(November 15, 2013) — A third of large US public defined benefit (DB) plans have altered their liability funding assumptions to a more conservative rate, reflecting their pessimism and recent market returns.
The Milliman 2013 Public Pension Funding Study found that out of the 100 large plans surveyed, 29 said they lowered their actuarial interest rate assumptions, with the median rate decreasing to 7.75% from 8% last year. The actuarial firm’s own calculations revealed a similar decrease—to 7.47% from 7.65% in 2012.
“Most plans are setting their interest rate assumptions in a realistic manner consistent with long-term market return market return expectations,” the report said.
These changes reflected a “declining market consensus” and a downward slide in long-term investment returns, according to the report: Equity and fixed-income expected returns have both fallen by around 200 basis points since 2000.
Milliman said pension plans could reduce their liability funding assumptions in two ways: a dramatic single cut to the actuarial interest rate or through a series of gradual changes.
The consequences of lowering these is an increase in liabilities and cut in funded ratio, the report found. According to Milliman’s calculations, these plans were on average 70.6% funded and had accrued liabilities of $3.77 trillion on aggregate—an amount that is unlikely to be covered by plans’ current assets.
“In aggregate, the plans currently have assets sufficient to cover 100% of the reported accrued liability for retirees and inactive members, but only 27% of the assets needed to cover the reported accrued liability for active plan members,” the report said.
For each 100 basis point decrease in actuarial interest rate, the liabilities of a pension fund could increase by up to 15%, the study found, impacting a younger plan with more active members more than a mature plan.
The report also found market volatility is still a concern for most pension plans: “While market indices have generally returned to pre-financial crisis levels, many pension plans have not fully recovered from the effects of the market meltdown.”
The median asset volatility ratio for the surveyed plans was 3.9. However, Milliman found 18 of the plans recorded a ratio of 5.5 or higher—a sign that those plans’ greater susceptibility to market instability.
Related content: Testing Public Pensions’ Sensitivity to Investment Returns, US Pension Plans’ Route to the Glide Path Endgame, Illinois Pension Plan Blames Low State Contributions for Serious Underfunding, Better Risk Management Required to Sustain DB Plans