New Contribution Strategies Needed to Improve Public Pension Funding

A study by the CRR finds that state and local pension funding is expected to improve in 2017 due to strong market returns, but a new approach to providing adequate contributions is needed to make the most out any recovery.

The aggregated funded status of state and local pensions declined in 2016 largely as a result of steady liability growth and slow asset growth, according to the Center for Retirement Research at Boston College (CRR).

The organization reports that in 2016, the ratio of assets to liabilities for pensions dropped whether measured based on the old Governmental Accounting Standards Board standard (GASB 25), which uses a smoothed value of assets, or by the new standard (GASB 67), which values assets at market.

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Liabilities valued under the old and new accounting standards grew by 5.6% and 6.3%, respectively. Thus, funding status measured by the traditional GASB standard dropped from 74% in 2015 to 72% in 2016. Under the new GASB standard funding declined from 73% to 68%.

The CRR notes that funded status is expected to improve in 2017 due to strong stock performance, but that ratio is expected to increase only modestly by 2021 even if plans reach their current assumed returns which average 7.6%. In order for any recovery in funded status to be sizable across the board, the CRR says “plans need to establish contribution levels that will actually reduce unfunded liabilities.” The challenge to this task lies in the current approach to calculating required contributions, CRR finds.

To determine the true value of liabilities, the CRR focused on the rate used to discount promised benefits. The traditional discount rate averaged 7.6% across public plans in 2016, while the blended discount rate used for the new GASB standard averaged 7.3%

This means liabilities under the GASB standard were about $160 billion or 3.3% greater than those measured under the traditional method. The CRR also finds “the percentage of required contribution paid has remained stable since 2015. Sponsors have steadily increased the percentage of required contributions paid since the financial crisis and, today, pay above 90%.”

CRR notes “In 2021, assuming plans achieve their expected returns, they are projected to be 72.9% funded under the old GASB standard compared to 71.8% today. That translates to 70.6% percent funded status under the new GASB standard compared to 67.9% today.

The CRR concludes “The revival of markets in 2017 has helped pension plan assets recover. But looking forward, the funded status of plans will depend heavily on both future investment performance and adequate contributions.”

The CRR Issue Brief may be downloaded from here