US. Rallying Stock Market May Help Public Pensions Reduce Shortfall This Year, Study Finds
KEY TAKEAWAYS
- State and local government-sponsored employer pension funds are projected to earn a 7.4% market return this year.
- However, these pension funds still face a long-run funding shortfall of more than $1 trillion, according to a new study by a nonprofit think tank working with the public retirement system.
- Public pension funds have increased their investments in hedge funds, private capital, and real estate to boost returns.
It’s been a good year for pension funds. While public pension funds still face pressure to resolve long-run funding shortfalls, a new study projected that in 2024, state and local government pension funds would net a solid average yearly return of 7.4% due to gains in artificial intelligence (AI) stocks.1
A pension fund is an employer-sponsored retirement benefit plan that’s funded by governments, companies, or organizations like unions, and sometimes also employees.2 Those contributions are then invested in the financial markets.
Whenever a pension fund has more liabilities, or benefits promised, than assets, it has a funding shortfall.3 The study by Equable, a nonprofit think tank that works with the public retirement system, found that the national shortfall in assets for public pension plans is expected to decrease to $1.34 trillion this year from $1.61 trillion in 2023. So despite strong returns performance this year, pension funds still face more than a $1 trillion debt.
Stuck in Pension Debt Paralysis
“This is a welcome improvement, but it will require additional years of similar performance to break public plans out of their pension debt paralysis,” researchers wrote in the State of Pensions 2024 report from Equable.
The researchers attribute the overall increase in public pension debt that’s led to underfunded plans, from 2000 to 2022, to three factors: better actuarial assumptions used to calculate benefits, underperforming investments, and interest on pension debt that’s grown faster than employee contributions.
Pension Funds Shift Asset Allocation To Increase Returns
Growing debt is “why pension fund investment managers continue shifting assets toward high-risk, high-reward bets even as contribution rates continue to set historic highs,” said the report.
Since fiscal 2001, state and local pensions have increasingly shifted their portfolio allocation toward private capital, hedge funds, and real estate in an effort to boost investment returns, according to the Equable report.
The study said government employers have had to increase their contribution rate to make up for the funding shortfalls as well. Between fiscal 2001 and fiscal 2024, government employer contributions increased more than threefold, from 9.30% of payroll to more than 31%.
