Though the fortunes of state pension plans made a 180-degree turn as the stock market fell this year, only a handful appear to be at risk of insolvency over the next few decades.

“Most public plans are fragile, not distressed,” said Anthony Randazzo, executive director of Equable, a bipartisan non-profit that works with public retirement system stakeholders to solve pension funding challenges.

 State and municipal retirement systems are on track to lose nearly half of 2021’s record investment gains and economic growth that pushed pension funds’ unfunded liabilities below $1 trillion in 2021, bringing the aggregate funded ratio to 84.8%, according to the 2022 State of Pensions report released Wednesday by Equable.

The funded ratio is projected to decline to 77.9% in 2022 from 84.8% in 2021, a loss of roughly half of last year’s improvement and the largest single-year decline since 2009, according to the report. The vast majority of plans have a fragile (90% to 60%) funded ratio, according to Equable, as opposed to a distressed (60% or less) funded status.

The 2022 stock market decline is projected to push the unfunded liabilities of state-run pension systems to $1.3 trillion for the fiscal year, completely undoing gains achieved in 2021, according to a Reason Foundation analysis.

“The risk of pension plan insolvency exists only in the medium-term for a handful of entities,” Tom Kozlik, head of municipal strategy and credit at HilltopSecurities, said.

What an insolvency would look like is that the “assets would be depleted from the plan and then the entity would be forced to pay pensioners on a pay-as-you-go basis from annual revenues,” Kozlik said. “This would be very difficult for most public sector budgets to handle.”

Last year, “people made a big deal about New Jersey making its full actuarially determined contribution (ADC) payment, but it was because of the risk of asset depletion,” Kozlik said.

“We are only seeing the potential for insolvency, in a couple of funds in Chicago, (one of the police plans, a municipal fund and the fireman’s fund have funded ratios between 19 and 23%), and maybe Kentucky’s non-hazardous pension fund,” Randazzo said. “As it stands, most plans have decades of cash to be able to pay off beneficiaries. So the concern, right now, is will they be able to pay off benefits in the next 20 or 30 years, or might they run out at 60? But, does it mean, they will have less money for roads, schools or anything you want to do in the public sector?”

And while Randazzo expects downward pressure on funded ratios, “it doesn’t mean they are falling off a cliff like after the 2008 financial crisis.”

As the pension funds lowered assumed return rates to ratchet their unfunded liabilities in the years after the 2008 economic crash, it pressured the finances of some local governments to the point that they flirted with insolvency, conducted layoffs or outsourced fire departments. In California, some pension funds explored exiting the California Public Employees’ Retirement System.

“In the near term, state and local government credit quality remains very strong,” Kozlik said. “This is a much different situation state and local governments find themselves in now, compared to just after the Great Recession. Many still have decent amounts of the 2021 federal aid available to them and they can use it to balance out any near-term fiscal issues. It is important they deploy the federal aid effectively, while also keeping the importance of structural balance in mind.”

When the average unfunded ratio fell to 10% amid the stock market gains of 2021, it appeared the pension stress was behind us, said Todd Kanaster, an analyst with S&P Global Ratings, but that no longer appears to be the case.

While last year’s improvements in pension unfunded ratios had S&P analysts weighing whether to upgrade ratings, they decided they would need to see it continue, and it did not, Kanaster said.

CalPERS, the largest pension fund in the country with $440 billion in assets under management, announced Wednesday a preliminary -6.1% net return on investments for the 12-month period that ended June 30, 2022.

“We’ve done a lot of work in recent years to plan and prepare for difficult conditions,” CalPERS Chief Executive Officer Marcie Frost said in a statement. “Despite the market conditions and their impact on our returns, we’re focused on long-term performance and our members can be confident that their retirement is safe and secure.”

The “tumultuous global markets” played a role in CalPERS’ first loss since the financial crisis of 2009, according to the pension fund, which pointed to volatile financial markets, geopolitical instability, domestic interest rate hikes, and inflation for the decline in public market returns.

With CalPERS’ discount rate of 6.8% and this year’s preliminary return of -6.1%, the estimated overall funded status stands at 72%.

CalPERS’ investments in global public stocks returned -13.1%, while fixed income investments returned -14.5%. Public market investments make up roughly 79% of the CalPERS’ total fund. The fund’s private market investments fared better, with private equity and real assets sectors returning 21.3% and 24.1% respectively.

“This is a unique moment in the financial markets, and we’ve seen a deviation from some investing fundamentals,” said CalPERS Chief Investment Officer Nicole Musicco, who was named to the position five months ago.

The fund’s traditional diversification strategies were less effective, because “both public equity and fixed income assets fell in tandem,” Musicco said in a statement.

“But despite, a challenging year, we were able to outperform our total fund benchmark by 90 basis points and provide strong returns from our private market asset classes,” Musicco said. “These are the bright spots that we can build on as we implement our new strategic asset allocation and increase our exposure to private market assets.”

CalPERS’ total fund annualized returns for the five-year period ending June 30, 2022, stood at 6.7%, the 10-year period at 7.7%, the 20-year period at 6.9%, and 30-year period at 7.7%, according to the pension fund.

One solution local governments have turned to pay down unfunded pension liabilities is pension obligation bonds, but the increase in interest rates raises questions about whether that is a now a viable solution.

The thinking behind POBs is that if a pension system can borrow money at a lower rate by selling bonds and earn a higher percentage from investing those funds, then it can realize a net gain.

In California, POB sales have slowed to 15 in the first six months of the year, five in January; compared to 42 sold in 2021, according to California Debt and Investment Advisory Commission data.

In the first six months of 2022, POB issuance was half of last year’s total, CDIAC data shows, which puts issuance on track to be the same as last year.

Issuance in the first two months of 2022 was up from the year before. Given how many months it takes to put a deal together, some issuers may have decided to go ahead with deals set in motion in 2021, particularly earlier in the year, said Marc Joffe, an analyst with Reason Foundation.

But there are few scenarios that would make sense for issuers to sell POBs right now given the escalating interest rates, Joffe said.

“If there is a triple A entity that needs to issue a POB, it might still be possible to get the interest rate, but it would depend day-to-day on market conditions,” Joffe said.

Brian Whitworth, a HilltopSecurities director, who specializes in POB deals, said deal volumes did start to slow as interest rates began to creep up.

“There are still deals in the works, but there are some that are sitting and waiting,” Whitworth said, those that would exceed the maximum interest rate set by their City Council.

Whitworth doesn’t see POBs falling out of favor, given the lower funded levels reported, but expects issuers might look at shorter maturities, which lower interest rates relative to a longer-term bond, and opt to sell larger ones.

Though CalPERS reported its funded status, the local pension systems served by CalPERS have not received their reports.

“The investment losses are phased in over five years, so it gives them a decent planning horizon,” Whitworth said. “If interest rates come down over the next two years, you would get an awful lot of people interested. And probably for larger bonds than in 2021, because the unfunded liability is bigger.”