August 18, 2013 7:43 am

Detroit lays bare US pension woes

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments
A group of AFSCME union city of Detroit worker retirees protest against any cuts in their pensions outside the city county building in downtown Detroit, Michigan©Reuters

Detroit’s citizens protest against cuts to pensions

The city of Detroit’s looming bankruptcy and its estimated $3.5bn in pension liabilities present a cautionary tale for public pension funds in the US.

And government workers who toil for the Motor city are not alone in fretting about their prospects for retirement. State and city governments across the country are struggling to correct the course of underfunded pensions as ageing workforces, a sluggish economy and low interest rates depress investment returns.

Indeed, things have become so dire that at least 40 states have unveiled radical changes to pensions since 2009 to place a tourniquet on losses and shave off liabilities, industry watchers say; tweaks range from pushing up the eligible retirement age to 67 to temporarily freezing contributions. “Almost every state has made reforms to their pension plans,” says Keith Brainard, research director with the National Association of State Retirement Administrators. “And in general, these reforms were calibrated to be roughly commensurate to the need for reforms.”

A glance at research conducted this summer by the Center for State and Local Government Excellence, a Washington think-tank, suggests the focus on the management and accounting of local public pensions is necessary.

On average, growth in the size of their liabilities is slowing a bit; however, growth in the size of their assets is more torpid still, according to Elizabeth Kellar, the centre’s president and chief executive. A second difficulty is that local governments must put increasing amounts of money towards pensions to get them on the road to being fully funded. Last year, for example, their annual required contribution as a percentage of payroll was 15.3 per cent, more than twice the 6.4 per cent demanded 10 years ago. And the aggregate ratio of assets to liabilities, a good indicator of funds’ strength, for the 126 plans analysed by the centre still declines steadily year after year, having dropped from 91.4 per cent in 2001 to an estimated 73 per cent last year.

But Mr Brainard stresses that, while some plans are “in very bad shape”, others are “just fine”.

The lengthy list of underfunded pension schemes with estimated aggregate ratios of assets to liabilities of less than 60 per cent includes the Louisiana and Alaska Teachers Union funds as well as government pensions for Kansas, Colorado, Illinois and Connecticut.

The situation for such funds is expected to become more difficult following the introduction of new accounting requirements from the Governmental Accounting Standards Board (GASB), which take effect in June of next year.

Under the current regime, public pension plans tend to stick to actuarial models and discount their liabilities by the long-term yield on the assets held in the pension fund, which is about 8 per cent, according to Alice Munnell, director of the Center for Retirement Research at Boston College.

Next year’s programme will make pensions’ annual valuations volatile as changes in the fair value of plan assets will no longer be smoothed over periods of three to five years, but will be taken into account immediately when measuring assets. “Assets will be reported at market value rather than actuarially smoothed,” says Ms Kellar.

The smoothing permissible now means that asset losses suffered in 2008 might still depress funded ratios in 2011, explains Ms Munnell.

Another key change in many cases will be the discounting of projected benefit payments by a blended rate that reflects not only the likely return for the portion of liabilities set to be covered by plan assets, but also the return on high-grade municipal bonds “for the portion of liabilities that are to be covered by other resources”, Ms Kellar says.

The GASB changes come as Standard & Poor and other credit rating agencies are set to demand new data about pensions to establish the ratings of municipal and state government bonds.

More conservative assumptions are expected to be used when it comes to analysing pension funds’ amortisation periods and investment returns. And Ms Kellar emphasises that the point of the exercise is to “stress test” how pension obligations might impede a government’s ability to repay its debt.

“The rating agencies are particularly interested in whether or not a plan is in place to solve a revenue problem or a funding problem,” she says.

The consensus is, however, that while the new accounting requirements will put downward pressure on funding ratios thanks to the adoption of a combined rate to discount benefit promises, the underlying fundamentals for funds will not be altered radically.

Copyright The Financial Times Limited 2015. You may share using our article tools.
Please don't cut articles from and redistribute by email or post to the web.

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments


FTfm is the voice of the global fund management industry, providing must-have news and sharp analysis to the world’s top asset managers and professional investors.

FTfm videos

Enter job search