Public and Private DBs Responding to Crisis Differently

March 23, 2010 ( - Although public pension plans and their corporate counterparts were hit equally hard by the global market crisis, a new study from Greenwich Associates shows they are responding to historic funding shortfalls in very different fashions.

Fearful of eventual implementation of mark-to-market accounting rules that will ultimately transfer the full impact of pension investment volatility to the corporate balance sheet, companies are electing to take down risk levels in their DB portfolios, Greenwich said. Its study showed that corporations’ chief tactic is lowering allocations to U.S. equities, which declined to an average 33.8% of total corporate assets in 2009 from 40.7% in 2008 and are expected to fall further in coming years.      

Free from these accounting concerns, public pension funds are moving in the opposite direction, increasing allocations to higher risk asset classes with the potential to generate higher levels of investment returns. According to a Greenwich press release, although public pension funds as a group also allowed U.S. equity allocations to fall last year, they are planning to cut fixed-income allocations in coming years while shifting assets into private equity, international stocks, hedge funds and equity real estate.       

Approximately 17% of public pension funds say they plan to reduce significantly fixed-income allocations over the next two to three years, with only about 9% planning reductions. Twenty-three percent of public funds say they are planning to make significant additions to private equity allocations between now and 2012. Almost 20% of publics plan significant increases to international equity allocations and about 18% plan to significantly increase hedge fund allocations by 2012. In each of these asset classes, these proportions far outweigh the much smaller shares of public funds planning to decrease these allocations.       

Greenwich said that public funds appear to be banking on the fact that the investment strategies they are implementing will help shore up solvency ratios by generating returns that far outpace the market. Municipal pension funds last year said they expect their investment portfolios to beat relevant benchmarks by 160 basis points — up from a 132 bps expectation in 2008. Public funds with assets of $500 million or less increased their stated expected outperformance to 180 basis points in 2009 from an already aggressive 135 bps in 2008.      

According to the press release, among public pension funds, the combination of growing liabilities and a drop in asset values to $2.7 trillion in 2009 from $3.2 trillion in 2008 depressed average solvency ratios to 83% from 86%. More than 30% of U.S. public funds now have solvency ratios of 79% or lower, and more than one in 10 public funds have a solvency ratio of 69% or lower. Average solvency ratios for state funds declined to 80% in 2009 from 84% in 2008 and average ratios for municipal funds dropped to 84% from 88%.        

Average funding ratios for the projected benefits obligation of U.S. corporate pension funds fell to 80% in 2009 from 101% in 2008. The proportion of U.S. corporate pensions funded at less than 85% rose from approximately 8% in 2008 to 57% in 2009, and the share funded at less than 75% increased from less than 1% to 31%.