Brainard, research director for NASRA. “Many have done it more than once. Even a very small change of 25 basis points in an investment return assumption has a disproportionate effect on a plan’s cost and funding level. And that’s basically because over time pension plans anticipate getting a majority of their revenue from investment earnings. So when you dial back the investment earnings even a little bit, the funding level is affected and so is the cost.”

NASRA reports that only six state pension plans currently assume an 8% rate of return, while 94 are clustered between 7% and 7.5%. There are eight higher than 7.5% and under 8%. Another 16 are under 7%.

Ned McGuire, managing director of Wilshire Consulting and co-author of the report, said the discount rate reductions are “a reflection of the return environment.”

“Based on the numbers we have in this report, I would say they are trending in the right direction with the increase in the funded ratio,” McGuire said.

State pension plans have reduced their investments over the last 10 years to 57.8% in equities from 62.5% in 2008.

“I would say that state plan fund sponsors are looking for more diversified return streams,” McGuire said. Investments in real assets, which include real estate, REITs, infrastructure and commodities, have increased to 12.9% from 5.9% a decade earlier.

At Boston College, Aubry said his center’s studies have found the top plans performed almost 2% better from 2001 to 2017.