Thursday, February 28, 2008

Public Pensions - What Crunch



Municipal pension plans are under pressure as noted in a recent WSJ article Dear Crunch, Wish You Werent Here.

"With interest rates low, stock markets uncertain in the credit crunch and real-estate prices falling, government pension funds are facing a brutal investment climate. As a result, some state and local governments are feeling the heat."

While the dynamic and temporal nature of politics and the disciplines required for sucessful long term pension funding may not always integrate well, the current public pension plan funding situation may not be be as dire as portrayed by funding statistics. The National Association of State Retirement Administrators publishes an annual compendium of public pension plan data that covers 85% of the assets and participants in state and local goverment pensions in the US.

The most recent Survey Summary indicates that funding ratios have declined from over 100% in fy 2001 to 86% in fy 2006. Funding ratio's are usually stated as the ratio of an actuarial value of plan assets over plan liabilities. Actuaries commonly use 'smoothing' or 'averaging' methodologies for public pension plans to calculate an actuarial value of assets, which is intended to make this value less volatile than the market value of assets. Averaging or smoothing is generally designed solely to reduce contribution volatility and improve funding predictability.

The characteristic of a smoothed actuarial asset value for a plan with substantial equity is that it is higher than the comparable market value through bear markets and lower through bull markets. Looking at the pattern of capital market returns over the past 5 years, smoothed actuarial asset values may continue to rise as they phase out the substantial market losses of 2000-2002 and phase in the strong investment gains from 2003.

An exhibit, reproduced above from the study, compares the actuarial asset valuations to market valuations of plans included in the study. The significant number of public plans with excess market value over actuarial value indicates that, all other things being equal, public plans may already have some funding level improvements "in the bank".

Finding the balance between current fiscal needs and funding long term commitments across taxpayer generations remains a distinct challenge for public pension plans. The nature of politics, human behavior and the capital markets virtually guarantee that not all plans will meet the challenge. This should not imply that most wont.

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