The median interest rate used by public pension plans dropped from 8% to 7.75%, according to Milliman 2013 Public Pension Funding Study.
Milliman 2013 Public Pension Funding Study analyses the funded status of the 100 largest U.S. public pension plans.
Lowered interest rate assumptions
Milliman study observes 29 of the 100 plans in the study have lowered their interest rate assumptions since the Milliman’s 2012 study. The median interest rate used by the plans decreased from 8% in 2012 to 7.75% in the 2013 study.
Rebecca A. Sielman, principal author and project coordinator of the study feels this drop is in line with a generally declining market consensus on expected long-term investment returns. The study’s median actuarially determined interest rate likewise decreased from 7.65% to 7.47% between the 2012 and 2013 study.
The following table captures the aggregate funded status of Milliman 100:
Sufficient assets to cover accrued liability
Milliman’s study notes the plans reported aggregate accrued liabilities of $3.77 trillion, split into $1.62 trillion for the 12.6 million plan members who are still working and $2.15 trillion for the 11.8 million plan members in the retired / inactive category. Interestingly, while the number of active members declined by 200,000, the inactive members have grown by 900,000 between 2012 and 2013. The following graph elucidates the accrued liability position of the pension plans:
The study notes in aggregate, the plans currently have sufficient assets to cover 100% of the reported accrued liability for retirees and inactive members. However, only 27% of the assets needed to cover the reported accrued liability for active plan members.
Consensus long-term investment returns decline
Milliman 2013 Public Pension Funding Study notes one of the striking trends noticed over the past decade is that the market’s consensus views on long-term future investment returns have declined. During the past decade, expected returns on both equity and fixed-income investments have declined by about 200 basis points. The report points out pension plans too have reflected this trend by lowering their interest rate assumptions, by making either a single significant cut or through gradual reductions.
The following graph highlights this declining trend by exhibiting the expected long-term return for a hypothetical asset allocation based on Milliman’s capital market assumptions for each year since 2000:
Milliman’s study also used each plan’s actuarially-determined interest rate to recalibrate the accrued liabilities and found these plans have an aggregate accrued liability of $3.86 trillion. As revealed in the following graph, for most plans in the study, the recalibrated accrued liability is not substantially different from the reported accrued liability. A similar trend was witnessed in the 2012 study as well:
