Equable Institute’s latest report on US pensions has some good news related to funding ratios. But its tone about the overall state of US pensions isn’t all that sanguine.
First the good news. The institute estimates that the funding ratio for US state and local pension plans will rise to 80.6% at mid-year in 2024, up from 75.8% a year ago. Additionally, an average investment return of 7.42% will outperform the average assumed rates of return, while employer contributions exceeded 30% of payroll on average for a third straight year. In all, these plans “paid a record amount into their public retirement systems last year - 31.3% of payroll on average, or US$180.7 billion”, the report says.
Nevertheless, it points out that “this level of money has not been enough”, noting that US pension plans still have $1.34 trillion in unfunded liabilities as of this year. Back in 2001, the funding ratio was 94.3%.
The least funded states with a funding ratio of less than 60% are Connecticut, Illinois, Kentucky, Mississippi and New Jersey. The low funding ratio in these states has persisted at least since 2023.
The overall problem, though, is not one of parlous or parsimonious states. “After a decade of insufficient funding, state agencies on average are now consistently paying 100% of their actuarially determined contribution rates,” the report says.
Rather, pensions have been a casualty of rising interest rates. According to the report, interest on pension debt is the fastest growing contributor to unfunded liabilities. “The result is that public retirement systems are mired in pension debt paralysis.”
It notes that private capital has been a growing share of US pension allocations since the global financial crisis, and now stands at some 13.7%, with real estate at a further 9.2%, and commodities at 5.7%. Because of pension debt paralysis, “pension fund investment managers continue shifting assets toward high-risk, high-reward bets”, it observes, potentially exposing state pensions to the risk of overpriced assets.
Furthermore, according to the report, the positive trends in rates of return and payments have not been enough to balance the steady increase in benefit payments or outflows over the past two decades. As a result, pension plans collectively face consistent negative cash flow. In fact, the report notes that increased longevity, benefit enhancements, and state payment shortfalls are “just small components of the collective pension funding shortfall”.
Ultimately, it concludes that the funded status of public pension plans remains “fragile”. And the only remedy it envisages is to pay down that unfunded ratio and thus reduce interest repayments on the debt. Whether that will be possible remains to be seen.