The massive shortfall in the state Employees’ Retirement System pension fund significantly dropped last fiscal year thanks to the best investment performance in the portfolio’s 96-year-history.

It was the first decline in the plan’s unfunded liability since 2007.

Irving, Texas-based actuary Gabriel, Roeder, Smith & Co. said in a newly released report that the unfunded liability in Hawaii’s largest public pension fund decreased to $14.2 billion from $14.6 billion in the 2021 fiscal year that ended June 30. The actuary pre­viously calculated that the fund’s deficit would continue growing and peak in 2026 before beginning to trend downward.

But last year’s 26.9% investment return in the fund, which provides benefits to more than 148,000 members and beneficiaries, has accelerated the time frame the portfolio will be 100% funded to 24 years, or June 30, 2045, a decrease from the prior year’s funding period of 26 years. The funding ratio, or the percentage of the fund needed to reach 100%, also improved as it rose to 58.3% from 55.3% in fiscal 2020. Assets rose to a record $21.9 billion from $17.4 billion in 2020.

ERS Executive Director Thom Williams described the improvement as “exceptional.”

“Many factors, both demographic and economic, influence actuarial outcomes,” he said in an email. “We have structured our program to achieve solid long-term gains from both an actuarial (demographic) and investment (economic) perspective. This year’s investment return of 26.9% has substantially improved our long-term outlook and is overwhelmingly responsible for the improvements we’re able to report.”

He said it is “enormously gratifying” to have the unfunded liability decline sooner than expected.

“As our actuary has stated, before your debt can get to zero it has to start going down,” he said. “Absent particularly adverse experience, we expect it to decline each year from this point forward. Importantly, this signals that our overall strategic administrative and investment plan is working and that our probability of long-term success has substantially improved.”

The state has taken steps in recent years to shore up the ERS shortfall, with lawmakers passing legislation in 2017 to close the funding deficit that was created partly due to existing unfunded liabilities, retirees living longer, and lower projected investment returns that now assume an average annual increase of 7%.

Those legislative pension reforms included increased contributions from state and county employers, namely taxpayers, that are based on a percentage of an employee’s pay. Those contributions were phased in over a four-year period for police and fire employees as well as all other employees. The employees’ contributions remained constant during that period.

The employer contribution rate for police and fire employees increased to 41% for fiscal year 2021, and the employer contribution rate for all other employees increased to 24% for the same year. That was the final phase of the increase in the employer contribution rates. Those contribution rates will remain in effect throughout the 24-year funding period, and under current law, rates are expected to stay at those levels until the ERS is fully funded.

“Of course, the new tier of benefits introduced in 2012 (which reduced the level and value of future benefits), in combination with employer contribution increases, have played meaningful roles in our plan’s improved positioning,” Williams said. “However, the biggest factor by far was this year’s extraordinary investment return.”

Williams said reducing the unfunded liability, shortening the plan’s period to full funding and increasing the funding ratio is a welcomed change of fortune.

“Collectively, these results represent several billions of dollars in potential savings to the state, counties, employers and taxpayers as full funding may be achieved earlier than forecast and total dollars paid in interest on the unfunded liability decline,” he said.

PENSION FACTS

The state Employees’ Retirement System actuarial valuation for fiscal years 2021 and 2020. The fiscal year ended June 30 of each year.

CATEGORY 2021 2020

Unfunded liability $14.2 billion $14.6 billion

Funded ratio 58.3% 55.3%

Funding period 24 years 26 years

Investment return 26.9% 2.1%

Assets $21.9 billion $17.4 billion

Source: Gabriel, Roeder, Smith & Co.