Public Pension Plan Sponsors Struggle to Contribute Sufficiently to Plans

Between 2005 and 2016, employer contributions to 133 large state and municipal pension plans more than doubled from $42.4 billion to $88.1 billion; however, during that same period, the unfunded liabilities of these plans grew 245% from $290 billion in 2005 to $1.0 trillion in 2016, according to an analysis from the Society of Actuaries (SOA).

Most of the plans studied received insufficient contributions to reduce their unfunded liabilities, assuming all actuarial assumptions were met exactly. In 2003, while still feeling the impact of the dot-com market crash, 55% of plans received insufficient contributions to reduce their unfunded liabilities. After reeling from the 2008 market crash, the percentage of such plans peaked at 84% in 2011 before falling to about 63% for 2016 and 2017.

The study considers three primary benchmarks for assessing employer contributions to public pensions:

• Target Contribution – Since 2014, the target contribution is the actuarially determined contribution (ADC) computed by the plan actuary for disclosure under Government Accounting Standards Board (GASB) guidelines, if such a figure was reported. The ADC may or may not represent the contribution determined under the plan’s funding policy. In some cases, the target contribution represents a value reported as “required contribution” or something similar. For years prior to 2014, the target contribution represents a similar concept, the annual required contribution (ARC) as GASB required prior to 2014. The analysis compares the target contribution for a given fiscal year to the contributions made for the same fiscal year.
• Reduce unfunded liability as a dollar amount (UL$). In technical terms, this benchmark is the cost of current benefit accruals (normal cost) with interest to mid-year plus a year’s interest on the unfunded liability, discounted for payment at mid-year. This benchmark reflects a common understanding of funding pension plans.
• Reduce unfunded liability as a percent of payroll (UL%). Except for the interest rate, the formula for computing this benchmark is the same as for reducing UL$. In this case, the interest rate is net of assumed payroll growth. This benchmark reflects another common but somewhat more complex understanding of funding pension plans relative to budgeting of salary-related employee costs.

The analysis found the percentage of plans receiving contributions at least equal to their Target Contribution remained somewhat stable during the years studied. In fiscal year 2003, 54% of plans received at least their Target Contribution, and 51% of plans received at least their Target Contribution in fiscal year 2017. Between 2003 and 2017, the percentage of plans that received at least their Target Contribution ranged from 44% to 62%, but neither consistently above nor consistently below 50%.

The percentage of plans that received insufficient contributions to reduce their UL$ increased from 55% in 2003 to 72% in 2005, at least partly a result of the dot-com crash in the early 2000’s. By 2008, generally prior to the 2008 market crash, the percentage was down to 58%, only slightly above the 2003 level. While most plans at the start of 2008 received insufficient contributions to reduce their UL$, the contributions of 42% of plans did reduce their UL$. At the worst point following the 2008 market crash, the percentage of plans that received insufficient contributions to reduce their UL$ peaked at 84%, in 2011. Since then the percentage generally declined to 63% for 2016-2017, meaning that 37% of plans received sufficient contributions to reduce their UL$.

Some plans that received insufficient contributions to reduce their UL$ did receive sufficient contributions to reduce their UL%. In 2003, 16% of plans received sufficient contributions to reduce their UL$, but 36% of plans received sufficient contributions to reduce their UL%. In 2017, 35% of plans received sufficient contributions to reduce their UL$, but 77% of plans received sufficient contributions to reduce their UL%.

In general, the proportion of plans with unfunded liabilities has been increasing since the dot-com crash. In 2003, 29% of plans had a funding surplus, meaning 71% had unfunded liabilities. By 2009, 88% of plans had unfunded liabilities, and in 2017, 97% of plans had an unfunded liability.

Authors of the study report analyzed the 107 plans that had at least 14 years of data sufficient for analysis and an unfunded liability in at least one of those years (the 14 years may not be consecutive). During 2002 to 2017, many of the plans regularly received insufficient contributions to reduce their unfunded liabilities. Of the 107 plans studied, 86 plans (80%) received insufficient contributions to reduce their UL$ at least half of the time, while 40 plans (37%) received insufficient contributions to reduce their UL% at least half of the time.

Twelve plans (11%) always received insufficient contributions to reduce their UL$, but no plans’ contributions were always insufficient to reduce their UL%. On the other end of the spectrum, 7 plans (7%) always received sufficient contributions to reduce their UL$, 12 plans (11%) always received sufficient contributions to reduce their UL%.

The SOA report concludes that plans that received insufficient contributions to reduce their UL$ in the short term may have a funding policy that will fully fund the plan over the long term. However, a significant portion of these plans received less than their target contributions, which may indicate that their plan sponsors were not following the plans’ funding policies.

The amortization approach, if any, used in computing the target contribution can influence whether contributions reduce the unfunded liability as a dollar amount. When the amortization approach does not reduce the UL$, the amortization approach is said to entail negative amortization.

The SOA concedes that employer contribution amounts are only one of many factors that influence pension plans’ funded status, including approaches to plan, cost and risk management; asset allocation; investment experience; changing plan demographics; actuarial methods and assumptions for computing plan liabilities; relatively long budget planning cycles; and contribution decisions that may be subject to legislative processes.

The full report from the SOA may be downloaded from https://www.soa.org/research-reports/2017/public-pension-indices/.