SLC Management and its affiliated investment managers will offer their alternative investment strategies to the U.S. high net worth market.
Helping investors meet their current cash flow and future capital appreciation goals.
Unlimited access to our bond offerings and dedicated, personal support
Customized portfolios selected and managed by professional managers
Partnering with select institutional managers
Expert advice, ongoing trade support, and transparent pricing
An emphasis on solid investment disciplines and specific asset classes
March 04, 2024
January 29, 2024
TOP
Financial Industry Insights from Advisors Asset Management
On August 13, 2018
AAM Viewpoints – Municipal Pensions: Light at the End of the Tunnel or Just a Mirage?
There was excitement last month when multiple sources released data indicating that state pension plans for all 50 states and Washington, D.C. ended up better at the close of 2017 than they were a year prior. At the plan level, plans have an aggregate funded level of 68% for 2017, up from 65% the year prior. On a state level, 36 states have reported 2016 actuarial valuation results for all plans. Of those, 32 realized a year-over-year increase in asset sufficiency levels (a comparison of net plan position and total pension liability) from 2016 levels. Moody’s subsequently published a report concluding that adjusted net pension liabilities (ANPLs) fell by 5% in fiscal 2018, using a 56-plan representative sample. On top of this, many states are attempting reforms, such as Kentucky, Minnesota, Colorado, Oregon, and others. So, are states finally seeing the light and getting their respective pension funding acts in order? Not so fast. Although the recent funding improvement and some state actions are positive, strengthening levels of pension funding may be short-term and masking a greater risk in the mid-term.
Despite the aforementioned positive developments, government credit risk from pensions remain high. Unfunded liabilities stand near historical peaks despite nearly 10% compound average returns since the 2008-09 downturn, and costs are still rising to cover past losses. Further investment losses, if they materialize, will accelerate the ongoing transition of pension burdens to operating budgets from balance sheets.
According to Moody’s, U.S. public pension funds have now completed a 2nd consecutive year with investment performance above their assumed annual rates, which still average above 7%. Based on the rating agency’s 56-plan sample, which encompasses more than half the $4.2 trillion in total U.S. public pension assets reported by the Federal Reserve, Moody’s estimates that ANPLs fell by almost 5% in 2018, and that reported NPLs (net pension liabilities) fell by 2%.
The key issue here becomes apparent when one examines what is known as the “treading-water formula”: to what degree governments are contributing to their pensions as a percentage of what is required (contributions required to prevent reported NPLs from growing). At face level it looks like things are getting much better. On average, per Loop Capital, states contributed 133% of the treading-water rate for 2017. Only four states contributed less than 100%: Minnesota (96.5%), Missouri (74.5%), New Jersey (93.2%), and Wyoming (86.2%). However, it is important to note that the burden on the General Fund from pension contributions has remained relatively steady over the past five years at roughly 4% – the high treading-water ratio for the year is largely due to investment earnings, and not due to a significant increase in contributions. In 2016, when equity markets were not as robust, actual treading-water rates were 50.2%. Despite this positive development (investment returns), government credit risk from pensions remain high. Unfunded liabilities stand near historical peaks despite nearly 10% compound average returns since the 2008-09 downturn, and costs are still rising to cover past losses. Any additional investment losses or returns on investment that come in less than anticipated, will accelerate the ongoing transition of pension burdens to operating budgets from balance sheets.
Nine years into economic expansion, many state and local governments are still grappling with rising pension costs from accumulated unfunded liabilities in the past and widespread assumption revisions, such as lower investment return expectations. These costs will increase further if U.S. public pensions, which are heavily invested in volatile asset classes such as equities, suffer material investment losses. Moody’s projects that a 10% investment loss in fiscal 2019 would push ANPLs up by roughly 22% and increase tread-water costs by roughly 35% in fiscal 2020.
A handful of preliminary fiscal 2018 return rates already announced suggest that most U.S. public pension systems with June 30, 2018 fiscal year-ends will report annual returns around 9%. The California Public Employees' Retirement System (CalPERS) – the largest in the United States – has announced a preliminary 8.6% return. The second largest system, the California State Teachers' Retirement System, has announced preliminary returns of 9%. Other plans in Florida, Oklahoma, and Oregon exhibit similarly strong preliminary return rates. A composite of market indices that Moody’s has compiled to broadly resemble U.S. public pension asset allocations similarly increased by 8.6% for the year ended June 30, 2018. Equity returns have been the main driver behind recently strong U.S. public pension investment performance. The Russell 3000 index, an indicator for domestic equities, increased almost 15% from June 2017 to June 2018. The MSCI All Countries World Index (ACWI), excluding the United States, increased by 7.3% over the same period. Conversely, fixed income returns in 2018 were near zero.
Finally, Moody’s believes that even if investment return targets are met, ANPLs will still increase due to growing liabilities.
In Conclusion:
CRN: 2018-0803-6818 R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
topics
Be the first to read our latest posts.