U.S. Pension Assets Up, But So, Too, Are Liabilities

With the aging of America comes increased pension fund liabilities, a topic which has been top of mind for fund managers. A recent Milliman study shows the double-edged sword of such plans, which have higher funding ratios but also increased liabilities. The reach for yield in a low-interest rate environment has, in part, caused funding ratios to move lower as the deficit between growing liabilities and available assets climbs to a new study high.

Good news in Millman study is that aggregate funding ratios and pension assets are up, the bad news is that liabilities are up, too

The good news in the Milliman Public Pension Funding Study is that the estimated aggregate funded ratio is up to 70.7%, up from 67.7% on a year over year basis. Total assets in the nation's largest public pension plans rose from $3.19 trillion, and as of June 30, 2017, to a combined $3.44 trillion, a feat that Milliman attributes to "strong market performance in late 2016 and early 2017."

The gains come as many pension plans are lowering their return assumptions. The Employees Retirement System of Texas, for instance, lowered its return assumption from 8% to 7.5% in the headwind of some on the board who advocated for a 7% return assumption.

Lowering of returns expectations comes as the median average returns assumption in the Milliman report is 6.71%, off 79 basis points from the 7.50% median discount rate used by the plans. All but six of the plans in the Millman study have a lower independently determined rate.  One-third of the 100 largest plans reduced return assumptions, with 66 of the 100 plans lowering them at least once since 2012.

The lowered returns expectations come as total pension liabilities are rising, up to $4.72 trillion in 2016 from $4.42 trillion. The 2017 number is expected to clock in at $4.87 trillion. The 26 million members who rely on the plans for retirement each have a $224,000 cost assumptions. Nine of the plans have higher funded ratios in excess of 90%, 59 have funded ratios between 60% and 90% while 32 plans have ratios below 60%.

In the 2017 study, the aggregate reported funded status hit a record deficit of $1.53 trillion, down from a low of $1.02 trillion in 2015 and also higher than the 2018 study estimate of a $1.43 trillion deficit.

"In this low-interest-rate environment, market expectations on investment returns have been falling faster than plan sponsors can reassess rates," Becky Sielman, author of the report, said in a statement.  "And the gap that creates between sponsor-reported and our recalibrated market-based liabilities is widening, which is all the more reason plans should continue to monitor emerging investment return expectations and adjust their assumptions as needed."

Risk exposure has not been increasing

When pension funds look at their investment horizon, the impact low-interest rates and the resulting search for yield is apparent. US Fixed Income accounts for 21.8% of the average 2017 asset allocation, while US equities gobble up 28.3% while non-US equities occupy 19.1% of the portfolio. Other assets tied to the performance driver of economic strength include real estate, which has an 8.8% exposure while Private Equity has a 9.9% exposure. Hedge funds, initially designed to hedge during periods of market turbulence, have a 5.1% exposure.

Over the past five years there has been very little change in the overall allocation mix, the report noted. Pointing to a reach for yield that hasn't resulted in a correlated rise in risk factors, the report noted that over the past four years "there has not been a material move towards riskier investments."

Since 2013, equities generally made up near half the total portfolio, while private equity and real estate clock in at near one quarter along with fixed income.