Over the past two economic cycles, state and local pension asset allocations have become riskier, raising their potential volatility and exposing participating governments to higher funding risks, according to FitchRatings.
Between 2001 and 2017, average allocations to higher-risk equities and alternatives increase from 67% to 77%, while lower-risk allocations declined form 33% to 23%.
The shift away from lower-risk to higher-risk allocations has not necessarily produced higher returns. The state and local governments in this survey saw average returns of 6.2% between 2008 and 2017 and 6.4% between 2001 and 2017. The lower returns were due to the Great Recession of 2008, the unsteady economic recovery that began in 2009 and the low interest rates in that period of time, FitchRatings says. Using weighted averages to aggregate data across each state’s major pension systems, actual returns by state fell short of the expected targets for all states between 2001 and 2017, with the exception of South Dakota.
Unfunded pension liabilities steadily increased to $1.2 trillion (74% funding) at the end of 2017 from $33 billion (98% funding) in 2001. FitchRatings attributes this to lower than expected returns, shortfalls in contributions and increases in projected future benefits.
FitchRating’s findings are based on data provided by Boston College’s Center for Retirement Research and includes data on 180 state and local systems in all 50 states, which the research firm believes account for 95% of the total state and local pensions by assets and plan participants.