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Pension Brief: 2022’s Down Markets Reverse 2021’s Unprecedented Gains For U.S. Public Pension Plans

After unprecedented fiscal 2021 pension fund returns for the U.S. public finance (USPF) sector, returns have almost completely pulled back in fiscal 2022. S&P Global Ratings expects the uncertainty in projecting pension contributions will continue for USPF issuers in fiscal 2023 because market returns are built into funding models influencing a large part of pension plan inflows and funding amounts. This volatility is clearly seen in the pension funding levels in budgets. Following fiscal 2021's very strong returns, which were often well over 20%, many plan sponsors expected contributions would be lower. However, poor fiscal 2022 returns will lead to increasing contributions down the road that could stress states and local governments that might have thought their pension woes were behind them. To understand the near-term future of market returns for U.S. public pensions, we consider three fiscal 2023 market scenarios:


Fiscal 2022 Returns At A Glance

As of June 30, 2022 (estimated as of June 1, 2022), a typical public pension plan will have experienced a return of about negative 7% for its fiscal year-end, compared with 27% as of June 30, 2021. It might appear at first glance that the fiscal 2021 return of 27% strongly outweighs in the positive direction the negative 7% return in fiscal 2022, but it's important to note that annual returns are compared against the expectation. According to a recent report from the National Association Of State Retirement Administrators ("NASRA Issue Brief: Public Pension Plan Investment Return Assumptions," March 2022), the median investment return for U.S. public pension plan assumptions is 7%. The 27% return in fiscal 2021 equates to a 20% gain above the 7% expectation, and similarly the negative 7% return in fiscal 2022 equates to a 14% loss below that expectation. This means that fiscal 2022 has wiped out much of the gains from fiscal 2021.

Funded Ratios Fall Back To Near-Fiscal 2020 Levels

In our internal state and 20-largest-city surveys, based on fiscal 2020 (most recent) audits, we found the average funded ratio was approximately 70%. Many public sector pension plans measure their assets in June and these are recognized on employer financial statements the following year.


To estimate the projected funded ratio for fiscal years 2021 and 2022, assets grow by the achieved return and liabilities grow by the assumption, as follows:


Credit Considerations

Recent broad-based acceleration in inflation has led to increased volatility in financial markets that are pressured further by global economic conditions. Inflation underscores many aspects of pension funding, most notably the market return assumption and therefore the funded ratio, and this can lead to contribution volatility. For more information, see "Global Credit Conditions Special Update: Inflation, War, And COVID Drag On," published May 17, 2022, on RatingsDirect.

Mechanisms such as the typical five-year asset smoothing or "collars" that limit rapid contribution changes are part of most funding policies, although such smoothing methods are not included in reported funded ratios. Smoothing practices do not reduce gains or losses but they can have a similar effect if subsequent years see opposing results. A primary purpose of smoothing is to delay contribution changes to provide time for necessary budgetary adjustments. S&P Global Ratings' forward-looking approach considers both current and future possible budgetary challenges, so contribution smoothing mechanisms are analyzed on an individual credit basis.

Plans that have either taken actions to reduce contributions or increase benefits (cost-of-living adjustments) due to excess fiscal 2021 returns are likely to experience increased stress as those higher costs could be backed by lower-than-previously expected plan assets. With tightening budgets and operating cost pressures, pension contributions might be an outlet for temporary budget relief at the risk of plan funding. Changes to pension contributions and plan design, if under consideration, will remain important credit factors in assessing structural balance. The current uncertain economic conditions will affect many aspects of pension system management. S&P Global Ratings will continue to evaluate the measures taken to balance near-term budgetary savings with implications for long-term costs and how those decisions affect credit outcomes.

Related Criteria And Research

This report does not constitute a rating action.

Primary Credit Analyst:Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Secondary Contacts:Christian Richards, Washington D.C. + 1 (617) 530 8325;
Geoffrey E Buswick, Boston + 1 (617) 530 8311;

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