By: Russ Kamp, CEO, Ryan ALM, Inc.

Ron has produced an interesting piece of research that might just enlighten, if not confuse, some pension folks. I suspect that most folks would believe that a plan’s funded status remains consistent if the desired return on asset (ROA) assumption is achieved annually. However, that is definitely not the case for a plan that is in a deficit position (assets less than the plan’s liabilities).

In fact, a plan with a 70% funded ratio (a 30% deficit to plan liabilities) striving for a 7% ROA can achieve that target each of the next 5-years and the funded status deficit will have grown by 42.3%, while maintaining that 70% funded ratio. A 50% funded plan striving for the 7% return target actually needs to achieve a 14% return just to maintain the funded status. Despite maintaining a level Funded Ratio, contributions into the plan will need to rise in order to keep the funded status from continually growing.

When we see reports that public pension funds have an “average” funded ratio of 83%, understand that the collective funded status is likely getting worse unless a significant outperformance occurs relative to the ROA objective, given the 17% funded status deficit. As a result, contributions into these pension plans will be rising.