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 America's Sinking Public Pension Plans Are Now $1.4 Trillion Underwater

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PostSubject: America's Sinking Public Pension Plans Are Now $1.4 Trillion Underwater   Sat Apr 14, 2018 6:45 pm

Investment shortfalls, insufficient contributions reduced funded levels for public worker retirement plans

Many state retirement systems are on an unsustainable course, coming up short on their investment targets and having failed to set aside enough money to fund the pension promises made to public employees. Even as contributions from taxpayers over the past decade doubled as a share of state revenue, the total still fell short of what is needed to improve the funding situation.

There is no one-size-fits-all solution to the pension funding shortfall and the budgetary challenges facing individual states, but without new policies that commit states to fully funding retirement systems, the impact on other essential services—and the potential for unpaid pension promises—will increase.

The Pew Charitable Trusts analyzed the state pension funding gap for fiscal year 2016, the most recent year for which comprehensive data were available for all 50 states. This brief outlines the primary factors that caused the widening divide in most states between assets and liabilities, and identifies tools that can help legislators strengthen policies and better manage risk for their state’s retirement plans.

In 2016, the state pension funds in this study cumulatively reported a $1.4 trillion deficit—representing a $295 billion jump from 2015 and the 15th annual increase in pension debt since 2000. Overall, state plans disclosed assets of just $2.6 trillion to cover total pension liabilities of $4 trillion.

Investment returns that fell short of state assumptions caused a major part of the increase in the funding gap. The median public pension plan’s investments returned about 1 percent in 2016, well below the median assumption of 7.5 percent—a disparity that added about $146 billion to the debt.1 Assumption changes—primarily states lowering the assumed rate of return used to calculate pension costs—accounted for another $138 billion in increased liabilities.

Even if plan assumptions had been met in 2016, the funding gap would have increased by $13 billion because states did not allocate enough to their systems. As a whole, they would have needed to contribute $109 billion to pay for both the cost of new benefits and interest on pension debt; the actual amount contributed, $96 billion, fell short.

Preliminary information for 2017 indicates that the year’s strong investment performance will decrease reported unfunded liabilities, as public pension funds—which continue to allocate an ever greater share of assets to complex investments such as equities, hedge funds, real estate, and commodities that can produce higher returns than other assets but may also expose plans to increased risk—experienced gains from the upswing in financial markets. However, that same market volatility could have an adverse impact in the long term, especially if lawmakers also fail to make adequate annual contributions to state plans.

Even small changes to projected returns can significantly increase liabilities. Pew applied a 6.5 percent return assumption, instead of the median assumption of 7.5 percent, to estimate the total liability for state pension plans and found that it would increase to $4.4 trillion—$382 billion more than the current amount. The funding gap would then jump to $1.7 trillion.

Similarly, public pension disclosures are now required to estimate funding levels using investment assumptions at 1 percentage point above and below the plan’s assumed rate of return.

Ultimately, differences in state pension funding levels are driven by policy choices, with well-funded states having records of making actuarial contributions, managing risk, and avoiding unfunded benefit increases. Measures of plan assets as a percentage of liabilities in 2016 ranged from 31 percent in New Jersey to 99 percent in Wisconsin. Colorado, Connecticut, Illinois, Kentucky, and New Jersey were less than 50 percent funded, and another 17 states had less than two-thirds of the assets needed to pay promised benefits. Only New York, South Dakota, Tennessee, and Wisconsin were at least 90 percent funded. (See Figure 1.)

Other metrics of pension plans’ financial health can indicate whether contribution policies are sufficient to make progress in paying down pension debt and keeping assets from being depleted. For example, net amortization measures whether expected contributions would have been enough to reduce unfunded liabilities—if return assumptions are accurate—while a new indicator, the operating cash flow ratio, can give a better sense of annual changes. These tools can help policymakers better track the financial health of state pension plans and act when warranted.
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