Some good news to report for public pension systems (and those that contribute to them). Fitch Ratings has reported that after hitting a high of 8.6% growth in fiscal 2011, median actuarially determined contributions (ADC) rose only 3.5% in 2017. Actual contributions rose slightly faster at 3.7%, as governments continued to pay a marginally larger share of what actuaries targeted for supporting these pension systems.
Unfortunately, despite the recent trend, pension contribution growth has been far faster than the growth in state and local tax resources, according to Fitch. State and local tax revenues (resources) are greater by roughly 33% during the last decade, while pension ADCs are 74% higher. Obviously, this differential in growth is not sustainable.
There is some concern being expressed that future contributions will have to rise as asset returns fall short of return on asset (ROA) objectives, while demographic shifts reduce employee contributions. We, too, are concerned about plans injecting too much risk into their investment structure and asset allocation decisions that might exacerbate funding volatility.
As we’ve stated on numerous occasions, just because GASB allows public and multi-employer pension systems to discount liabilities at the ROA doesn’t make it a prudent action. Furthermore, it hides that fact that the present value of future liability payments can fall as interest rates rise. But, those only discounting liabilities at the “fixed” ROA would not recognize that fact.
Sure, pension systems might fall shy of their return objective (median ROA target is 7.5%) during the next decade, but if liability growth is actually negative, does it matter? Public pension systems would benefit from a greater understanding of what their promise looks like (benefit payments) and use that output to drive future asset allocation decisions. As funded ratios improve, plans should de-risk. With a de-risking glide path in place, contribution volatility should be reduced as well.