Public Pensions May Need to Lower Return Assumptions

The Milliman 2014 Public Pension Funding Study, which annually explores the funded status of the 100 largest U.S. public pension plans, found larger plans in the study tend to be better funded than the smaller plans in the study. The best funded plans, those in the top quartile of plans as measured by the sponsor-reported funded ratio, account for 34% of the aggregate sponsor-reported accrued liabilities, whereas the worst funded plans, those in the bottom quartile, account for only 18% of the aggregate sponsor-reported accrued liabilities.

This year’s study found that the gap between the accrued liability of plans as recalibrated by Milliman and the sponsor-reported accrued liability widened, from 2.6% in the Milliman 2013 Public Pension Funding Study to 3.8% in 2014. This widening gap in liability mirrors a corresponding widening between the investment return assumptions reported by the plans in the study relative to Milliman’s independently determined investment return assumptions.

While 13 of the 100 plans in the study have lowered their reported investment return assumptions since the Milliman 2013 Public Pension Funding Study, most plans in the study have left their investment return assumptions unchanged. The median investment return assumption reported by the plans decreased from 8% in the 2012 study to 7.75% in the 2013 study, and it remains at 7.75% in the 2014 study. Meanwhile, Milliman sees market consensus views on long-term future investment returns continuing to decline, so its median independently determined investment return assumption decreased from 7.65% in the 2012 study to 7.47% in the 2013 study and to 7.34% in the 2014 study. In aggregate, this suggests that for many plans that have not recently lowered their reported assumptions, some decrease in the investment return assumption may be appropriate, Milliman says.

The plans in the study reported aggregate accrued liabilities of $3.88 trillion for the nearly 25 million members covered by the plans. This total breaks down into $1.61 trillion for the 12.5 million plan members who are still working plus $2.27 trillion for the 12.1 million plan members who are retired and receiving benefits or who have stopped working but have not yet started collecting their pensions. Milliman notes that over the past three years, the number of active members has been fairly stable while the number of retired and inactive members has climbed steadily.

While the aggregate 2014 investment allocation is 73% in non-fixed-income classes and 27% in fixed income, there is considerable investment allocation variation from plan to plan. Milliman found a low correlation between reported funded ratios and the percentage of non-fixed-income assets.

The Milliman 2014 Public Pension Funding Study report is here.