New State Budget Solutions Study Shows $4.1 Trillion Pension Funding Gap
It’s no secret that most state pension plans across the country are deep in the red. However, a study by the nonpartisan group State Budget Solutions, Promises Made, Promises Broken: The Betrayal of Pensioners and Taxpayers, reveals that defined-benefit public government pension plans face a cumulative $4.1 trillion funding gap. Moreover, the study shows that combined, state pension plans are only 39 percent funded. In order for states to keep their pension promises to retirees and taxpayers, reform is crucial.
State Budget Solutions uses fair market valuation to fully examine state pension unfunded liabilities. Currently, there are two main approaches to calculating unfunded liabilities: the Governmental Accounting Standards Board (GASB), and fair market valuation. Both approaches have very separate views on the discount rate (the investment return that the retirement plan’s managers hope to achieve given market returns on investments) that they use to calculate unfunded liabilities. Fair market valuation uses a discount rate grounded in reality: the yield of a 15-year Treasury bond, which in the State Budget Solutions study is based on 3.225 percent.
GASB accounting, on the other hand, discounts pension liabilities according to the assumed annual rate of return of the plan’s assets, ranging from an optimistic 7 to 9 percent return each year for the next 30 years. In reality, market fluctuation often causes yields to be much lower over the long term. With such a high assumed rate of return, plan administrators are forced to look for riskier investments to chase the 7 to 9 percent return. As the State Budget Solutions study explains, “this reduces the resources required today to pay for the promises of tomorrow.” As a result, while the GASB approach estimates that pension funds are 73 percent funded, the fair market valuation approach more accurately reveals that state pension plans are only 39 percent funded.
To get the full picture of each state’s pension plan, State Budget Solutions analyzes each state’s overall funded ratio, unfunded liabilities per capita, and unfunded pension liabilities as a percentage of annual state gross product. Data is taken from Comprehensive Annual Financial Reports (CAFRs), the Census Bureau’s Annual Survey of Public Pensions, and state level financial reports. As a result, State Budget Solutions identifies 9 states that have notably large unfunded liabilities when compared to their population size and economic output: Illinois, Ohio, New Jersey, Oregon, Connecticut, Nevada, Hawaii, and Alaska. As we point out in our new pension reform publication, Keeping the Promise: State Solutions for Government Pension Reform, Alaska moved in a positive direction by adopting a defined-contribution plan for new government employees in 2006. However, the state still faces legacy costs of unfunded liabilities from the state’s defined-benefit plans.
Promises Made, Promises Broken demonstrates that state officials can no longer afford to ignore unfunded liabilities. The fair market approach used by State Budget Solutions promotes greater pension accountability. Transparent and accurate pension accounting is a positive step towards reform that will benefit government workers, retirees, and taxpayers. As Senator Dan Liljenquist, author of Keeping the Promise: State Solutions for Government Pension Reform recently explained, “[Pension reform] is not a partisan issue, nor a left vs. right issue or an employer vs. employee issue. It’s a reality issue.”