Milliman 2014 Public Pension Funding StudyCategories: National Developments
Milliman Press Release, November 11, 2014
The Milliman Public Pension Funding Study annually explores the funded status of the 100 largest U.S. public pension plans. We collect key sponsor-reported information about each plan’s assets, accrued liabilities, investment return assumptions, and asset allocations. We then determine an independent investment return assumption for each plan based on its unique asset allocation and Milliman’s current capital market assumptions. That independently determined investment return assumption is used to recalibrate each plan’s accrued liability. This process enables an independent assessment of plans’ investment return assumptions relative to the reported returns that sponsors expect to earn on their investments. This study employs a version of the budgeting methodology used by sponsors to fund their plans over a long time horizon as a going concern. This differs from near-term settlement calculation methodologies, often referred to as “risk-free rate” methods, that have been used in some academic studies of the health of public pension plans.
Funded ratios using the market value of assets increased modestly in the Milliman 2014 Public Pension Funding Study relative to the 2013 study, largely reflecting strong asset growth. This study generally is based on valuation information from July 1, 2013, or later. The 12-month period from July 2012 to July 2013 saw very strong investment results for most pension plans, with market rates of return well into the upper teens.
The larger plans in the study tend to be better funded than the smaller plans in the study. The best funded plans, those in the top quartile of plans as measured by the sponsor-reported funded ratio, account for 34% of the aggregate sponsor-reported accrued liabilities, whereas the worst funded plans, those in the bottom quartile, account for only 18% of the aggregate sponsor-reported accrued liabilities.
This year’s study found that the gap between the recalibrated accrued liability and the sponsor-reported accrued liability widened, from 2.6% in the Milliman 2013 Public Pension Funding Study to 3.8% in 2014. This widening gap in liability mirrors a corresponding widening between the investment return assumptions reported by the plans in the study relative to our independently determined investment return assumptions. While 13 of the 100 plans in the study have lowered their reported investment return assumptions since the Milliman 2013 Public Pension Funding Study, most plans in the study have left their investment return assumptions unchanged. The median investment return assumption reported by the plans decreased from 8.00% in the 2012 study to 7.75% in the 2013 study, and it remains at 7.75% in the 2014 study. Meanwhile, Milliman sees market consensus views on long-term future investment returns continuing to decline. Reflecting this trend, our study’s median independently determined investment return assumption decreased from 7.65% in the 2012 study to 7.47% in the 2013 study and to 7.34% in the 2014 study. In aggregate, this suggests that for many plans that have not recently lowered their reported assumptions, some decrease in the investment return assumption may be appropriate. Plans should continue to monitor emerging market return expectations and adjust their assumptions as needed, to ensure that liabilities are calculated using assumptions that are based on best estimate expectations from investment professionals. Note that lower investment return assumptions cause accrued liabilities to increase and therefore cause funded ratios to fall.
Plans report on the size of their assets in two ways: market value, which is well understood; and actuarial value, which reflects asset-smoothing techniques that are used to dampen year-to-year contribution fluctuations. While there are a multitude of asset smoothing techniques in use, generally speaking they offset investment gains/losses from a particular year with investment gains/losses from a nearby year. This process means that actuarial values tend to lag changes in the market and can deviate from market value substantially when there are large market movements. The 100 plans in this study reported assets totaling $2.75 trillion on a market value basis and $2.80 trillion on an actuarial value basis. By comparison, reported assets in the Milliman 2013 Public Pension Funding Study stood at $2.58 trillion on a market value basis and $2.73 trillion on an actuarial value basis. For most plans, the large market losses suffered during the financial crisis resulted in actuarial values that temporarily were far higher than market values for several years after the crisis; the generally favorable market returns since 2009 have allowed market values to gradually catch up to, and in some cases exceed, actuarial values.