New Study Offers "Fresh" Perspective on Pension Funding Gap

September 8, 2003 ( - The funding status of public pension plans may not be as bad as widely reported, depending on how you look at the data.

A recent analysis finds that more than half of 93 of the nation’s larger public pension systems are more than fully funded, at least when one considers status based on the actuarial value of assets, while another 16 have an actuarial funding ratio of between 95% and 100%.   That’s the result of a recent analysis found in the Public Fund Survey, sponsored by the National Association of State Retirement Administrators (NASRA) and the National Council on Teacher Retirement.   In fact, the report says that the fiscal year 2002 aggregate funding level for the programs evaluated is 96.1%.

The actuarial funding ratio is derived by dividing the value of a pension plan’s assets by its actuarial liabilities accrued year to date, a measure that report author Keith Brainard characterizes as “perhaps the most recognized measure of a public retirement plan’s health.

Contrasting Perspective

Those findings stand in some contrast to a report released earlier this year by Wilshire Associates that claimed that some 79% of all state plans are now underfunded, up sharply from 51% in 2001, and 31% just two years ago (see  Wilshire: Public Pension Landscape Still Bleak ).   The National Association of State Retirement Administrators (NASRA) called the Wilshire report “alarmist,” and said the report didn’t adequately take into account that pension plans are designed to fund their liabilities over a long period of time (see  State Pension Group: Wilshire Research ‘Alarmist’ ).

At this point in time, the Public Fund Survey data paints a more optimistic view because it is based on the actuarial value of assets, whereas Wilshire measures market value, according to Brainard, who isDirector of Research at the National Association of State Retirement Administrators.   Somewhat ironically, he notes that several years ago, at the height of the bull market, Wilshire’s funding ratios were much higher than what the Public Fund Survey would have shown.

Still, while the recent market upturn has certainly been a welcome relief for the nation's public pension plans, the longer term implications could be a bit more complicated, according to the report.   First off, while the funding ratio can be a useful indicator of a pension plan's "health," the report notes that calculating an actuarial funding ration involves "many financial and demographic assumptions, of which most, if not all, will be incorrect to one degree or another in the short terms."

Nevertheless, the sustained slump in equity values has taken its toll on these programs.   The Public Fund Survey notes that the aggregate change in the actuarial value of assets from fiscal year 2001 to FY 2002 was $57 billion, or 3%, while liabilities grew $154 billion during the same period, an increase of 8.1%.   Indeed, the median liability growth of 7.9% substantially outpaced the 3.3% median increase in assets.   Still, public funds have fared better than major US equity indices due to a variety of factors, including:

  • Diversification of assets (the average asset allocation of the 93 systems in the study was 41.1% in domestic equities, while nearly a third was invested in domestic fixed income);
  • Lagging actuarial valuation dates;
  • The use of asset valuation methods that smooth investment gains/losses over a period of years.

Leveling the Playing Field

The smoothing methods appear to be fulfilling their intended purpose - insulating pension funding calculations from the temporary and sometimes turbulent vicissitudes of the markets.   Despite a negative market return in fiscal year 2001, a plan using a five year asset valuation method not only would have had a positive actuarial return, it would have enjoyed one that exceeded the 8.0% public fund median benchmark for actuarial returns - despite a decline in investment returns.

Similarly, the report notes that a plan with an actuarial value at June 30, 2002, will have begun to experience the actuarial effects of an equity market that began in April 2000.   That result, in conjunction with a five-year smoothing method, would see the high returns from FY 1997 disappear from the calculation, as FY 2002 is brought into the calculation.  

Back to Normal?

The study notes that if investment returns revert to historic norms during the next few years, this smoothing effect will result in funding ratios and contribution rates that are "steadier" than they would have been if valuations were more timely and assets were measured at market value.

However, based on changes in funding levels, current investment returns, and an assumed public fund rate of return of 8.0% for calendar year 2003, the report projects that the FY 03 aggregate funding level is projected to decline to approximately 90%, though the shift could be more pronounced for some programs.

Other findings from the survey:

  • Benefit payments as a percentage of systems' market value at year-end increased from 4.6% in FY 2001 to 5.5% in FY 2002
  • Five of the 92 systems surveyed enjoyed a positive market return in 2002.   Four of the five have a low equity allocation (one of those has NO equity allocation)

The survey is online at