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The Ticking Time Bomb in Public Sector Pension Plans—And What Can Be Done To Solve the Problem

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

By Stephen R. Rolandi 
February 4, 2022

Persons in the public sector in the United States—sanitation workers, firefighters, police officers, teachers, administrators and other state and local government employees—have performed their duties for many decades with the understanding that their salaries, which do not compare favorably with their counterparts in the private sector, would be nonetheless supported by excellent benefits, including strong pensions to be enjoyed upon retirement and good health insurance coverage plans. 

In the United States, public employee pension plans—formally known as Public Employee Retirement Systems (PERS)—are offered at all levels of American government to most, but not all public sector employees. Most of these plans are defined benefit pension plans, where employees typically vest after a time period of around 5-10 years of service. Historically, public pensions began in the United States through various promises—informally and formally legislated—made to veterans of the American Revolution and more extensively of the Civil War (1861-1865). In the late 19th and early 20th centuries, they were greatly expanded to include military and civilian retirees.  

In recent years, however, public pension systems in a majority of state and local governments are experiencing severe funding shortfalls that, according to Moody’s Investors Service and the Wharton School, are estimated to be as high as a total of $5 trillion—this is an amount equal to approximately 17 percent of the U.S national debt. By contrast, private sector pension plans of Fortune 1000 companies—largely contributory in nature—are very strong; one estimate made by the Milliman Pension Funding Index in late 2021 put the percentage of full funding at 99.6 percent.   

Put another way, the average public pension shortfall would translate to about $35,000 per public employee, that is, before one calculates the looming shortfall in Social Security benefits. If you combine both pension and Social Security benefits, the shortfall per retiree could be as high as $171,000.   

States and local governments will tell you that they can fund 70 percent of their current pension obligations; however, the real number is closer to 45 percent, according to Professor Olivia Mitchell of the Wharton School of the University of Pennsylvania and Director of the Pension Research Council at Wharton.   

While some states—notably, Vermont, New York and Iowa—have very strong pension systems, other states such as Illinois, New Jersey, Maryland, Wisconsin and Tennessee are much weaker. Illinois, according to Pew Charitable Trusts, has the lowest funding ratio, currently 39 percent as of November 2021.    

How did this situation occur?  

There have been a number of reasons suggested to explain this, and many analysts say that there is enough blame to go around: 

  • Reliance on overly optimistic actuarial assumptions (for example, retirees would not live as long when they retired; now they are living much longer); 
  • There has been little Federal oversight of such actuary pension assumptions; 
  • Government pension administrators believed that investment returns (pension funds are invested in private markets) would be very high; and in recent years, they have not been; also, many believed that the long-term nature of these pension investments could handle higher risk; this has not been the case;  
  • Compounding this problem, state and local governments are also facing increasingly large health insurance obligations. 

Many analysts believe that this problem can be fixed, and suggest the following solutions: 

  • Enact pension reform legislation, as was done in New York in 2011 during the administration of now former Governor Andrew Cuomo, by creating newer pension plans (Tier V and VI) for younger employees which raised the retirement age from 62 to 65; increased pension contributions made by retirees; and eliminated “pension padding”—this refers to the practice of including overtime earned in the final years of one’s service to boost the final average salary (FAS) from which pension benefits are calculated; 
  • Use more conservative actuary assumptions when determining pension system benefits; 
  • Devise more efficient investment fund strategies for state-appointed pension fund managers. For example, my colleague and trade association executive Mark Uncapher, who formerly served with New York State Controller Edward V. Regan, pointed to recommendations made in 2020 by the Maryland Public Policy Institute that a portion of state pension funds be shifted to low-cost, passively managed index investments, as well as transition future state employees to 401(k) style defined contribution plans similar to ones offered to private sector employees; 
  • Require state and local governments to be more transparent about pension fund obligations to government employees, citizens and investors as to how pension funds are handled. This in turn should lead to such stakeholders being more proactive in such matters.  

In my opinion, these are good suggestions which can lead to a better state of affairs. 

I also believe that public sector employees (and eventual retirees) need to become better educated about long-term financial planning and not rely exclusively on pensions and social security as a nest egg. Time will tell. 


Author: Stephen R. Rolandi retired in 2015 after serving with the State and City of New York. He holds BA and MPA degrees from New York University, and studied law at Brooklyn Law School in its J.D. degree program. He is an adjunct professor of public administration at John Jay College of Criminal Justice (CUNY) and Pace University, where he teaches courses in public finance, public policy and the not-for-profit sector.  He is a past President of ASPA’s New York Metropolitan Chapter and served four terms on ASPA’s National Council, in addition to serving as either an officer or director on several association boards in New York City, Washington, D.C. and Westchester County, NY. You can reach him at: [email protected] or [email protected] and at 212.237.8000 or 914.536.5942 

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