‘Risk addicted’ pension systems?

Public pensions are taking on more high-risk, high-reward investments.

Photo by Ben Hershey on Unsplash

Happy weekend, readers! After two snowstorms this week, my shoveling muscles are sore, our kid has barely had school this week, and my chicken (the lone survivor of a fox attack this fall) hasn’t set foot outside the coop in days. But gosh, it sure looks pretty.

On to the topic this week, which is about public pensions and the fact that they’re doing pretty darn well these days. But (yes, there’s always a “but”) because of the way investment strategies have changed since the 2007 stock market crash, many of them are more volatile and slightly more secretive than they were two decades ago.

Lookin’ good, pensions

A new release from the pension-focused think tank Equable updates their previous report on pension funding levels back in July. The numbers are even better than previously predicted. 

• The national funded ratio average for state and local pension plans is projected to increase from 74.9% in 2022 to 78.1% in 2023.

• The total pension funding shortfall will decline slightly to $1.44 trillion in 2023, compared to $1.6 trillion in 2022.

• The average investment return for 2023 is 7.47%, overperforming the average 6.9% assumed rate of return.

The report, however, is full of warnings about pensions’ fiscal risks, which I’ll get to in a minute. Before I do, it’s important to put this source in context: Equable is very focused on the risk its leadership believes public pensions are taking on with their investment strategies. The institute is NOT anti-pension, as some would argue, but it does tend to be more conservative in its fiscal management approach than other pro-pension organizations.

For example, the latest report says the 78% funded ratio is “a continuation of the fragile funded status that has persisted for more than a decade and a half after the financial crisis.”

Here’s another way to look at it: 78% is the best average funded ratio pensions have had in 15 years. And the last time it was at this mark, assets were on a downward trend. Now, they’re trending upward.

So, context matters. It’s also worth mentioning that Equable uses a more “real-time” valuation of public pension assets compared with what plans report each year for actuarial funding purposes. The long-term outlook is the same but pension plans “smooth” their asset values, gradually bumping them down or up so that governments aren’t stuck with unpredictable pension bills from one year to the next. These two charts illustrate how the reported valuations from pensions resemble a trend line version of the real time numbers used by Equable.

Sources: Equable Institute, Boston College Center for Retirement Research

Now let’s get into the risks that pension plans are taking on, because the report makes some very good points about that.

Addicted to risk