Thanks to historic investment returns over the past year, state public pension plans are at their best since the Great Recession.
After the state’s pension debt hit more than $ 1.4 trillion last year, two new reports estimate the gap between the total amount states have promised retirees and what they have actually set aside in their investment funds for pensions will shrink considerably. A recent analysis of Pew Charitable Trusts said the spread could drop below $ 1 trillion this year. And a report released today by the Equable Institute estimates that the 2021 returns will reduce the state’s pension debt to $ 1.08 trillion.
Gains in the stock market played a big part. The Equable report calculates that preliminary investment returns for 2021 averaged a stunning 20.7%. This is almost three times the assumed average rate of return for a given year. These gains will propel the average pension plan to around 80% funding, the highest funding ratio since 2008.
“The volatility of financial markets over the past 18 months of the COVID-19 pandemic has ultimately been a positive investment climate for institutional investors like public pension plans,” the Equable report states. “And the federal government has provided substantial financial assistance to states and municipalities, alleviating what could have been seismic budget deficits in some jurisdictions due to declining tax revenues.”
While this is probably the most positive retirement news we have had in a long time, no one forgets that $ 1 trillion is still a huge number. So that doesn’t mean taxpayers can stop worrying about whether the health of their pension plan will cost them in the future.
Plus, market volatility has worked this time around for pension funding, but it’s not always the case. In 2015 and 2016, bad economic news from China and more uncertainty around Britain’s decision to leave the European Union has contributed to the wild swings in the stock market. This has led pension plans to declare their worst returns on investment since the Great Recession.
For taxpayers, all of this means that there is no guarantee that problematic pension funds are now on the road to recovery. They can always be asked to pay higher taxes or accept reduced services so that states can continue to invest more money in their pensions afterwards. State plans in places like Illinois, Kentucky, New Jersey, and Pennsylvania are still woefully underfunded and have less than 60% of assets to pay for all of the promised benefits. The Kentucky state plan is in the worst form – less than 20% funding.
On the one hand, these states have all made difficult and even controversial policy changes over the past decade to make their pensions financially viable. None of these states were paying all of their retirement bills when the Great Recession hit, and they had to rectify that or risk their funds collapsing. But on the other hand, this process has been very expensive. All four have collectively put more than $ 100 billion into their retirement plans over the past decade, quadrupling their annual cost according to Pew.
Now that they’ve gotten to the point where they’re paying their bills in full, the question is, can they keep those payments? The same could also be asked of Alaska, Hawaii, Missouri and New Mexico, which Equable says also have retirement debt that is equivalent to more than 15% of the state’s GDP.
“There is a theoretical limit to the contribution rates that heads of state will want to draw from their general funds, from school district funding or from city budgets,” the Equable report said. “The larger a state’s unfunded liability relative to GDP, the more difficult it will be for that state’s tax base to close the pension funding gap.
Nevertheless, there are good reasons to be optimistic about the stability of pensions in the future. Many governments have had to carefully consider the weaknesses of their plans after the Great Recession and lower their annual return on investment assumptions. Ten years ago, plans still assumed an average annual return on investment of 8%. Most are now lowering that target to 6%, which economists and rating agencies say is a more realistic target.
Policymakers have also cut benefits for new hires, slowing the growth in pension liabilities and increasing the chances that governments will be able to keep up with annual payments.