Public Pensions’ Resilience Is the Untold Story of the Market Downturn
By Hank Kim, Executive Director and Counsel, NCPERS
It's important to remember that for public pensions, the highs generally aren't as high as the market at large, and the lows aren't as low, but this is a result of deliberate risk management.
Since before the mid-term elections, headlines have been screeching about another “dismal” year for public pensions, as if 2021's exceptional performance was the benchmark for gauging results. But the fact is, pensions are remarkably resilient even in the face of short-term negative returns.
Measuring the stability and health of public pensions
One-year returns are not how we measure the stability and health of public pensions. What counts is their ability to make good on their promises over a long-term horizon. No U.S. public pension system has ever missed a payment to workers, and if we muster the political will to keep pensions strong, we can ensure that our faithful public servants continue to have the prospect of the dignified retirement that they have earned.
Pensions are long-term investors, and the long view is instructive: A recent report by the Organization for Economic Cooperation and Development noted that public and private pension plans around the world have recovered from steep losses suffered in the Global Financial Crisis of 2007-8. In the U.S., the National Institute on Retirement Security has pointed out that public pension plans had erased these losses by 2014.
Indeed, U.S. public pensions have reached a point where they could “sustainably fund their pension promises for the long run,” according to a report from the Pew Charitable Trusts.
Yet every time the stock market gyrates, some people seem to be caught off guard by the very simple reality that in the short term, markets can be volatile. We are coming off a stellar financial performance for public pensions in 2021, and already the chorus has begun: Returns are down! The sky is falling!
It isn't surprising that anxiety runs rampant whenever the stock market hits turbulence and prices decline, as has been the case throughout 2022. The S&P 500 and the Nasdaq were both deeply in the red as of mid-December, and obviously their slump has short-term implications for pension plans. But long-term investment horizons and short-term market movements are not the same thing. Giving into free-floating anxiety and hand-wringing is a willful exercise in overlooking the big picture.
As we look back wistfully on the market gains from 2021, it's important to remember that that was an exceptionally strong market, just as 2022's is an atypically weak market driven lower by geopolitical factors that applied significant inflationary pressures. This forced central banks to raise interest rates in efforts to curb the inflation curve further depressing the public equities markets.
As inflation is beginning to ease, we've already seen some glimmers of hope in the market. Milliman's Public Pension Funding Index, which looks at the nation's largest public defined benefit plans, saw the funded ratio improve from 69.3 percent at the end of September to 74.7 percent as of November 30, as plans added approximately $200 billion in market value.
However, investment performance isn't the only thing that affects pension sustainability. Employees continue to contribute to funds, as mandated. Employer contributions have risen as states and localities have faced up to the consequences of earlier decisions to withhold their actuarially required funding. Replenishing the coffers to make up for skipped payments is a positive step. Paying the piper is never pleasant or easy, but we are seeing improvement in the number of states and localities that opt to honor their commitments rather than invent new reasons to avoid them.
Retirees fuel the economy by spending pension checks
These increases in employer contributions are ultimately benefiting states and localities as retirees fuel the economy by spending their pension checks. NCPERS research shows that in 2018, pension funds generated approximately $341.4 billion in state and local revenues. The taxpayer contribution to pension plans in the same year was $162 billion. In other words, pension funds generated $179.4 billion more in revenues than taxpayers contributed to the pension funds.
As 2022 grinds to its end, we are likely to continue to see some negative headlines and hear more lamentations about “dismal” performance by public pensions, because this year will pale in comparison to last. In this volatile market, we need to be prepared to hear that funding ratios have slipped a bit, but how could they not under the circumstances?
It's important to remember that for public pensions, the highs generally aren't as high as the market at large, and the lows aren't as low, but this is a result of deliberate risk management. Slow and steady wins the race. And that's why public pensions invest for the long haul.