Pension Funds’ Silver Lining Has a Touch of Gray: Aaron Brown
There has been an unusual burst of good news for State pension plans in the past week. New Jersey, one of the shakiest plans in the country, reported a 28.6% return for the fiscal year ended June 30, the highest in more than 20 years. Other funds have reported or are estimated to have returns around 25%. The Pew Charitable Trust estimates that State and local pension funds have finally recovered from the 2008 market crash and are back up to 80% funded, meaning assets currently in the fund could cover 80% of the benefits owed under optimistic assumptions about investment returns.
Moreover, reforms adopted in the last decade such as increasing taxpayer and employee contributions, and limiting benefits for new hires, mean funds as a group are now in “positive amortization,” with more cash is collected net of benefits than the present value of new benefits added, shrinking the funding gap.
This proves many forecasters, including me, wrong when we predicted back in the depths of the March 2020 market crash that the State pension fund system might have been the tipping point from which recovery would be impossible for the most troubled plans. A 65% gain in the S&P 500 Index while interest rates fell (meaning bond prices rose) moved funds from the critical list to, if not the full health of 100% funded under realistic assumptions, at least to the walking wounded state that has been the norm since the 2000 stock market crash.
But every silver lining has a touch of gray. The bad news about the stock market rally is that it is only in stock prices; corporate revenues, profits and book values have not kept pace. As a result, the cyclically adjusted price earnings ratio (the best well-known measure of stock valuations) stands at 37.2—far above the high of 31.3 just before the Black Friday stock market crash that was the harbinger of the Great Depression, and only exceeded by the 43.8 in 1999 that marked the top of the dot-com bubble. Unless there is a miracle recovery in actual business profits and economic growth, it seems inevitable that there will either be a major stock market crash, or at least a period of many years of mediocre stock market returns rather than the robust gains necessary to maintain pension plan funding levels.
The reforms increasing employee contributions and limiting benefits for new hires means an increasing share of covered employees have no stake in maintaining the current system that threatens to pay generous benefits to older and retired workers, then run out of money before younger workers retire. Taxpayers for the first time are experiencing the consequence of paying in full for promised future benefits to State and local workers. This seems likely to tilt the political calculations toward pension “reforms” that cut benefits promised to older and retired workers—benefits already accumulated.