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Here is a look at the states with the best-funded ratios under the risk-free rate recommended by ALEC, and a comparison to Pew's numbers on funded ratios and assumed rates of return. (Photo: Getty)[/caption] How trustees of state-sponsored pension plans value the cost of future liabilities, and in turn determine funded ratios, is a touchy subject among retirement policy experts and lawmakers. Pew Charitable Trusts' annual report on state pensions, released last April, showed $1.1 trillion in unfunded liabilities in 2015. The aggregate funding level for plans across the country was 72 percent. Pew ranked state pensions based on the assumed rates of investment returns — or discount rates — that state trustees apply to pensions. The average assumed rate of return was 7.6 percent. Pew found eight states have funded ratios above 90 percent; 21 states were funded below 70 percent; and four were funded under 50 percent. How much pensions expect to earn from assets has tremendous implications for the annual contributions made by taxpayers to pensions. Higher expected rates of return, of course, lower the cost of future liabilities, and lower annual contributions required to maintain solvency. Some in the policy and actuary world claim states are applying generous return expectations. Count the American Legislative Exchange Council (ALEC) among that group. The non-profit advocacy's membership is comprised of mostly conservative state lawmakers and corporations. "The public sector's current assumed rates of return significantly distort how much money is needed to fund the plans today to guarantee and eventually pay out future benefits," ALEC said in its recently published pension report. "Ultimately, this will result in broken promises to state employees and financial hardship for taxpayers." ALEC applies a risk-free discount rate of 2.14 percent to pensions, drawn from a blend of recent yields on 10 and 20-year Treasury bonds. Under the risk-free assumption, ALEC found that more than 280 state-sponsored pensions have an average funded ratio of 33.7 percent, amounting to $6 trillion in total unfunded liabilities. If ALEC had its way, only one state—Wisconsin—could claim a funded ratio above 50 percent. But is a pure risk-free discount rate a reasonable measurement to apply to public pension plans? In the private sector, sponsors of single employer pension plans apply a discount rate set by Congress, based off the 25-year average return on high quality corporate bonds. That sliding scale puts corporate discount rates generally between 4 percent and 6 percent. An inquiry to ALEC as to the practicality of applying a risk-free rate of return was not returned before press time. In 2014, the Society of Actuaries released a report recommending that assumed rates of returns should be "more heavily based on current risk-free rates." But the report also said assumed returns shouldn't be "aggressively conservative." While some states are taking measures to recalculate their investment assumptions, most are relying on the status quo. Here is a look at the states with the best-funded ratios under the risk-free rate recommended by ALEC, and a comparison to Pew's numbers on funded ratios and assumed rates of return:
Here is a look at the states with the best-funded ratios under the risk-free rate recommended by ALEC, and a comparison to Pew's numbers on funded ratios and assumed rates of return. (Photo: Getty)[/caption] How trustees of state-sponsored pension plans value the cost of future liabilities, and in turn determine funded ratios, is a touchy subject among retirement policy experts and lawmakers. Pew Charitable Trusts' annual report on state pensions, released last April, showed $1.1 trillion in unfunded liabilities in 2015. The aggregate funding level for plans across the country was 72 percent. Pew ranked state pensions based on the assumed rates of investment returns — or discount rates — that state trustees apply to pensions. The average assumed rate of return was 7.6 percent. Pew found eight states have funded ratios above 90 percent; 21 states were funded below 70 percent; and four were funded under 50 percent. How much pensions expect to earn from assets has tremendous implications for the annual contributions made by taxpayers to pensions. Higher expected rates of return, of course, lower the cost of future liabilities, and lower annual contributions required to maintain solvency. Some in the policy and actuary world claim states are applying generous return expectations. Count the American Legislative Exchange Council (ALEC) among that group. The non-profit advocacy's membership is comprised of mostly conservative state lawmakers and corporations. "The public sector's current assumed rates of return significantly distort how much money is needed to fund the plans today to guarantee and eventually pay out future benefits," ALEC said in its recently published pension report. "Ultimately, this will result in broken promises to state employees and financial hardship for taxpayers." ALEC applies a risk-free discount rate of 2.14 percent to pensions, drawn from a blend of recent yields on 10 and 20-year Treasury bonds. Under the risk-free assumption, ALEC found that more than 280 state-sponsored pensions have an average funded ratio of 33.7 percent, amounting to $6 trillion in total unfunded liabilities. If ALEC had its way, only one state—Wisconsin—could claim a funded ratio above 50 percent. But is a pure risk-free discount rate a reasonable measurement to apply to public pension plans? In the private sector, sponsors of single employer pension plans apply a discount rate set by Congress, based off the 25-year average return on high quality corporate bonds. That sliding scale puts corporate discount rates generally between 4 percent and 6 percent. An inquiry to ALEC as to the practicality of applying a risk-free rate of return was not returned before press time. In 2014, the Society of Actuaries released a report recommending that assumed rates of returns should be "more heavily based on current risk-free rates." But the report also said assumed returns shouldn't be "aggressively conservative." While some states are taking measures to recalculate their investment assumptions, most are relying on the status quo. Here is a look at the states with the best-funded ratios under the risk-free rate recommended by ALEC, and a comparison to Pew's numbers on funded ratios and assumed rates of return:
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
