The Center For Retirement Research at Boston College is out with a new brief highlighting the growing divide among well-funded and poorly-funded state and local defined benefit plans (the universe is 180 plans). The funded status of this cohort in the fiscal year 2017 was 72%, which is roughly in line with previous years. However, the “average plan” masks what is happening within this public fund universe.
According to the study, the top 1/3 of public systems have a 90% funded status, while the bottom third sits at 55% funding and the middle third was at 70%. Was this divergence always present? Heck no. The researchers looked at how this universe has changed since 2001. Incredibly, the bottom third had a funded status above 90% in 2001. The deterioration has been most notable since the great financial crisis, and is likely the result of poor performance and underfunding. It is estimated that the weakest third of the universe only received about 60%-70% of the annual required contributions.
With regard to performance, each of the three groupings fell short of their 7.4% target return, with the weakest third generating only a 5.5% return versus the top third’s 6.1%. As a reminder, contributions are based on plans achieving their target ROA, so in this case, each of the three tiers would have received smaller contributions than necessary to keep pace with liability growth.
As we’ve discussed many times, managing a pension plan, public or private, needs to be about providing the promised benefit at the lowest cost and not necessarily the highest return. The 72% funded status is based on GASB permitting the discounting of liabilities at the ROA and not a true mark-to-market evaluation of the liability. Furthermore, this comes after a 10-year bull market recovery for equities. How bad will things get following the next market correction?