The Growing Crisis in State Pension Funds

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Andrew Vaz
December 4, 2015

The majority of the American workforce has some form of a retirement fund, known as a pension plan. You may identify it as a Thrift Savings Plan (TSP) or a 401(k). Either way, there is a financial package in place upon retirement in the future.

What the majority of Americans may not realize is the growing crisis in the allocation of pension funds, especially concerning state public service pensions. Now, not every American works for their state government. However, a good number do. The question is beyond whether governments should overhaul or underfund pension plans, but what can government do to fix the problem.

Let’s establish what a pension fund is. A pension fund is established by an employer (in this case the government) to facilitate and organize the investment of employees’ retirement funds contributed by the employer and employees. The pension fund is a common asset pool, meant to generate stable growth over the long term and provide pensions for employees when they reach the end of their working years and commence retirement. You can imagine the level of appreciation of public service workers over their future earnings toward pensions. That’s why there is a great concern over the lack of funding with most pension funds, a phenomenon occurring in a number of states.

Many states promise a certain amount for public employee retirement benefits, but do not deliver in the end. According to this post from State Budget Solutions, last year’s unfunded pensions reached an all-time high of $4.7 trillion. This funding gap is affecting every state, but for some it hits harder than others. In the United States, pension funds include schemes that result in a deferral of income by employees, even if retirement income provision is not the intent. The United States had $24.5 trillion in retirement and pension assets ($15.5 trillion in private funds, $9 trillion in public funds) as of June 30, 2014. The largest 200 pension funds accounted for $4.540 trillion as of Sept. 30, 2009.

State employee retirement systems are underfunded by $4.7 trillion, for a funding ratio of 36 percent, said a report from State Budget Solutions, a nonprofit organization advocating state budget reform. The nation’s state-run retirement systems had a $968 billion shortfall in 2013 between pension benefits governments have promised to their workers and the funding available to meet those obligations—a $54 billion increase from the previous year.

Many states are working to discount liabilities based on the equivalent of a bond yield from the U.S. Treasury. Using fair market valuation, the discount rate should help to balance out public pension payments but the payments will still come up short.  However, if the theory behind this method is correct, it should gradually bring the funded ratio to a more reasonable rate.

Many states’ fiscal health continues to suffer as the economy struggles to regain its footing. Because of the lack of capital to back current pension plans, there is not much that can be done to improve the current status. But there are several actions being taken by the most underfunded states.

Pension Debt 

On top of the lack of funding to state pension programs, they are largely in debt. The nation’s state-run retirement systems had a $968 billion shortfall in 2013 between pension benefits governments have promised to their workers and the funding available to meet those obligations—a $54 billion increase from the previous year.

However, state governments are making efforts to fix this matter by making steady, level interest payments rather than deferring larger payments until later and using defined payment schedules, called closed amortization periods. States such as Tennessee and West Virginia have succeeded in reducing their unfunded liabilities by adhering to debt payoff plans designed to close the funding gap. Alabama and Arizona have fallen short of this measure in the past but made recent changes to their contribution policies, specifically switching to a closed funding schedule so the current pension debt will have to be fully paid off within a fixed period. That may improve how they stand in the future. 

Conclusion

If state governments are devoted to the long-term protection and maintenance of pension plans, there will not be a need for a massive overhaul of one of the nation’s retirement systems.

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Author: Andrew R. Vaz, M.S., M.P.A., is a graduate of the Master of Science in Criminal Justice and Master of Public Administration double master’s program at Florida International University. He can be reached [email protected].

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