Public Pension Stress Testing: Montana
LEGISLATIVE FINANCE COMMITTEE MEETING (66TH LEGISLATURE)
HELENA, MONTANA
AUGUST 11, 2020
DAVID DRAINE, SENIOR OFFICER
BEN HENKEN, ASSOCIATE
STRENGTHENING PUBLIC SECTOR RETIREMENT SYSTEMS
2
The Pew Charitable Trusts
➢ An independent, nonprofit and nonpartisan research and policy organization.
➢ “Driven by the power of knowledge to solve today’s most challenging
problems.”
➢ Our mission is to:
o Improve public policy
o Inform the public
o Invigorate civic life
Pew’s Public Sector Retirement Systems Project
➢ Research since 2007 includes 50-state trends on public pensions and retiree
benefits related to funding, investments, governance, plan design, and
retirement security.
➢ Technical assistance for states and cities since 2011.
3
Background
➢ After nearly ten years of economic recovery, public pension debt still remains at
historically high levels. Now the emergence of the COVID-19 pandemic is putting
strains on pension plans and state budgets.
➢ Stress testing provides state officials with a tool to understand how pension plans and
state budgets will weather economic downturns and volatile investment markets and
to test the impact of policy decisions.
➢ Pew was invited by the Pensions and Local Trends Legislative Finance Subcommittee to
prepare a stress test analysis of Montana’s major pension systems based on our
Foundation for Public Pension Risk Reporting to be reviewed at their May 4th meeting.
➢ Our analysis found that the state’s current funding policy may not be sufficient to
improve funded status if investment returns fall short of expectations. Additionally, in
a severe market downturn, there is a risk of insolvency.
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Pension Fund Risk Premium at Historic HighPlan’s average assumed rate of return remains relatively stable, while bond yields have
declined
Sources: Pew analysis of comprehensive annual financial reports, actuarial valuations, and related reports from states; U.S. Treasury data; and
Center for Retirement Research at Boston College, Center for State and Local Government Excellence and National Association of State
Retirement Administrators, Public Plans Data
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Rat
e o
f re
turn
Investment Risk: Target Return vs. 30-Year Treasury
Average assumed rate of return Treasury 30-year yield Presence of Recession
5
State Pension Debt Remains at Historically High Levels
Pension Debt as a Share of GDP (Aggregate of 50 States)
Sources: The Federal Reserve and U.S. Department of Commerce Bureau of Economic Analysis
States that have Enacted or are Considering Stress
Testing Requirements
NDMT
MN
WY
SD WI
WV
WA
VAUT
TX
NM
PA
NV
AZOK
NY
NC
OR
AK
FL
CA
HI
CO
ID
MD
ME
IL
LA
DE
NJ
MI
KY
IN
AL
RI
MS
AR
NE
KS MO
IA
GA
MA
CT
NH
VT
OH
SC
TN
Adopted Stress Testing Requirements
Considering
Note: Map is as of August 2020.
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Montana
Stress Test Results
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Fiscal Position on a National and Regional Level
o As of 2018, Montana’s:
• Funded ratio was 72.6% (24th in the nation).
• Nationally, public pension plans were 71% funded.
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Montana Stress TestASSUMPTIONS
o Forward-looking analysis: Completed by Pew’s external actuaries
based on publicly available plan documents.
o PERS and TRS modeled separately; results then aggregated for
presentation.
o Model based on 2019 Actuarial Valuations and do not include the
impact of COVID-19.
o We modeled the baseline and two downside economic scenarios:
• Baseline
• 5% Returns
• Asset Shock: -25% return in year 1, 3 year recovery, long-term
returns of 5%
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Results Highlights
o The 2013 reforms helped improve the fiscal health of both plans,
increasing pension assets by more than $600 million and improving
the combined funded ratio of PERS and TRS by approximately 5
percentage points.
o However, contribution levels under current policies may be
insufficient to improve funded status if long-term investment returns
are lower than the plans’ current assumptions. We estimate a 63%
chance that funding will decline and a 6% chance of insolvency
under current policy.
o Applying an actuarial funding policy to Montana’s pension plans would
allow current policy to be sustainable across a range of outcomes.
