US Public Pension Shortfall Triples in Under a Decade

Funding gaps in the 25 largest US public pension sector tripled in the eight years to the end of 2012 with unfunded liabilities hitting $2 trillion, rating agency Moody’s has claimed.

In a research note, the firm claimed a focus on investment rather than contributions had left the sector in disarray.

“Employer and employee contributions are the bedrock of any defined benefit pension plan because they establish the base of assets that investments should then help expand,” said Al Medioli, a senior credit officer at Moody’s. “However, the Governmental Accounting Standards Board (GASB) pension accounting and disclosure regime emphasizes investment returns over annual contributions; the resulting funding disincentive is at the core of the public sector pension asset-liability gap.”

Moody’s claimed that even though many of the funds managed to attain their investment targets, these figures were used to calculate discount rates, which in turn pushed up liabilities.

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The average annual return in this sector over the period was 7.45%, Moody’s said, but this had not been enough to counteract losses made in the financial crisis and chronic lack of contributions.

“What went wrong that state and local governments could neither grow their plan funding nor prevent its decline?” Medioli asked in the note. “Part of the answer is the simple deferral of contributions for budgetary reasons, but the back-loading of costs through asset smoothing and 30-year amortization allowed by GASB suppresses near-term contribution increases, in many cases causing Unfunded Actuarial Accrued Liabilities to rise for years by design.”

Medioli said state and municipal governments had been permitted to use liberal return assumptions and pay less than the annual required contribution to their pension funds.

Last year, the executive director of the Teachers’ Retirement System (TRS) of the State of Illinois Dick Ingram said inadequate employer contributions had pulled the fund further into deficit. In November, the system was 40.6% funded.

“It’s important to note that the TRS 30-year rate-of-return at the end of fiscal year 2013 was 9% per year on average,” Ingram said. “Our assumed return rate of 8% also is a 30-year expectation. TRS investments over time are more than right on target.”

The problem, Ingram said, was that the contribution from the state that is required by the law was far short of the amount required to ensure long-term sustainability.

“Without changes to the pension code to ensure sustained and adequate funding, TRS faces the very real possibility that in a few decades the system will not have enough money to pay benefits to retirees,” Ingram warned.

On a more positive note, Moody’s Medioli said that strong investment returns, combined with benefit reforms and moderating wages, were beginning to ease the rate of liability growth this year—but added there was still a long way to go.

Hedge fund assets have grown by more than a quarter since the collapse of Lehman Brothers in September 2008, according to Preqin—and fewer are sticking to old fee models.

The data provider has published a factsheet illustrating changes to the hedge fund sector since the point that it argued was “the very height of the global financial crisis”.

It revealed total industry assets have increased to nearly $3 trillion since September 2008.

Preqin also found that proportionally fewer hedge funds were charging the traditional “2 and 20” fees, which have come under scrutiny following bouts of underperformance in some areas. The data provider found that roughly 23% of hedge funds currently active used this model, compared with 28% in 2008.

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This was evidently not enough of a change for the California Public Employees’ Retirement System, which earlier this month announced it was to wind down its $4 billion allocation to hedge funds.

There are currently 5,882 hedge funds still active that were launched after the collapse of Lehman Brothers, while 5,165 launched before September 2008 are still operational, Preqin said.

The makeup of the hedge fund investor base has changed too: In 2008, 45% of industry assets were from institutional investors—this proportion has now increased to 63%. Preqin identified roughly 4,750 separate investors now allocating to hedge funds, compared to 3,500 in 2008—an increase of 44%.