Data and Research July 16, 2024

State, Municipal Retirement Systems Remain Stuck in ‘Pension Debt Paralysis’

Equable projected that state and local public pension plans will have an average funded status of 80.6% in 2024. 

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Despite the fact that state and local governments have been increasing their contributions to their retirement systems—totaling about $180.7 billion in 2023—U.S. public pension plans are projected to still have $1.34 trillion in unfunded liabilities in 2024, according to new research from the Equable Institute. 

In better news, the average funded ratio for state and local plans is projected to increase to 80.6% in 2024 from 75.8% in 2023, marking the second largest year-over-year increase in the last decade. 

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After a decade of insufficient funding, Equable found that state agencies are now consistently paying 100% of their actuarially determined contributions, and state legislatures have used surplus revenue over the past few years to make supplemental contributions to state pension funds. 

In the 12 months through June 2024, the average public pension fund’s 7.4% investment return beat the funds’ average 6.9% assumed rate of return, the main target to hit each year in order to prevent further growth of unfunded liabilities. All asset classes had strong performances over the last year, especially in the period from January through June 2024, which helped investment returns. 

Pension Debt Paralysis 

While this is a welcome improvement, Equable reported that it will require additional years of similar performance to break public plans out of their “pension debt paralysis.” 

Anthony Randazzo, Equable’s executive director, said in a briefing about the research that volatility in investment returns for public plans has “dramatically increased” since the pandemic. 

“In fact, volatility is approaching levels last seen during the [global] financial crisis,” Randazzo said. “So for … public pension [sponsors] who value stability and steady improvement, this is a significant concern.” 

The “record contributions” to pension funds have been insufficient to prevent interest on unfunded liabilities from continuing to accumulate. According to Equable, interest on the pension debt is the fastest-growing contributor to unfunded liabilities over the last two decades. 

As a result, Equable argued in its report that states and cities are not doing enough to eliminate unfunded liabilities, which are driving steadily rising contribution rates that will lead to more costs in the long run. 

“Government complacency is harming taxpayers with lower quality public services and harming public employees who are experiencing reduced benefit values and insufficient inflation protection—problems which are not likely to change even with good investment returns,” the report stated. 

According to Equable, pension debt paralysis has caused average public employer pension contributions to increase to 31.3% of payroll from 17.3% between 2008 and 2024. 

Negative net cash flows from contributions and benefit payments have also steadily increased over the past two decades, reflecting more “mature” pension plans. However, larger negative cash flows put increased pressure on investment return each year to make up for the difference.  

Causes of Unfunded Liabilities 

Jonathon Moody, vice president of research at Equable, explained that some of the main causes of unfunded liabilities are underperforming investments, interest on the unfunded liability growing faster than employer contributions, and changes to liabilities due to adopting new actuarial assumptions. 

According to the report, the largest contributor to the $1.2 trillion in unfunded liabilities in 2022 was necessary improvements to actuarial assumptions.  

The improvements to assumptions include more accurate expectations about investment returns, payroll forecasts, mortality rates and more. While the funding shortfall is a problem, Moody said it is a good thing that public pension funds are improving the accuracy of their accounting.  

“[Pension plans] are improving the accounting for pension liabilities and investment, which suggests that, in the past, pension funds were less accurate in their actuarial assumptions,” Moody said.  

Status Varies By State 

Looking at 2024 estimated funded ratios by state, many states are projected to have improved their average funded status from 2023 to 2024, including Delaware, Maryland and West Virginia, all of which moved up into the 90% funded status range. South Carolina was the only state to move from the less-than-60%-funded category to the 60%-to-70% category. 

Overall, Equable found that funded ratio and unfunded liability levels vary considerably from state to state. For example, a small group of states have historically resilient statewide pension systems, including New York, South Dakota, Tennessee and Wisconsin.  

Meanwhile, more than 13% of all statewide plans and local plans were considered “distressed” in 2023, as these plans face a considerable uphill climb to recovery. The costs of paying down unfunded liabilities for these plans, such as the Teachers’ Retirement System of the State of Illinois and Kentucky Employees Retirement System Nonhazardous, are challenging for state budgets, but Equable argued that costs of insolvency and shifting to “pay-as-you-go” could be even more expensive.  

 

Compliance July 16, 2024

Insurers Continue Effort for Retirement Security Rule Injunction

Nine insurance industry organizations and representatives have responded to the DOL’s rebuttal of the groups’ litigation against the rule as September implementation date nears.

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A group of insurers seeking to halt the Department of Labor’s Retirement Security Rule from taking effect has responded to a counter-filing by the regulator alleging that “changes” the department made from a 2016 fiduciary proposal are not enough to make the 2024 proposal viable.

The initial suit, filed in May by nine insurance trade groups in the U.S. District Court for the Northern District of Texas, argued that the new proposal regarding what it means to be a retirement plan investment fiduciary faced the same issues as a 2016 proposal struck down by the U.S. 5th Circuit Court of Appeals.

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On June 28, the DOL responded in American Council of Life Insurers et al. v. U.S. Department of Labor defending the rule, which is scheduled to take effect on September 23. In that response, the regulator argued in part that this proposal differed from the 2016 rule and was consistent with the appeals court’s ruling in that case, noting that the DOL “has been careful to craft a definition that is consistent with both the statutory text and with the Fifth Circuit’s focus on relationships of trust and confidence.”

In a reply filed on July 12, the group of insurers and industry trade group Finseca argued that the differences were not enough to “save the rule’s sweeping redefinition of fiduciary status,” which names agents and brokers who sell retirement income annuities as fiduciaries, along with those who provide rollover recommendations or small retirement plan investment advisement. The insurance industry plaintiffs have asked the court to “enjoin the Rule and stay its effective date.”

In setting up their response, the insurance groups first argue that the definition of an investment advice fiduciary under ERISA is created by common law, not the “DOL’s regulatory preferences.”

“Like the 2016 rule, the Rule seeks to transform virtually all insurance agents and brokers who recommend retirement products in compliance with existing state and federal laws into fiduciaries without regard to whether those relationships actually are or would be ‘fiduciary’ at common law,” the plaintiffs wrote.

The DOL, in its rebuttal to the initial complaint, had made the case that the rule was, in fact, focused on those offering advice regarding ERISA plan assets and was separate from those making a “sales pitch” for products or services.

But the plaintiffs disagreed with the assessment, arguing that the DOL’s rule is too broad and would put sales into a fiduciary context. In the response, the plaintiffs first argued that the new rule sweeps up all agents and brokers operating under the Securities and Exchange Commission’s Regulation Best Interest, as well as those operating under state-specific annuity sales rules.

They argued that operating within this regulation, according to the 5th Circuit’s 2016 ruling, does not necessarily mean someone is acting in a fiduciary capacity.

In addition, the insurers argued that an agent selling a service can have a relationship of “trust and confidence” with a client under the law without creating a “fiduciary relationship with every salesperson.”

The insurers also made the case—as they have in prior responses—that the DOL is going beyond its statutory authority with the rule under the so-called major questions doctrine, which they say “applies whenever agencies claim the power to make ‘major policy decisions’ normally reserved for Congress.”

In its response to the initial complaint, the DOL had argued that the major questions doctrine was inapplicable because “Congress expressly granted” the DOL the “wide authority to grant exemptions and to interpret the term ‘fiduciary’ in ERISA.”

The lawsuit is one of two filed to challenge the Retirement Security Rule. The Federation of Americans for Consumer Choice, an insurance industry group, filed a suit in U.S. District Court for the Eastern District of Texas on May 2. That case is also still pending.

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