(Bloomberg) — U.S. state and local government contributions to public pensions hit their highest level last year and investment returns are running above average in 2024, according to a new report by Equable Institute, which said risks are growing as the funds ramp up bets on risky private capital strategies.
The annual report published Tuesday by the nonprofit projects the national public pension funding shortfall to drop this year to US$1.3 trillion from $1.6 trillion in 2023. The average funded ratio of public pensions will increase to nearly 81% from about 76% last year, the group said.
The improvement is attributed to record high contribution rates: state and local governments paid more than 31% of payroll or $180.7 billion into their public retirement systems last year, and the average public pension fund generated preliminary returns of 7.4% for the first six months of the year, above the assumed baseline of 6.9%.
But that still is not enough to make up for the increase in benefit payments over the past two decades that have consistently left pension plans with negative cash flow.
“The simple reality is that states and cities are not doing enough to eliminate unfunded liabilities, and the result is steadily rising contribution rates that will lead to more costs in the long run than if legislatures took this problem seriously,” the group said in its report.
Public pension plans are increasingly shifting to riskier alternative investments, such as real estate and private equity, to make up for the outflows. Alternatives make up about a third of the assets in public pensions, according to the report.
“Pension funds over the past two years have been doubling down on private capital,” said Equable Executive Director Anthony Randazzo.
Bets in private capital in particular hit an all-time high of $694 billion, according to Equable. This shift is introducing new risk since alternatives are priced based on valuations, as opposed to market-based pricing, and can lag by three to nine months, making it harder to calculate contribution rates.
Pension fund assets exposed to valuation risk have roughly tripled over the past two decades, representing about 28% of assets at the end of 2023 from 8% in 2001, according to the report.
“Today there’s this risk that assets, in being overpriced, are putting downward pressure on the amount of contributions that would otherwise be needed,” Randazzo said. “The irony is that as public plans have sought to address their pension debt paralysis, they are running the risk of making the problem worse.”
Randazzo said Texas pension plans are a “significant driver” of this trend with 45% of the state’s total $336 billion in assets under management invested in alternatives.
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