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Source: The Terry Group and The Pew Charitable Trusts
Funding Progress on Track in Baseline ScenarioRoughly ¾ of the current pension debt will be paid off by 2049 – with full funding expected soon after – if all actuarial and investment return assumptions are met
-
100
200
300
400
500
600
-
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
20
19
20
20
20
21
20
22
20
23
20
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27
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20
49
Emp
loye
r C
on
trib
uti
on
s ($
M)
UA
AL
($M
)
Unfunded Liabilities (UAAL) and Employer ContributionsPERS & TRS
UAAL ERC
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Source: The Terry Group and The Pew Charitable Trusts
Plan Finances Deteriorate in Downside ScenariosImproved funding relies on hitting return target
0%
20%
40%
60%
80%
100%
120%
20
19
20
21
20
23
20
25
20
27
20
29
20
31
20
33
20
35
20
37
20
39
20
41
20
43
20
45
20
47
20
49
Funded RatioPERS & TRS
0
5,000
10,000
15,000
20,000
25,000
20
19
20
21
20
23
20
25
20
27
20
29
20
31
20
33
20
35
20
37
20
39
20
41
20
43
20
45
20
47
20
49
Unfunded Liabilities ($M)PERS & TRS
Baseline 5% Returns Asset Shock
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Source: The Terry Group and The Pew Charitable Trusts PRELIMINARY RESULTS
Plan Investment Performance Follows the Stock MarketPERS and TRS investment returns tend to exhibit the same high volatility from year to year
-30%
-20%
-10%
0%
10%
20%
30%
40%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Annual Investment Returns for the S&P 500, PERS, and TRS
S&P 500 PERS & TRS
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Source: The Terry Group and The Pew Charitable Trusts
Simulation Analysis Shows UncertaintyPlan funding could take starkly different paths depending on how investments perform, with a more than 50% chance of having lower funding in 2039
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039
Range of Projected Funded Ratios PERS & TRS Combined
u 95th 84% 90% 95% 100% 105% 109% 114% 117% 123% 128% 132% 137% 141% 147% 150% 158% 165% 171% 179% 188%
–– 75th 77% 79% 80% 81% 83% 84% 85% 86% 87% 87% 88% 88% 89% 89% 90% 91% 91% 92% 93% 94%
l 50th 72% 71% 71% 70% 69% 69% 68% 67% 67% 65% 64% 63% 62% 61% 60% 59% 58% 57% 55% 54%
–– 25th 67% 64% 62% 60% 57% 55% 54% 52% 50% 47% 45% 43% 40% 38% 35% 33% 30% 28% 25% 22%
u 95th 59% 54% 50% 47% 43% 41% 38% 35% 31% 28% 25% 21% 18% 15% 11% 7% 3% 2% 0% 0%
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Source: The Terry Group and The Pew Charitable Trusts PRELIMINARY RESULTS
Financial Distress Could Arise QuicklyTrial 9223 shows how two asset shocks in a span of 10 years could drive both plans into insolvency without changes in plan policy
-8
-6
-4
-2
0
2
4
6
8
10
12
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
Mar
ket
Val
ue
of
Ass
ets
($B
)
Inve
stm
ent
Ret
urn
Annual Investment Returns and Combined Plan Assets in Trial 9223PERS & TRS
Combined Plan Assets Annual Investment Return
Combined plan assetsare depleted in 2038
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Note: Expected returns are 7.65% for PERS and 7.5% for TRS. High returns are 8.65% for PERS and 8.5% for TRS. Source: The Terry Group and The Pew Charitable Trusts
Sensitivity Analysis of New Benefit CostCosts for new hire benefits could vary substantially if returns fall short.
• New employees pay the bulk of the cost of new benefits under current assumptions.
• If long-term returns are 5%, that would increase costs by 5 percent of payroll.
17
Note: Data from Standard & Poor Dow Jones Indices LLC via Federal Reserve Economic Data (FRED)
Historic Market Volatility Post-COVIDEquities up 5% in FY 2020 despite huge losses earlier in the calendar year.
S&P 500 Cumulative Returns Since July 1, 2019
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20
Cu
mu
lati
ve R
etu
rn S
ince
Ju
ly 1
, 20
19
Down 4% calendar
Down 35% peak-to-trough (Feb. 19 to Mar. 23)
Up 5% in FY 2020 (July 1, 2019 to June 30, 2020)
18
Note: Moody’s Analytics pre-COVID forecast is the baseline (50th percentile) Moody’s Analytics 90th percentile forecast is a downside scenario, representing a 90th percentile outcome for GDP—or an outcome worse than 90% of all possible scenarios.
Pandemic to Have Major Impact on GDPStates expecting revenue losses from associated reduction in economic output.
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Conclusion
➢ Montana, under current policy, depends on hitting investment targets to get
to full funding and significant shortfalls could lead to declining assets or
insolvency.
➢ Regular stress testing analysis, as currently required, would enable
policymakers and plan administrators to regularly monitor the pension
system and evaluate any potential changes going forward.
➢ State pension plans will face additional challenges from COVID-19, both in
terms of budget stresses for plan sponsors and additional volatility in plan
investments.
➢ A actuarial funding policy allows pension funding to adjust to market
performance and would allow current policy to be sustainable across a
range of scenarios.
David Draine
pewtrusts.org/publicpensions
Ben Henken
pewtrusts.org/publicpensions
pewtrusts.org
Appendix
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Source: The Pew Charitable Trusts, The Terry Group, and FactSet Research Systems Inc. Based on Federal Reserve’s “2017 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules.”
Pew’s Asset Shock ScenarioInvestment returns are similar to those during Great Recession
Question: Why Pew’s asset shock vs. a simple 20% loss in year 1?
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Source: The Terry Group and The Pew Charitable Trusts
Range of Projected Employer Contribution RatesRates are expected to remain stable due to fixed-rate contribution policy; although unlikely, huge increases will come into effect if PAYGO benefits are required
Question: What is the range of possible outcomes for the ERC rate?
24
Source: The Terry Group and The Pew Charitable Trusts
Stochastic Trial 7792Mid-phase rise and late decline cause the funded ratio to drop to 66% by 2039 even with above average returns throughout much of the period
Question: What happens in a trial with a mid-period rise in assets and late decline?
Key Pension Terms
➢ Actuarial Required Contribution (ARC) – This is the sum of the actuarial cost of
benefits earned in the current year (called service cost or normal cost) and an
additional payment on the unfunded actuarial accrued liability (UAAL) called the
amortization payment. Also referred to as the Actuarially Determined Employer
Contribution (ADEC)
➢ Assumed Rate of Return – Estimated return on investments used by actuaries to
project the rate of return on plan assets and calculate the value of plan liabilities.
➢ Funded Ratio – Assets divided by the actuarial accrued liabilities. A measure of fiscal
health.
➢ Net Amortization – A measure of whether state pension funding policies are sufficient
to reduce, or amortize, pension debt in the near term.
➢ Pension Debt – The difference between the actuarial accrued liability and the value
of plan assets on hand. Also referred to as the Unfunded Actuarial Accrued Liability
(UAAL).
