Should the public be concerned by a 70% funded ratio for public pension plans?

In the inaugural Milliman Public Pension Funding Study,* the aggregate funded status of the 100 largest public pension plans was reported to be 69.8% using information reported by the funds and the market value of assets. Some observers have commented that, because the funded ratio is less that 80%, public pension plans are in trouble. Maybe, maybe not.

The funded ratio of a pension plan is the value of plan assets divided by the value of plan liabilities. It is sometimes calculated on an actuarial value of assets basis and sometimes on a market value of assets basis, depending on the purpose. For comparison purposes, the funded ratio calculated on the actuarial value of assets is 75.1%.

The funded ratio is a snapshot measurement as of a particular valuation date and is typically calculated once a year. Actuaries then use this information to develop a contribution strategy to reach a funded ratio of 100% or greater over a reasonable period of time. While a funded ratio makes it easier to compare plans on a plan-by-plan basis, or to quickly determine if a plan is overfunded or underfunded, it doesn't tell the whole story needed to determine if a plan is in trouble or not.

There are many factors to consider when determining the health of a plan:

• Size of the unfunded liability compared to the financial resources of the plan sponsor
• Financial health of the plan sponsor (e.g., budget surplus, level of debt, cash flow)
• Ability of the plan sponsor to make changes to the plan design to reduce future plan liability
• Actions the plan sponsor has taken or is considering taking to reduce future plan liability
• Historical changes in the funded ratio of the plan over time
• Causes for the changes in funded ratios over time
• Funding or contribution policy
• Plan sponsor's history of making actuarially required contributions
• Investment policy and the level of risk inherent in the investment policy
• Impact of the plan's investment risks on future benefit payments and contribution requirements

After reviewing the plan and plan sponsor's situation from these different angles, then a judgment can be made about the financial health of a plan. Among individual plans, there is a wide range of results of the status of the plan. In many jurisdictions where there are concerns about the long-term health of the plan, pension reforms have either been implemented or proposed to address the long-term funding.

*The Milliman Public Pension Funding Study independently measures the aggregate funded status of the 100 largest U.S. public pension plans using basic actuarial principles and reported plan liabilities and assets. The aggregate accrued liability information provided has been determined on a uniform basis with respect to the interest rate assumption across all of the plans in the study. This uniform approach allows for an accurate picture of the overall funded status of these 100 pension plans based on an independent application of Actuarial Standards Board (ASB) standards of practice, actual investment portfolios, and current capital market assumptions.