Two Pension Articles
Frederick H. Nesbitt,
Of course we know public pensions.
Public Pensions Press State Budgets
S&P Study Notes Shortfalls And Warns That Stresses Threaten Creditworthiness
By DEBORAH SOLOMON February 23, 2006; Page A2
Underfunded public-employee pension plans are straining state budgets just as states face other rising expenses and steep debt levels, according to a Standard & Poor's Corp. analysis to be released today.
The report said state pension plans fell short by about $284 billion nationwide in 2004, the latest year for which data are available, leaving the plans in need of hefty contributions. The budgetary stress could ultimately hurt states' creditworthiness, leading to higher borrowing costs for some governments, which sell debt to finance all types of projects, such as roads and schools.
"The big picture is that funding levels have fallen, and we think that they may fall a little bit more," said Parry Young, a director with S&P in New York.
While state revenue growth is stronger than it has been in the past five years, states face a "double-whammy" of declining pension fund assets and rising liabilities, which means they must contribute more money, according to the report.
As of June 30, 2004, the value of public pension fund assets fell to 84% of projected liabilities from 100% or more in the late 1990s, according to the report. The drop stems from several factors, including the bursting of the stock-market bubble, the promise of enhanced benefits and weak financial contributions by state and local governments.
Most public pension funds get monetary contributions from state and local governments and also make money off investments in the stock market. Many funds were flush during the 1990s as big investment gains bloated pension plans, leading some state and local governments to scale back their contributions and grant enhanced benefits.
When the stock-market bubble burst early this decade, pension funds saw their funding levels sink, and state and local governments were on the hook to make up the difference. As a result, states have had to boost their contribution rates.
But many still have large holes to fill before their pension plans are fully funded. Among the most underfunded plans in fiscal 2004 were West Virginia, Oklahoma and Rhode Island.
The need to contribute more money comes as states face other budgetary pressures, including skyrocketing costs for Medicaid, the federal-state health-care program for the poor. Costs are rising at about 7% a year. State and local governments will also have to start setting aside money to pay for retiree health benefits as the result of a pending accounting change; for the first time, governments will be required to disclose these obligations. States are also carrying an enormous debt load of $288 billion, which they must finance in both the long and short term.
Because of the rising budget pressures, ratings firms such as S&P want to see pension asset-to-liability ratios reach 90% or more so that contribution rates can level off and states can afford to make their debt payments.
"Pension liabilities...must be managed so as not to adversely affect the employer's credit profile," the report said. If they are ignored or if they hurt a state's financial position, it added, that could "exert downward pressure on the state creditworthiness at least over the intermediate term."
Opinion: Too Little, Too Late: 2006 DB Survey
The Defined Benefit Dilemma
PlanSponsor Magazine February 2006 Nevin Adams
After years of references to the "perfect storm"—that confluence of declining interest rates, slumping investment markets, and looming pension liabilities that sent many a defined benefit plan sponsor scrambling—the past 18 months have seen a dramatic turnaround. Most pension plan returns have exceeded targets, interest rates have moved marginally higher, and many plan sponsors reached for their checkbooks—in the process, dramatically reducing those once-yawning pension plan deficits to more reassuring levels.
Despite that progress—or perhaps, in no small part, because of it—a growing number of employers now appear to be taking a second look at the longer-term viability of these programs, albeit for a variety of reasons.
According to the 2005 Fidelity Investments/PLANSPONSOR study of defined benefit plan practices, while the percentage of plan sponsors with plans underfunded on an ABO/accrued liability basis has remained relatively constant—61% were underfunded in 2002, while 64% were in 2003 and 2004—the distribution has shifted noticeably from the number of plans that are 80% to 90% funded to those that are more than 90% funded. In fact, the 2005 survey reveals that nearly two-thirds (64%) of responding plans are more than 90% funded. Indeed, half the corporate plans surveyed now are fully funded, and 42% are more than 100% funded.
