Monday, March 7, 2011

Battered Public Pensions Doing Better?

Jeanette Neumann of the WSJ reports, Battered Public Pensions Do Better:

A rebounding stock market helped buoy state pension plans' assets in 2010. But the plans still have a long way to go to bridge a funding gap caused in large part by losses suffered during the financial crisis, according to a report expected to be released Monday.

Any upswing is good news for state pension plans, typically funded by contributions from public employers and workers and investment returns on assets held in the plans.

State pension systems had an estimated funding ratio of 69% for fiscal year 2010, ending June 30, up from 65% for fiscal year 2009, according to Wilshire Associates, a Santa Monica, Calif.-based investment-consulting firm. But pension plans remain well below the 95% estimated average funding ratio for 2007.

The ratio means that 126 state pension systems surveyed by Wilshire on average have 69% of the assets on hand compared to projections of what they will owe in pension payments to government workers over the long term. That figure is based on the market value of the assets.

"The trajectory is up, albeit it's up off a pretty low base," says Steven Foresti, managing director at Wilshire and an author of the report.

The so-called actuarial estimate, which most plans use and which spreads out investment gains and losses over longer periods, leads to a projection of 77% for 2010. That's down from 79% a year earlier and 87% in 2007.

For most of the pension plans, figures reflect funding through June. Since then, robust market returns have likely bolstered pension plans' assets, Mr. Foresti said.

Over the next decade, Wilshire projects public pension plans will have a median annual return on their assets of 6.5%. The pension plans included in the study have projected a median actuarial return of 8% over several decades, Wilshire says.

Public pension plans' asset allocation has shifted over the past decade, according to Wilshire.

In 2010, funds had 31.1% of their assets in U.S. stocks, down from 45% in 2000, while foreign equities have increased to 17.5% from 13% over the same time frame. Investments in so-called "alternative" assets classes, such as real estate, private equity, commodities and hedge funds have also increased.

Public pension funds' health has received heightened attention in recent months amid increased stress on states' finances and questions by some over the size of retiree pensions. Representatives of government workers have said gaps are due at least in part to employers' failures to make required contributions.

The Wilshire report comes as other data also point to signs of improvement in state and local finances.

State tax collections, for instance, increased 6.9% across 41 states that have reported their fourth-quarter revenue, the fastest rate in nearly five years, according to a February report by the Nelson A. Rockefeller Institute of Government at the State University of New York.

Federal Reserve Chairman Ben Bernanke in a speech in New York last week said that if the economy continues to strengthen "states and localities may start to get a little breathing space," as tax collections rise with income and spending and the demand for support programs such as Medicaid, a federal-state partnership to provide health coverage for the poorest Americans, diminishes. But Mr. Bernanke and others also say that state and local governments face a tough slog ahead.

Wishire recently reported that the Master Trusts rose nearly 6% in the fourth quarter, resulting in a median return of over 12% for calendar year 2010:

For the second year in a row, master trusts had a stellar year returning 12.72 percent in 2010 following an 18.29 percent return in 2009, as measured by the median Wilshire Trust Universe Comparison Service® (Wilshire TUCS ®), a cooperative effort between Wilshire Analytics, the investment technology unit of Wilshire Associates, and custodial organizations. Wilshire TUCS, the most widely accepted benchmark for the performance of institutional assets, includes approximately 900 plans representing $2.8 trillion in assets.

The Public, Taft-Hartley Defined Benefit and Endowment and Foundation plans were all top performers posting median returns in a tight range of 6.0, 5.98, and 5.95 percent, respectively, in the fourth quarter. For the year, it was the corporate Defined Benefit plans that came out on top with a median return of 13.19 percent while Public (12.94%), Taft-Hartley Defined Benefit (12.61%), and Endowments and Foundations (12.50%) all trailed behind.

The large plans are once again outperforming the smaller plans as demonstrated by the median Master Trust over One Billion return of 5.86 percent for the quarter and 13.11 percent for the year, while the Master Trusts less than One Billion returned 5.78 and 12.39 percent, respectively. Within the large plans, it was the Taft Hartley Defined Benefit plans that outperformed all others with 5.68 percent for the quarter and 13.71 percent for the year. This can be somewhat explained by their large exposure to equities at 63 percent, as represented by the median allocation to US and International Equity combined.

Drilling down to the asset class level, equity portfolios showed a large spread in median returns for both the fourth quarter and the year ending December 2010 with a strong size effect resulting in small cap significantly outperforming the mid and large cap styles. There was also a large style effect, according to the Wilshire TUCS medians, with growth managers dominating value managers in all capitalization ranges for both the quarter and the year. “Looking at the Small Cap Growth median returns of 16.78 and 28.42 percent for the quarter and the year, as compared with Large Cap Value portfolios which returned 10.28 and 14.69 percent for the same period, really illustrates these points”, said Hilarie C. Green, CFA, Managing Director, Wilshire Analytics.

Turning to the fixed income managers, the High Yield managers (3.09%) easily beat the other strategies with the Long Duration managers delivering the weakest performance (-4.39%) as the yield curve adjusted upwards during the quarter. On the other hand, for calendar year 2010, the Long Term duration managers outperformed all others (11.76%), except the High Yield managers which returned a median of 14.47 percent.

Strong returns in stocks and bonds bode well for public pension assets. The problem is that interest rates remain near historic low levels, so even if the funding gap is shrinking a little, it's still high and won't get better anytime soon. You would need a sharp rise in rates and continued strength in the stock market to see those funding deficits shrink substantially.

In her article, Lisa Lambert of Reuters notes the following:

Public pensions have recently sparked heated debates, from the halls of the U.S. Congress, where lawmakers have suggested allowing states to go bankrupt to undo pension promises, to the streets of Wisconsin's capital, where thousands of demonstrators are pitched in a battle over public employees' rights.

Stock market declines drove down the value of many retirement systems' funds recently, and many states pulled back on putting money into the funds as they faced their worst budget crises in decades.

The retirement systems have been caught short in paying for future retirees. Estimates of the shortfalls range from $800 billion to $3 trillion, depending on how much the systems' investments are expected to appreciate.

All this to say that US public pension funds are doing better but are by no means out of the woods. If you want to know what the future might have in store for many public sector workers, have a look at what is going on in the UK where a review by former Labour Cabinet minister Lord Hutton is expected to recommend an end to "gold-plated" final salary schemes. He is set to say that workers should instead receive payouts linked to average salary over their careers.

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