articles Ratings /ratings/en/research/articles/220608-pension-brief-2022-s-down-markets-reverse-2021-s-unprecedented-gains-for-u-s-public-pension-plans-12402584 content esgSubNav
In This List
COMMENTS

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

COMMENTS

U.S. States' Fiscal 2025 Budgets Navigate Evolving Risks As Economic Growth Prospects Wane

COMMENTS

Table Of Contents: S&P Global Ratings Credit Rating Models

COMMENTS

Rethinking The American Dream Of Homeownership In New York City

COMMENTS

Your Three Minutes In The Greenhouse Gas Reduction Fund: Efficient Networks Put U.S. CDFIs In Good Position To Lead Change


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:

image

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.

image

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:

image

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;
Todd.Kanaster@spglobal.com
Secondary Contacts:Christian Richards, Washington D.C. + 1 (617) 530 8325;
christian.richards@spglobal.com
Geoffrey E Buswick, Boston + 1 (617) 530 8311;
geoffrey.buswick@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.

 

Create a free account to unlock the article.

Gain access to exclusive research, events and more.

Already have an account?    Sign in