The True Burden of Unfunded Liabilities

The deficit of US cities’ pension funds ranges between under $1000 and $18,000 per resident, according to Morningstar.

(January 22, 2014) — The median unfunded actuarial accrued liability (UAAL) per capita reached $3,550 for the 26 most populous cities in the US, according to Morningstar.

The research found by analyzing unfunded pension liabilities on an aggregate basis could result in a better understanding of the burden on each taxpayer.

“We think the aggregate pension burden is important and individual city and state pension data should not be examined in a vacuum,” the report stated.

One significant change in Morningstar’s actuarial calculations was taking the pension liability of overlapping districts into consideration.

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“By including overlapping jurisdictions, we gain a firmer grasp of the feasibility for governments to collect this amount of revenue over a period of time from residents,” said Rachel Barkley, municipal credit analyst and author of the report. The result not only saw an increased in UAAL per capita but also led to a grasp of the “true magnitude of the burden” on the residents.

Of the analyzed 26 cities, Washington DC was the strongest, with an overfunded plan with a funded ratio of 104.9%. Instead of a deficit, DC’s residents are owed $409 per capita.

On the other hand, Chicago recorded the highest aggregate per capita at $18,000, or five times the median. The city’s pension plan struggled for years with high unfunded liability of $19.4 billion, and must also deal with the Illinois state pension liability of $94.6 billion.

Morningstar reported that Chicago’s residents face multiple overlapping jurisdictions, further hiking up the UAAL per capita.

New York City follows Chicago with a similarly high unfunded liability, with its UAAL per capita at $9,482. The report stated that despite the New York state’s well-funded pension, per capita liability saw an increase in 2013.

“Although the combined unfunded liability of $9,482 per capita is still quite high, it lies well below that of Chicago primarily because of the well-funded state plan,” the report said.

Changes in actuarial assumptions also contributed to the higher numbers of UAAL per capita, the study found. Assumed interest rate decreased in 2012 from 8% to 7%, and the actuarial cost method had adjusted from a frozen initial liability to the entry age method.

“With the implementation of the new Governmental Accounting Standards Board (GASB) legislation on pensions in the coming years, only the entry age normal method will be allowed if entities wish to comply with GASB standards,” the Barkley said.

Municipal bankruptcies could also play a role in identifying aggregate pension liability, the report stated. As seen in the bankruptcies in Detroit and San Bernardino, the biggest question is whether the city’s pension benefits could be lost in the bankruptcy or if the state constitution could provide protection.

“[These] bankruptcies have potentially far-reaching implications on how pension liabilities and state protection of benefits are viewed in bankruptcy proceedings,” Barkley said.

Related content: Accountable Accounting

Which Equities Helped UK Charities and Pension Funds?

State Street data has revealed the driving force behind 2013’s double-digit returns for the institutions.

(January 23, 2014) — UK equities, small caps, and medium-sized listed companies led the way for pension funds and charities to record double digit returns in 2013.

Data from State Street, which compiled information from 200 pension funds with a combined asset value of £500 billion and 240 charities holding £9 billion in assets, showed a strong year for risk assets led to a 11% average return for pension funds and a 15% average return for charities.

Equity markets hit near record highs in May, before progress was briefly halted by a slowdown in the Chinese economy and talk of unwinding of the US Fed’s asset buying programme. The third and fourth quarter equity returns were strong again, however.

The data also found that UK equities, strategically important and the largest single component of the majority of UK institutional funds, gained 22% over the year. In addition, small and mid-cap issues outperformed the mega-cap stocks.

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But it was North American equities which led the pack, returning 30% for the year. By comparison, emerging markets lagged significantly, returning just 1% on aggregate.

“This latest year of positive results brings the five year performance for pension funds to around 10% per annum and the 10-year to 8% per annum, comfortably exceeding most actuaries’ assumptions for asset growth,” said Jeanette Patrizio, senior vice president of State Street Investment Analytics.

Despite the strong returns, pension funds and charities continued to sell off equities and buy bonds at a macro level.

State Street noted this was likely to be because the institutions sought to preserve allocations in line with asset strategies, as opposed to actively de-risking.

Exposure to alternative assets remained broadly static at around 10% of the average pension fund but the mix has begun to change with infrastructure and diversified growth products gaining traction.

Related Content: Which Investment Calls Came Good Last Year? and 2014: A Good Year for Illiquid Credit?  

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