* Funding gap in 109 state pensions swells to $834.2 bln
* 95 percent of plans underfunded
* Average plan has funding ration of 68 pct
* Managers up exposure to alternative assets
By Edward Krudy
NEW YORK, March 3 The recovery in the U.S. state
pension system suffered a setback in 2012 as the huge funding
shortfall in a large swath of state pensions swelled more than
20 percent, interrupting two years of improvement following the
devastation of the financial crisis.
The shortfall in 109 of the nation's state pension plans,
which guarantee retirement for millions of public workers such
as police, firefighters, and teachers rose to $834.2 billion in
2012, up from $690.3 billion the previous year, according to a
new report by Wilshire Consulting, a unit of independent
investment management firm Wilshire Associates.
The report highlights the uphill struggle faced by many of
the state pension plans nationwide and is a reminder that
financially strained state governments will have to make some
tough choices in order to make up the shortfall.
It also shows state pension fund managers are continuing to
up their exposure to less conventional assets such as real
estate, private equity, hedge funds and commodities as they try
to boost their returns and diversify away from over exposure to
"The hit that was taken through the global financial crisis
was significant and now they are on the road to looking at
recouping that over the long term," said Steven Foresti, head of
investment research at Wilshire. "But it will require without
question significant contributions and adequate investment
Collating timely data on state pension systems is hard as
they report with different time frames. Wilshire's report
focuses on 109 funds that reported data as of June 30 last year,
and uses prior data for another 25 plans that reported earlier.
Wilshire notes that in the use of any sample there is the
chance of statistical error and although the 109 funds with 2012
data are a sizable majority of the state plans in the survey,
there will be a degree of variance from the entire plan cohort.
Sticking with the 109 plans, in 2007 before the financial
crisis struck, state pension plans were 93 percent funded, up
from being 81 percent funded in 2002 as stock markets rallied.
In 2012 the total market value of their assets amounted to 69
percent of their liabilities, down from 73 percent in 2011.
Although that is much better than during the aftermath of the
financial crisis when the funding ratio plummeted to 61 percent
in 2009, the move in the wrong direction is a concern with
levels still way below where they need to be. A healthy funding
ratio is considered 80 percent or above.
ARE MANAGERS TOO OPTIMISTIC?
The length of time it takes pensions to report means
Wilshire's analysis is necessarily backward looking.
The authors point out that the swelling shortfall is due to
market volatility in the 12 months leading up to June 30 last
year when most funds reported data. That was when the euro zone
crisis was at its worst. Following strong performance in markets
since then the pension are probably in better shape now, they
Still, given the bumpy ride that appears to be a feature of
today's markets, the report is likely to reignite debate about
whether managers are too optimistic when forecasting returns.
Wilshire estimates that the median state pension fund can
expect an annual return of 6.9 percent. That is much less than
the current median rate of 7.8 percent that pension use as
long-run expected returns.
The report's authors acknowledge that their more modest
assumptions assume risk-adjusted market returns and do not allow
for higher returns that could be added by active money
management. They also use a time horizon of 10 years rather than
the 30-year time horizon that pension forecasters often use.
Even so, a closer look at the number reveals the scale of the
task that many state pensions face.
Of 109 state plans, 95 percent are underfunded, with asset
values less than their liabilities. The average underfunded plan
has a ratio of assets to liabilities of just 68 percent.
The problem varies greatly across plans. Nine have assets
with a market value less than 50 percent of their liabilities,
62 plans have less than 70 percent of liabilities and 81 plans
have assets less than 80 percent.
Wilshire's report does not list individual plans although
that data is publicly available.
The report shows managers continued to ditch U.S. equities
last year in search of yield and diversification. Exposure to
the asset class fell 13 percent through the middle of last year
and total U.S. equity exposure across the plans stood at 28
percent, down from 41 percent since 2007.
The money coming out of U.S. equities has been flowing into
non-U.S. equities, real estate, private equity, and other
investments such as hedge funds and commodities.
This may be an attempt by fund managers to increase their
exposure to more leveraged investments in an effort to meet
return targets or reduce volatility across the fund by
diversifying assets, according to the report.
"They all recognize that there will be short periods of time
when that risk works against them but if they have the liquidity
to stay in those positions and returns are adequate over the
long run that will have the most emphasis in terms of what level
of contributions will be required," said Foresti.