Lower Asset Growth Hampers State and Local Pension Outlook

The funded status of state and local pensions increased in fiscal year 2018 to 72.8%, according to the Center for Retirement Research at Boston College’s “Update on the Funded Status of State and Local Pension Plans.” However, the funded status has been largely flat since 2008 and is well below its peak of 102.7% in 2000.

Liability growth has steadily declined in the past two decades, from 7.7% in 2002 to 3.8% in 2018—but asset growth has been even slower. In terms of asset growth, the average annualized investment returns for public plans was 5.9% and cash flows averaged about -2.7%. Combined with the relatively small impact of actuarial smoothing, actuarial assets have grown by only 3.5% per year since 2001. Because actuarial assets and liabilities grew by 3.5% and 5.6%, respectively, the aggregate state and local funded ratio declined from 103% in 2001 to 73% in 2018.

Given these trends, if plan sponsors want to improve plan funded ratios, a key challenge is to increase their asset base through contributions. One way forward is to adopt more stringent funding methods, such as level-dollar amortization and shorter amortization periods.

Another, more important, change is to lower assumed investment returns, which would help ensure funding progress by further raising required contributions.