Analysis: Rising returns give U.S. public pension funds chance to reform

Thu Aug 22, 2013 8:05am EDT

A senior citizen looks out to a lake in Sun City, Arizona, January 4, 2013. REUTERS/Lucy Nicholson

A senior citizen looks out to a lake in Sun City, Arizona, January 4, 2013.

Credit: Reuters/Lucy Nicholson

Related Topics

(Reuters) - Many U.S. public pension funds are benefiting from double-digit annual returns in fiscal 2013 that are giving them breathing space to try to implement reforms and fix gaping deficits.

A raft of pension reforms since the financial crisis by many U.S. state and local governments have not repaired their pension debt, a factor in the bankruptcies of Detroit, Michigan, and the California cities of Stockton and San Bernardino.

A 20 percent gain on the U.S. stock market in the twelve months to June is, however, alleviating acute funding gaps in many areas.

"It is a marathon, not a sprint," said Keith Brainard, at the National Association of State Retirement Administrators. "I do not think any one-year returns are likely to affect the thinking about pension reforms but we have seen very strong returns since the low point of the equity market in 2009 and it is encouraging," he said.

Recent reforms by many U.S. cities and states have seen retirement benefits for new hires cut, and their contributions into pension plans raised. It will be several years before these reforms start to have an effect on gaps in pension funding.

As well as stock market gains, pension funds are being helped by relatively low exposure to the struggling bond market.

In the last decade bonds held by public pension funds fell from around one third to around one fourth of assets as yields declined.

According to Wilshire Associate U.S. public pension funds have about 25 percent of assets invested in bonds, compared to an average of 37 percent for corporate funds.

In the longer run, higher yields could even provide a boon for pension funds because of higher returns.

FUNDING GAP COULD SWELL UNDER NEW RULES

Funds will need higher returns as they adapt to new accounting rules set to begin taking effect next year.

Alicia Munnell, at the Center for Retirement Research at Boston College, co-authored a report last month showing U.S. state and local public pensions would have been a paltry 60 percent funded in 2012 if measured by the new rules. That compares with an estimated 72 percent for fiscal 2012 under old rules.

The new rules have been issued by the Governmental Accounting Standards Board (GASB). One key provision is to slash projected rates of return for pension funds' unfunded portions from roughly 7.5 percent to a much lower market level. The move will greatly increase the amounts at which unfunded liabilities are calculated and the money states and cities will have to pay into their funds.

Munnell's study showed that if current projected return rates for public funds are reduced nationwide to five percent, the unfunded figure for America's public pensions jumps from $1 trillion currently to $2.8 trillion.

Still, Munnell is warning against alarmism.

"Public plan sponsors have made numerous changes to reduce their pension costs in the wake of the financial crisis and ensuing recession. The market has performed well in the last few years. Let's give the plans the time and space to work their way back to more comfortable funding limits," Munnell said. The funded ratios of state and local pension funds was at 103 percent in 2000, after a decade-long bull market.

RETURNS COULD MAKE OR BRAKE REFORMS

So far this year, plans such as the California Public Employees' Retirement System, Florida's state fund, Ohio state teachers and Connecticut have reported returns well above 11 percent. Most others are expected to follow suit.

A recent report by Wilshire Associates found that in the 12 months preceding June all public funds had a median return of 12.4 percent, although that declined in the last quarter to just 0.24 percent.

Similar results are reported by Callan Associates, the San Francisco-based investment consulting firm.

A report by the credit rating agency Standard & Poor's said there are signs of stabilization in public pension underfunding.

John A. Sugden, primary analyst on the report, said signs were encouraging but warned against over-optimism.

"Good returns are a positive development," Sugden said. But he said recent reforms, where many states and cities have curbed benefits and increased contributions for new hires, will take a long time to produce results.

Rachel Barkely, a municipal credit analyst at Morningstar, said the new GASB accounting system and the stock market "are the two key factors that will drive the pension conversation for governments over the next few years."

Barkley said stock market returns could change if the Federal Reserve eases off its expansionary policy known as quantitative easing.

"There is a lot of uncertainty on whether and how financial markets will keep delivering good results," Barkley said.

(Editing by Andrew Hay)

FILED UNDER:
We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
Comments (1)
eatingdogfood wrote:
Yeah; My Union Boss down at the Town Hall emailed me yesterday and.
Told me that this article was hitting the Papers today, and He told Me.
to make it Look like I was Working till this Blows Over in a week. I
know the routine! In a week, I’ll be back to my usual activity of.
Collecting A Paycheck for Doing Nothing! Hey, Private Sector.
Workers; You really gotta Pony Up more Taxes! I need at least a 10 %.
raise! My Cabin Cruiser at the Dock behind my Vacation House in.
Florida needs a New Engine. My wife has been after me for a new car.
She wants a BMW X6 G-Power Typhoon S! I told her I can’t afford that.
car. So then she says she will accept a Mercedes-Benz CL-Class and.
Nothing else! I also got Private School Tuition of $ 40,000.00 due.
in September. I got Credit Card Expenses coming out my AXX! That
new 3000 sq ft extension on my house raised my property taxes $ 15,000.
The maid and the housekeeper want raises. The gardener also wants a.
raise. You see Bunky; It ain’t easy in the Public Sector! So come
on Private Sector Worker; Pony Up and Pay More Taxes so I can afford to.
live here! You See; Life Is Not Fair, and the DemoRats will take.
care of Everything! HAPPY DAYS ARE HERE AGAIN!

Aug 23, 2013 1:01pm EDT  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.