By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Equable Institute has released a year-end update to their State of Pensions 2022 report. They’ve concluded that the aggregate funded status of US state and local retirement plans deteriorated from 2021’s 83.9% to 77.3%, based on the available data as of year-end. Unfortunately, this reverses nearly half the gain achieved in 2021 following the incredibly strong market performance. Equable further estimates that total unfunded liabilities are roughly $1.45 trillion. Of course, this estimate is based on using the return on asset (ROA) as the discount rate under GASB accounting rules.
Public pension systems averaged -6.14% for the fiscal year ending June 30, 2022, dramatically underperforming the roughly 7% ROA objective. Furthermore, performance remained flat during the second half of 2022 putting pressure on the first 6 months of 2023 to see dramatic improvement or suffer the consequences of two consecutive subpar performance years. Of course, underperformance of this magnitude creates contribution volatility and plays havoc with state and municipal budgets.
It is this funding volatility that needs to be minimized. As exciting as 2021 may have been from a performance standpoint, extraordinary performance years can not be counted on going forward as inflation remains well above the Federal Reserve’s 2% objective which will lead to continuing rising rates and the potential for a US recession and rising unemployment. None of those events will support higher equity returns. As we’ve mentioned on multiple occasions, pension America would be well served by adjusting the asset allocation focus away from the ROA onto plan liabilities. It is the promise that needs to be funded and secured. Achieving the ROA but failing to beat liability growth is not a success!