This Report addresses the widespread underfunding of the retirement systems in the nation’s state and local governments. It begins by summarizing some past, current, and probable future trends of unfunded pension liability at the state and local levels. It describes the scope of unfunded pension debt in various state and local jurisdictions and calculates both their aggregate debt and per capita debt, based on states’ self-assessments; it then incorporates a variety of other measurements of unfunded liability. Results from many of those other measures suggest that the magnitude of unfunded pension liability may be considerably larger than previously indicated.
This Report then describes and analyzes the inherent dynamics of government retirement systems that have produced this underfunding, finding that there are a variety of pressures and processes within these retirement systems that can operate to the disadvantage of employees, beneficiaries, and the public generally. It then summarizes attempts to reform pension systems in several states. Some of those states now have relatively sound retirement systems; others less so. It then contrasts the requirements that govern most private-sector pensions to the relatively relaxed regulatory regimes of state and local government pensions, concluding that adoption of rules similar to those governing private sector requirements would likely have positive consequences if implemented for state and local government pension plans and their beneficiaries.
The nation’s experience with unfunded pension liability at the state and local government levels may provide some lessons for policymakers; this Report concludes with several recommendations in this area.
Author(s): Daniel Greenberg: Senior Policy Advisor in the Veterans’ Employment and Training Service; Jay Sirot: Special Assistant in the Office of the Assistant Secretary for Policy
Pension costs are already eating away at Illinois government services. The ballooning costs caused a nearly one-third cut since 2000 in core services such as child protection, state police, mental health and college money for low-income students.
Pension contributions accounted for less than 4% of Illinois’ general funds budget from 1990 through 1997 but have grown to consume 28.5% of the budget. Still, the pension debt has mushroomed to $144.4 billion by the state’s estimates, which more realistically was at an all-time high of $261 billion at the end of fiscal year 2020 according to Moody’s Investors Service calculations using more realistic assumptions. In any case, public pension debt is eating a larger chunk of Illinois’ gross domestic product than anywhere else.
Last week, the House Ways and Means Committee approved a massive taxpayer bailout of private sector multiemployer defined benefit pension plans, or MEPs, as part of a budget reconciliation package that is purportedly meant to deal with COVID-19. Senate Budget Committee Chairman Bernie Sanders claims MEPs are underfunded because “of the greed on Wall Street.” But MEPs are troubled because of mismanagement, not because of COVID-19 or Wall Street.
MEPs are jointly sponsored by a union and companies employing members of that union. It is not clear why taxpayers, who had no role in making these pension promises, should be funding them.
The proposal would saddle taxpayers with unfunded pension promises made by eligible MEPs, which are underfunded by more than $100 billion, while providing perverse incentives for other MEPs to subsequently qualify. This would be extremely expensive as MEPs are already underfunded by $673 billion as of 2017 (a funding ratio of 42%).
Vermont Treasurer Beth Pearce released a report containing recommendations that she said could reduce pension UAAL for the Vermont State Employees’ Retirement System (VSERS) and the Vermont State Teachers’ Retirement System (VSTRS) by $474 million and reduce the actuarial determined employer contribution (ADEC) by $85 million.
“While shy of the total target of $604 million in the UAAL and $96.6 million for the ADEC, it is a significant reduction to the existing liabilities and costs to the taxpayer,” said the report, which added that the net other post-employment liabilities could be reduced by $1.68 billion by directing a “minimal amount” of funds for prefunding. “All in, these recommendations will reduce the state’s post-employment liabilities by $2.2 billion.”
According to the report, the county’s retirement apparatus is now 71% funded, compared to 70% in January 2020.
Although the unfunded pension gap increased from $3.5 billion to $3.6 billion in that time, the total market value of the county’s assets also grew, from $8.1 billion to $8.8 billion, according to PARC.
If investment growth remains positive, and the county’s financial condition does not suffer from additional financial shocks like the one stemming from coronavirus, PARC estimated that the 80% funded status could be attained by 2027.
As states respond to the Covid-19 pandemic, many also face severe revenue shortfalls because of the economic downturn. These gaps between resources and planned spending pose immediate challenges for policymakers, who must balance budgets while addressing increased demand for public health and other essential services. Some states have already tried to cut costs by reducing or delaying contributions to public pension plans, and others may consider doing so if federal aid to states does not materialize.
