Public Pensions Weathered “The Great Recession” and Took Action to Ensure Long-Term Sustainability

The Great Recession, lasting from December 2007 to June 2009, was the most severe economic downturn in the U.S. since the Great Depression. Virtually all investors lost assets during the financial market crash, typically about a quarter of assets. The economic effects lasted for years, with jobs slow to recover and unemployment remaining stubbornly high.

Similarly, the impact of the Great Recession on public pension plans was significant and not just due to the loss of assets during the crash. Many policymakers, academics, and everyday citizens have had their views of public pensions permanently colored by the experiences of plans during the crisis. This wouldn’t be a problem if their views of public pensions agreed with the facts, but, frequently, they do not.

The majority of public pension plans recovered their pre-recession asset levels within six years, while continuing to pay trillions of dollars in benefits. During the period from 2007 to 2013, public plans paid $1.4 trillion in benefits. This is a notable achievement and attests to the strength and longevity of these plans. Recent years have seen public plans achieve record asset levels, reaching nearly $6 trillion in the fourth quarter of 2021, according to data from the Federal Reserve.

Many have asked, though, why funded levels have not rebounded as quickly as asset levels. It’s important to bear in mind two facts. First, a funded status or ratio is a snapshot in time and does not necessarily reflect the full range of factors influencing the underlying strength of the plan. Second, public plans have made a number of changes since the Great Recession that, while increasing costs and liabilities in the short-term, have made plans fundamentally stronger and better prepared to weather future market downturns. New research from the National Institute on Retirement Security, Lazard, and Segal examines these changes.

The first and most publicly debated change has been the broad lowering of discount rates, or the assumed rate of return on investments. Before the Great Recession, the median public pension plan assumed an eight percent return on investments; today, the median plan assumes a seven percent return. This lowering of the discount rate reflects the information that actuaries and investment professionals are receiving from the markets about likely future returns. While the lowering of discount rates has been significant, it should be noted that public plans, historically, have done well at achieving their investment return targets, as the data from Callan featured below shows.

Second, there has been a major shift toward the adoption of generational mortality tables. Fifteen years ago, most public plans used “static” mortality projections. Each time a plan would have its actuaries conduct an experience study, the actuaries would note that people were living longer and costs would increase because benefits would be paid for longer. Actuaries began to develop generational mortality tables, which incorporate and project increased longevity, once financial modeling software made it technically feasible to do so. Now, nearly all large public plans have adopted generational mortality tables, some of which are plan-specific. The advantage of generational mortality is that future longevity improvements are “baked into the cake”, so to speak. Plans should expect minor calibrations of mortality upwards or downwards, but not significant increases as used to occur with static projections.

Third, many public plans have shortened their amortization periods, or the period of time they give themselves to pay off unfunded actuarial accrued liability. This reflects evolving guidance from the actuarial community, which now advocates for shorter amortization as a best practice. In 2007, 72 percent of participants were in plans with amortization periods of 26 years or longer. By 2020, less than half (42 percent) of participants were in plans using 26-30 year periods. Tightening amortization periods increases costs in the short term, but it will save money in the long run as existing costs are paid down more quickly. This is akin to the difference between a 15-year and 30-year fixed rate mortgage: the cost is paid down more quickly in a 15-year mortgage, but with higher monthly payments. Shorter amortization periods–unlike the first two items–do not inflate reported liabilities, but they generally increase contributions. As a result, it is common for this to be worked into inaccurate claims that costs are unsustainable.

Finally, the investing environment has changed since the Great Recession. Investing for public plans has become more complex as market conditions have led to revised asset allocations. Plans were heavily weighted toward public equities and fixed income before the financial crisis, with nearly 86 percent of aggregate plan assets in those two asset classes in fiscal year 2007. Since the crisis, plans have moved away from those two classes and invested more in real estate, private equity, and hedge funds. This has been a sound decision in many cases.

One of the advantages of a defined benefit pension plan is that a professional investment staff manages the assets of the plan. These professionals actively monitor the markets and rebalance and make adjustments as markets move. This active rebalancing accrues to the benefit of plan participants. To give an example, over the period from June 30th, 2009 to June 30th, 2014, had public plans made zero allocation changes, we would have expected to see public equity balances grow from just over 50 percent of the asset allocation to 57.8 percent, due to the strong performance of public equities during this period. As it was, public plans reallocated away from public equities and into other asset classes. Doing so was advantageous as the following two years delivered a total public equity return of negative 0.3 percent while other asset classes delivered total returns of over 26 percent for real estate, 16.6 percent for private equity, and 7.5 percent for fixed income.

The professional investment staffs of pension plans also avoid the mistakes of buying high and selling low that so many individual investors make. During both the Great Recession and the Covid-19 pandemic recession, instead of rebalancing after losses, too many individuals mistimed the market and missed out on the recovery following the trough. This behavior often locks in losses, undermining retirement security for those saving in defined contribution plans.

Public pension plans have come under a great deal of scrutiny from some quarters since the Great Recession, but the reality is that most public plans recovered their asset bases by 2013 and now have assets 88 percent above their 2007 level–all while paying out $3.8 trillion in benefits over the past fifteen years. In addition, plans significantly modified their funding processes, all while investing in a challenging climate. A more balanced and nuanced assessment of public plans in the period since the financial crisis reveals that public plans have continued to adapt, learned lessons from the recession, and adjusted so they can continue to provide retirement security for firefighters, teachers, and other public servants for decades to come.