There remains a real distinction between the funded levels of corporate and public pension plans, however. Three-quarters (75%) of corporate plan respondents were better than 90% funded in this year's survey, compared with just 48% of public plans. Of course, the problems were slower to manifest themselves in the public sector, and smoothing no doubt imposes something of a lag factor on the results. Additionally, public plans must contend with an array of political concerns in addition to those confronting their corporate brethren (see “Their Own Worst Enemy,” PLANSPONSOR, August 2005).
The differences manifest themselves in other ways as well. Near-term cost volatility dominates the concerns of corporate plan management (69%), but garners the attention of just 44% of public plan sponsors. Political risk is a concern for 18% of public plans, but is not a factor for corporate programs. On the other hand, mark-to-market requirements, discount rate concerns, and PBGC premium trends were cited by 33%, 22%, and 18% of corporate plan sponsors, respectively; for the most part, they were not concerns for public plans. However, long-term cost concerns loom large for both—and were among the top concerns of respondents to this year’s survey for both corporate and public plan sponsors.
Differences also were evident in the articulated contribution policies. Most (54%) public plan respondents said they contributed the maximum amount each year, and a full two-thirds of those with less than $2 billion in plan assets did, compared with less than a third of corporate plan respondents. The most prevalent policy among corporate plans was a focus on the contribution level necessary to hit the targeted funded level (38%), a factor that was cited by nearly half (48%) of the plans with less than $2 billion in assets.
One area where there was not much difference was asset allocation. Both corporates and public plans held nearly half their portfolios in domestic stocks (48.2% and 44.2%, respectively), both held about 15% in international equities, and both held roughly a quarter in fixed income (27.6% and 28.9%, respectively). Public plans held slightly more alternative investments (6.3% versus 5.3% for corporate plans), and also held more real estate (5.6% versus 2.8%).
Corporate plans were more likely to rebalance portfolios on a regular basis; nearly a third (30%) of corporate plans said they rebalanced every month, more than twice the pace among public plan respondents (13%). Public plans were significantly more likely to reposition their investments when their portfolios moved outside the target allocation, by a margin of 55% to 38%. Larger plans were more likely to rebalance on a regular frequency than were those with less than $2 billion in assets.
Despite those gains, the shrinking funding gap, current interest rate environment, and concerns about an increasingly punitive regulatory environment have led a growing number of defined benefit plan sponsors to consider an exit strategy. Nearly all corporate plan sponsors viewed proposals to increase the PBGC premium as a concern (39% deemed those proposals to represent a “significant” cost increase). Another feature imbedded in the pension reform proposals—a potential resolution for the legal limbo in which cash balance plans have been ensnared—has been a factor for some, but perhaps not in the way one might imagine. While more than half (58%) of corporate plan sponsors say the current uncertainty around cash balance plans has not had an impact, more than a quarter (29%) said it has led them to maintain their current traditional pension plan, rather than convert. Defined contribution designs were the beneficiary of the uncertainty in 12% of the cases—6% said they had closed or frozen their cash balance plans and moved to a defined contribution design, and 6% said they had opted for defined contribution rather than convert to a cash balance plan.
All in all, however, despite the inhospitable environment, a robust 84% of plan sponsor respondents said their organization is “very likely” to continue offering its defined benefit plan over the next five to 10 years, roughly identical to the number in 2002. Significantly, particularly in view of recent headlines, nearly three-quarters (73%) of corporate plan sponsors evidenced that level of support that, alongside the 21% who said it was “somewhat likely” that their programs would survive, means that the vast majority of defined benefit plan sponsors remain committed to those benefits—a commitment often at odds with the sensationalism of today’s headlines.
What remains to be seen is whether that commitment can survive Washington’s attempts at reform—the squeeze of new accounting constraints—and the burdens imposed by the current interest rate environment, not to mention the astonishing ambivalence of the nation’s workforce (outside the confines of the public sector and unionized labor).