Last week, the Pension Practice Council of the American Academy of Actuaries released a useful Issue Brief whose main purpose is to refute the "urban legend" that 80% is the appropriate funded ratio for public pension plans. It's a bit of straw-man job, but that's not the AAA's fault. Their point is that no one ever did make a real argument as to why 80% was adequate. It was only ever a rumor, which acquired truthiness simply through being repeated numerous times by the news media. (The brief includes a compendium of "80% funding standard" media hits. The original culprit seems to have been the Government Accountability Office, which should have known better.)
The AAA's position is that "[p]ension plans should have a strategy in place to
attain or maintain a funded status of 100% or greater over a reasonable period
of time."
But the AAA also has a further and more interesting point to make, which is that funded ratios have been over-hyped. A funded ratio is just a snapshot of assets to liabilities at a certain point in time. It's determined by several variables such as the stock market and asset smoothing methods. Thus, on its own, a funded ratio tells you little. The context must always be considered. How healthy is the pension plan's sponsor? What's the size of the obligation relative to the sponsor's size and payroll? Is there a responsible funding policy in place and is the sponsor sticking to it? These questions are critical in evaluating a plan's overall soundness. An 85%-funded pension plan could be better-run, and thus more fiscally-sound, than a 95%-funded plan.
True, beyond a certain point, a low funded ratio is prima facie evidence of mismanagement. No one can deny that the Illinois (45%, discounted highly optimistically) and Rhode Island (49%, ditto) state pension plans have been terribly managed. And yet, who can forget the debacle of the late 90s, when dotcom bubble-driven overfunding caused state and local legislatures to enact unsustainable benefit increases? Though overfunded, these plans were also terribly managed.
In short, there is no one quantitative measure that will, on its own, demonstrate the health of a pension plan. Indeed, one is tempted to suggest that a pension system's health cannot be quantified, or at least not perfectly so. It all comes down to wise and effective management, something which eludes precise quantification.
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