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State pension funds are an integral part of retirement security for teachers, police officers, firefighters and other public employees. Unfortunately, their pre-paid trust funds may be vulnerable to market fluctuations like the recent collapse of b crypto currencies.
States should take simple, common-sense measures to restore their pension programs to full financial health. This may involve increasing contributions from governments and employees into pension funds, while cutting benefits as necessary to cover the cost of restoring them back to full funding.
Following the collapse of a global equity market, state pension funds in America's top 100 publicly traded companies are expected to lose an incredible $136.8 MILLION by 2022 - equivalent to almost one-quarter of their assets. This loss is caused by stocks holding these plans' investments declining more than 20% since January and declining benchmark corporate bond interest rates used for valuation, according to Milliman Investments.
These results demonstrate that, despite a marked decrease in their funded ratio from last year's stellar returns, pension systems remain vulnerable to financial shocks and an impending recession. States must ensure they maintain fiscal discipline to reduce the risk of rising liabilities, as well as implement policies which minimize future volatility on these plans' investments.
Up until recently, public pension plans' funded ratios had been in the mid-70s. However, those levels have now fallen below half their 1983 values.
This is due to several factors, including the fact that state governments running these funds have taken on increasing debt to finance their plans. Furthermore, pension funds have recently shifted their investments away from safer assets.
State pension plans on average have a funded ratio of 47.5%, just below the national average of 57.2% - suggesting many are underfunded and have yet to make significant progress toward full funding.
Comparatively, the best funded state plans in America--Wisconsin, Washington and South Dakota--are more than double the national average at 80.2% due to taking on twice as much debt as average states have.
State pension systems have made progress recently, yet these developments also highlight the ongoing struggles public retirement systems still face as they strive to fulfill their promises to employees and taxpayers. Furthermore, public pension systems are more vulnerable than ever before to economic or political fluctuations which may negatively affect their finances.
The funded ratio, or the amount of money in pension funds compared to what is promised to retirees, has seen a remarkable improvement since 1999, rising from around 73%. This improvement can be attributed in part to states' success in increasing contributions towards their pension systems.
State and local public pensions were first established in the early 20th century, and for many decades their investment portfolios appeared secure. But as interest rates rose throughout the 1980s and '90s, so too did investment return assumptions - leading to increasingly riskier portfolios for public-pension plans over time.
Plans are now using a wider range of investments than they did previously, which in turn increases risk. For instance, pensions have tripled their portfolio shares in alternative investments like private equity and hedge funds since 2001 - increasing expected returns by three or four times; however, this also comes at the cost of greater potential losses should those returns not materialize as expected.
States that want to improve their funding performance must make more of the right kinds of investments. To do this, they must be mindful of both the risks and rewards associated with various investment strategies - especially those designed to weather economic downturns.
Some states, such as New Jersey and Illinois, have implemented strategies that increase contributions and reduce pension debt while still fulfilling benefit promises. Furthermore, some have taken measures to mitigate costs during times of economic downturns.
Finally, the most effective way to enhance a pension fund's funding performance is by selecting an approach tailored to each particular circumstance. This involves analyzing different investment strategies, weighing the advantages and drawbacks of various asset classes, and identifying cost-effective ways of meeting retirement benefits for workers and retirees alike.
States that make full contributions to public pension funds in order to meet future obligations will keep costs from spiraling out of control. On the contrary, skipping payments or delaying them for short-term budgetary reasons may add substantially to future pension costs, particularly when states enact benefit changes that create additional liabilities.
A state's funded ratio is a measure of how much it has saved for the future by investing and earning interest on assets in its pension plan. When these assets exceed what employees owe in future pension benefits, then the plan is fully funded with no unfunded liabilities.
This ratio, based on an assumption of a "riskless rate," is often used to calculate how much states and localities must contribute annually toward their pension obligations. It also serves as a benchmark for future contributions necessary to restore underfunded plans to full funding levels.
State and local pension plans typically rely on various assumptions when calculating how much funding they need in the years ahead, as well as other factors that might impact funding requirements. For instance, many use "asset smoothing" to smooth out stock market fluctuations; if a plan's assumed annual returns fall below the average returns from five years of smoothing periods, then contributions must be increased accordingly.
Essentially, over the next five years, it must deposit one-fifth of its annual contribution needs in the first year, two-fifths in the second, and so forth. By making these payments annually, however, the state will have saved enough to cover its future obligations without needing to add the full $3 trillion that the riskless rate assumes.
State and local governments are currently striving to increase their funded ratios by raising employee contributions or decreasing benefits for new hires. Furthermore, they have implemented other strategies designed to reduce reliance on taxpayers for pension funding.
These strategies are all sound, but can be challenging to implement due to the reliance on an assumption about a riskless rate that may not always be accurate and is subject to market volatility. Therefore, states and localities should take precautions in making necessary adjustments in their methods for calculating future costs and necessary contributions.
State workers and retirees rely on the earnings generated by trillions of dollars in public assets to meet their retirement promises. To ensure these resources can meet these obligations, investment strategies that properly balance risk, returns, and costs must be employed.
These investments typically consist of publicly traded stocks, also known as equities, and alternative vehicles like private equity, real estate, and hedge funds. Unfortunately, these investments can be subject to market volatility and the loss of value in these investments can have a negative effect on plan assets.
Over the past decade, public pension systems have experienced increasing volatility. This is partly due to their rapidly increasing liabilities and a shift in investment returns away from fixed-income securities such as government bonds.
Many pension funds have been forced to increase their debt in recent years to meet payout obligations. As a result, they are borrowing larger sums to invest in increasingly risky assets.
According to a report by the Federal Reserve, many pension funds are investing in risky asset classes such as private equity. These investments usually carry higher fees than other investment options and must be carefully evaluated for transparency regarding fees and reporting practices.
Despite this large allocation to risky assets, stock market returns have been relatively low this century. According to the Congressional Budget Office (CBO), prices may decline further in coming years as interest rates reach historic lows and economic forecasts indicate lower expected returns from fixed-income investments.
State pension funds may be forced to adjust their investment return assumptions or borrow additional amounts in order to fund payments. Doing so puts them at greater risk of not meeting retirement benefits, potentially damaging their reported funding levels.
For these reasons, access to accurate data and comprehensive reporting is necessary for effective management of retirement assets that guarantee benefits to workers and retirees. This includes knowledge on how plans manage their investment portfolios, how much they pay in fees, as well as the performance of these investments.