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Municipal Pension Funds: How Much Is Enough?

Two of the most common questions raised by municipalities when it comes to analyzing pensions is: How does our funding level compare to other municipalities, and how much is enough?  

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Two of the most common questions raised by municipalities when it comes to analyzing pensions is: How does our funding level compare to other municipalities, and how much is enough?  

Two of the most common questions raised by municipalities when it comes to analyzing pensions is: How does our funding level compare to other municipalities, and how much is enough?

According to one study of roughly 200 municipal pension plans as of June 30, 2018 the average funded ratio (the market value of assets divided by the accrued liability) was 74.9%.

With the average funded ratio being 74.9%—is that where a municipality should be? Not exactly. According to the Government Finance Officers Association (GFOA) in their Best Practice, “Sustainable Funding Practices of Defined Benefit Pension Plans,” municipalities’ public pension plans should target a 100% funded ratio. A misconception of 80% has been assumed in the public sector as this has been used as guidance for corporate plans. It should also be noted that some rating agencies consider a funded ratio of 70% or above to be adequate and below 60% to be weak, with this being just one of many factors in analyzing a municipality’s pension obligation.

The next issue for municipalities, once they have an idea where they are and how it compares to other municipalities in the area, is finding ways to increase the funded percentage. To accomplish this the municipalities should ask themselves a few initial questions, such as how do we increase the employer and/or employee contributions to the plan, what is the plan invested in and what is the return on investments, and how does the discount rate impact the plans funded status?

Employer and employee contributions are guided by various employee agreements and budgetary limitations and are the most difficult areas to try to navigate while improving the funding status of the plan. Negotiations with employees or employee groups are one way to try to increase the level of employee contributions. Developing a plan to accumulate small year-end budgetary savings and use these to increase employer contributions without increasing the budget may be an effective way to increase employer contributions.

Investment vehicles should be considered in the overall assessment of pension funds. There are several different assets that municipalities can invest in such as stocks, bonds, private equity, real estate and other securities. The investment choices of the municipalities should be analyzed on a regular basis to ensure they are serving the needs of the pension plan. Since the market value of investments is used to determine the value of the plan assets, the current market conditions can also cause dramatic swings in the funded status of the plan.

Another important factor is the discount rate (the rate used to value the current cost of future pension obligations) and its relationship to the expected rate of return. Due to this fact, periodic reviews of the municipalities’ discount rate in conjunction with the realized investment returns is important to ensure that the liability is being accurately calculated. If the discount rate is decreased, the corresponding pension liability will increase, the funded status will decrease and vice versa.

Although this provides only the tip of the iceberg for understanding the municipalities’ pension plans, this knowledge will hopefully help to initiate discussions to improve the plans’ funded status.

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