Very few state and local public pension plans have earned bragging rights for their performance over the past year, and others have climbed deeper into the danger zone. Overall, state and local pension funds saw little improvement during the 2012 fiscal year, according to the Eleventh Annual Pension Review released this week by Loop Capital Markets. While a few states saw an improvement in the funded status of their pension funds, the weighted average for all states dropped two percentage points over the course of the year.
The Loop report examined 247 of the largest state pension plans and 77 local pension plans, using data provided by the Comprehensive Annual Financial Reports for the fiscal year ended June 30, 2012.
“Several factors appear to be contributing to the pressure on state and local public pension systems across the board,” said Christopher Mier, Managing Director of Loop Capital Markets’ Analytical Services Division. “The tepid economic recovery, slow (although consistent) growth in tax revenues, and reduction in federal support over recent years continue to keep state budgets under pressure, making progress in improving funded ratios difficult due to the limited ability of states to pay in full their actuarially accrued liabilities.
In the interview that follows, Mier sheds additional insight into the findings of this year’s Pension Review.
MuniNet: Why does the focus seem to be on the “problem children” of the pension world rather than on the majority of public pension systems that are managing to stay afloat, or even thrive, in this economic climate? Are more state and local systems headed in the direction of Illinois, Chicago, or even Detroit?
Mier: Public policy is rarely guided by the experience of the many; but rather it is typically guided by the extreme circumstances of the few. With several situations still unresolved and garnishing a lot of attention, policy is more likely to focus on those problems, considering them systemic, rather than the take the more nuanced view that recognizes that many states’ pension plans are adequately funded under the current economic circumstances. That said, it is unlikely that any state or local pension systems are headed down the same path as Detroit.
MuniNet: According to the report, Illinois is “at the top of the heap” when it comes to severe unresolved pension issues.” Are the state’s pension challenges surmountable?
Mier: While the State of Illinois – and the City of Chicago – are both facing significant pension challenges, they cannot be legitimately compared to the City of Detroit which is insolvent and in bankruptcy. Illinois is facing a very difficult pension problem that has been widely discussed. The market knows, however, that a comprehensive bill, not unlike those seen in other states that have accomplished reform, could in fact succeed in substantially resolving the pension problem in Illinois, if passed. That bill, of course, is the Madigan bill, which at the moment is gathering dust.
Public policy is rarely guided by the experience of the many; but rather it is typically guided by the extreme circumstances of the few.
MuniNet: Just across the border, Wisconsin’s public pension system appears to be faring quite well. What is the state doing right … and what can other states learn from its example?
Mier: Wisconsin is the only state with a 100% funded ratio. (The District of Columbia also has a 100% funded ratio, but it is not a state.) However, the distinction between a state with a 100% funded ratio and those that are 90% funded is less significant than one might assume, simply because these funded levels do change over time and both of these funding levels-100% and 90% – represent more than adequate funding of pension liabilities. Furthermore, being too well funded can be a problem, too. Since pension obligations span generations, being “over-funded” today means that taxpayers are paying more now so that other taxpayers can pay less in the future. While some may argue that 100% funding is not a level that is “over-funded”, the rule-of-thumb funding criteria of 80% that has been in use by actuaries operating in the public pension arena for many years suggest that 100% might actually be too high!
MuniNet: What conclusions/observations can you draw by looking at the five states that increased their respective funding ratios between 2011 and 2012?
Mier: The improvement in four of the five states on a weighted average basis was less than 2%. That is meager improvement. Also, of those four states that had less than a 2% increase on a weighted average basis, only one state – Tennessee – would be considered well-funded (above the 80% rule-of-thumb level previously mentioned). West Virginia, the fifth state with year-over-year improvement in the weighted average funded ratio, 5.50%, is definitely positive, but is attributable to investment returns and the increase in the annual required contribution to the Teachers and Public Employee Retirement funds. West Virginia is still considered underfunded (67%) and will need to take additional measures to ensure long-term solvency.
… these problems were not created in a day, nor will they be resolved in a day.
MuniNet: According to the report, pension reforms have been enacted in 40 states over the past three years – and yet, no substantial cost savings have yet been evident. What needs to happen before we can expect to see change in condition of pension systems … and over what time horizon?
Mier: While more than 40 states have taken reform measures, most of the measures are directed at realizing savings from new employees. Those savings will not build for years until the proportion of employees under the new plan starts to represent a very large proportion of the total employees covered by the entire system. In the meantime, many of the reform measures involve upfront costs that actually make the situation temporarily worse until the savings begin to trickle in. People need to remember that these problems were not created in a day, nor will they be resolved in a day.
MuniNet: What about cities? How was their performance over the past year?
Mier: The 77 local plans covered in this year’s review fared slightly better than the state plans. It should be noted, however, that these 77 plans are a small subset of the total number of local plans across the country, culled from 20 large cities and therefore, not a statistically valid sample of all local pension plans. While state plans continue to garnish considerable concern from taxpayers, municipal professionals, and policy analysts, local plans have drawn increasing scrutiny given the smaller tax base and limited financial flexibility available to fund them.
MuniNet: When are the new GAAP pension accounting reforms going into effect? How might these changes contribute to greater confusion in comparing one system to the next?
Mier: The phase in period for Statement No. 67 is June of 2013, and for Statement No. 68 is June of 2014. The largest areas of confusion will be with elimination of the smoothing period and use of a blended discount rate. Without use of the smoothing period it will be more difficult to decipher whether changes in a plans funded ratio is due to market volatility, change in demographics, or actual structural changes to the plan itself. The other issue is with the use of the blended discount rate.
Broadly speaking, what GASB does, which can be very problematic for the analyst, is that it makes a plan incomparable to itself over time and it also makes a plan incomparable to other plans at a point in time. Thus, a statistician cannot do time-series analysis, nor can they do cross-sectional analysis. Using both of these approaches at the same time (referred to as “panel data” analysis) is the primary activity of social scientists. Thus GASB has made the study of pension liabilities more difficult for the people who we rely on to help us better understand these important problems.
For a complete copy of the Loop Capital Markets Eleventh Annual Pension Review, please contact Ivan at email@example.com.