Pension Planning Risks Increased With New Strategy : A $1 Trillion Shortfall

Over the long haul, it has been proven that the stock market will have a positive return. And as the pension planners have moved to a more risky strategy for future demands for retirees, it make sense to move away from a system that will not provide advocated funding.

The important part is to educate the retiree that they also must understand the risks involved and plan for a future that might be tight in some years when the market slows.

Changes in Pension Plan Funding
Source: Mark Wolff, "State Public Pension Investments Shift Over Past 30 Years," Pew Charitable Trusts, June 3, 2014.

June 20, 2014

As public pension plans have shifted towards more volatile investments, sound investment strategy is critical for the health of such state and local pension plans, according to a new study from the Pew Charitable Trusts.

As of 2012, within state and local pension plans, there was a $1 trillion shortfall between pensions earned and assets available to pay those pensions. 14.5 million state and local employees are eligible for public pension plans with $3 trillion in assets.

Sixty percent of promised pension benefits are funded by investment earnings, but future investment returns are inherently uncertain. In order to deal with the funding gap, efforts to increase investment returns have led to a shift in investment strategies over the past 30 years:

• Over the last few decades, public pension plans have shifted funds away from fixed-income investments such as government and corporate bonds and towards stocks, private equity, hedge funds, real estate and commodities.
• In 1952, almost 96 percent of public pension assets were invested in fixed-income assets and cash. By 2012, that figure had dropped to just 27 percent.
• These changes were aimed at increasing returns, and they have done so: Between 1982 and 2000, public pension assets more than doubled per worker.
• However, they have also increased fees and created uncertainty, and pension funds suffered large losses from 2000 to 2002 and in 2008. While state pension plan funding was above 100 percent in 2000, it was at 72 percent as of 2012.

Increasing investments in equities can mean greater financial returns, the report says, but it can also cause large losses. The study notes that just a 1 percentage point difference in returns in a single year on $3 trillion adds up to $30 billion.