March 5, 2014 / 3:41 AM / 4 years ago

Funding - and returns - for U.S. public pensions improve

WASHINGTON, March 4 (Reuters) - Swelling investment returns improved funding for U.S. public pensions last year, but almost all retirement systems are still in weak shape and unable to cover their liabilities fully, according to a report released by Wilshire Consulting on Tuesday.

In the annual study provided to Reuters, Wilshire estimated 134 state retirement systems had enough assets to cover 75 percent of their obligations in the year ended June 30, 2013, up from 72 percent in 2012. Still, 96 percent of those plans were considered underfunded, with an average ratio of 70 percent.

“The takeaway from this year’s study is, at its most benign, a message of ‘steady as she goes,'” said Russ Walker, Wilshire vice president and author of the report. “They still have a way to go before they achieve a more firm funding standing.”

For years many states short-changed their public pensions, putting in far less than actuaries suggested, and then cut further during the 2007-09 recession as revenues plummeted. At the same time, the financial crisis sent the plans’ investments, which provide two-thirds of revenues, into a downward spiral.

From coast to coast, battles have erupted over whether states have enough money to pay promised benefits, especially now that the first wave of the baby boom population is retiring. The fights are especially heated over assumed rates of return, with many conservatives saying the current expected rates are too high to attain.

State pension portfolios on average have a 65 percent allocation to equities, with the remainder in fixed income and other assets. That makes the plans particularly sensitive to stock market moves, although Wilshire notes that over the last decade they have rotated out of U.S. equities into offshore markets, real estate and private equity.

“Global stock markets rallied strongly over the twelve months ended June 30, 2013, offsetting weaker performance by global fixed income and allowing pension asset growth to outdistance the growth in pension liabilities over fiscal 2013,” according to the report.

Still, it projects public pensions’ investments will return a median 6.63 percent each year over the next 10 years, more than 1 percentage point below the plans’ median assumption of 7.75 percent. Walker said many pensions look at a longer timespan of about 30 to 40 years when averaging their rates of return.

“They had an encouraging tailwind to push their asset growth forward,” Walker said of 2013. “Now the investment environment is setting itself up to be challenging.”

Last month, Wilshire found all public pensions had returns of 5.31 percent for the last quarter of 2013. For the year, their returns were 16.1 percent and for five years they were 12.3 percent.

The U.S. Census has told a similar story. Throughout 2013, public pension holdings hit record highs: as of the third quarter, their holdings were $3.06 trillion, versus the low of $2.1 trillion reached in 2009. Investment earnings totaled in the hundreds of billions.

But the question remains as to how long this gangbuster growth can last, especially as earnings have slowed recently, according to the Census.

Rising interest rates could help public pensions by allowing them to discount future liabilities by larger amounts. Still, anticipation of the Federal Reserve curtailing its monetary stimulus and allowing rates to rise has held markets captive for half a year.

“The challenges of 2014 are: When is the shoe going to drop? When are interest rates going to rise?” said Walker.

States such as California have lowered their expected rates of return in recent years. Meanwhile, plans considered underfunded will have to estimate lower rates under Government Accounting Standards Board rules that take effect this summer.

Last month, the Society of Actuaries recommended that all pension plans use a standardized assumed rate of return, based on “current long-term risk-free rates” such Treasury yields, plus a margin representing common investments that return a higher rate. When the report was released, the Society estimated that rate at 6.4 percent.

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