The pandemic’s effect on state budgets has been significant. Fiscal year 2020 marked the first time that state general fund revenues declined since the Great Recession, with preliminary projections issued since March showing that states expected fiscal 2021 revenues to fall below initial estimates by about 10%, on average. More recent estimates indicate that state revenue shortfalls could total more than $300 billion cumulatively over fiscal years 2020-22.
“Everybody knows it exists,” Rep. Adam Koenig, R-Erlanger, said of illegal sports betting. “Everybody knows it happens. But people who do it don’t have any protections and the state’s not reaping any benefits from it.”
For several years now Rep. Koenig has sponsored sports wagering bills, including House Bill 241 this session.
He says an estimated $2 billion is wagered illegally in Kentucky each year. Under HB 241, five percent of the net money the state receives from sports wagering would go to addiction prevention and treatment, with the rest going toward the state’s pension liabilities.
Using publicly available data and annual financial reports published by FRS, our quantitative team has built an actuarial model of the FRS system that has allowed our analysts to spotlight areas of systemic risk and inefficiencies that have resulted in not only the FRS defined benefit plan going from 118 percent funded and a surplus of $13.5 billion to 82 percent funded and holding over $36 billion in earned, yet unfunded, pension obligations that are implicitly protected by law, but also how the defined contribution Investment Plan, as currently built today, falls well short in providing adequate retirement security to public sector employees.
Regarding the current state of the FRS pension plan, underperforming investment returns have been the largest contributor to the unfunded liability, adding $17 billion in debt since 2008. Milliman Inc.—the actuaries hired by the system—warned for three straight years (2016, 2017, and 2018) that the system’s assumed rate of return was not reasonable, leading to its eventual reduction to 7.0 percent. Even with the reduced assumption, however, our analysis indicates that FRS still has a less than 40 percent probability of achieving or exceeding that rate over the next ten years. Market outcomes below FRS expectations will still likely be an issue generating unexpected costs for taxpayers, and the unfunded liabilities that exist today will continue to inhibit plan assets from compounding over decades, making paying down the $36 billion debt and honoring the state’s long-term obligations more difficult.
Next year’s state budget proposal includes an extra $66 million for Georgia’s massive teacher and university pension system to keep it on solid financial footing.
But after not meeting its assumed rate of investment return in fiscal 2020 — which ended June 30 — the more than $90 billion Teachers Retirement System has made a strong recovery during the COVID-19 pandemic, as did the investment markets it relies on to make sure it can pay pensions to 137,000 former educators.
A similar program that provides pensions to 50,000 state employees — the Employees Retirement System — saw a similar bounce back.
Buster Evans, executive director of the TRS and a former school superintendent, told a legislative retirement committee Tuesday that the teacher system saw a return on investments in 2020 of about 15%, which is pretty close to the return for the S&P 500-stock index.
“We are glad we had a V-shaped recovery,” Evans said.
That’s good news for a system relied on by more than 400,000 former and current educators to provide retirement benefits.
The system has had its ups and downs in recent years, with the state having to make huge contributions at times to keep the books in good shape. Those taxpayer contributions have prompted Republican lawmakers to raise the possibility of making changes to the pension programs, something teacher groups have fought off.
When the markets plummeted at the beginning of the pandemic, the system’s assets lost billions of dollars in value.
“There was a sick feeling in my stomach,” Evans told the TRS board last year.
But the TRS has ridden the wave of market gains since then.
Over time, changes in a pension plan’s funded ratio, also referred to as a pension’s funded status, can show the rate at which the plan’s debt is growing.
In 2001, West Virginia was the only state where public pension plans had an aggregate funded ratio of less than 60 percent. However, 18 years later, in 2019, nine states faced aggregate funded ratios below 60 percent.
In that same time period, the number of states with funded ratios below 70 percent (but above 60 percent) grew from three to 14. Together, these numbers show that, as of 2019, 23 states had less than 70 percent of the assets on hand that they need to be able to pay for promised future retirement benefits.