Unaccountable and Unaffordable 2019: A Snapshot of Pension Liabilities Before COVID-19
Like much of the economy, COVID-19 hit public pension investments like a wrecking ball. Early reports from Moody’s estimated that state public pension plans lost nearly $1 trillion in pension investments. More recent estimates note that public pension investments still need a sharp rebound to maintain the average funding ratio levels from last year. and unfunded liabilities are growing.
This year’s Unaccountable and Unaffordable is important because it shows that pension underfunding existed long before COVID-19. Data from FY 2018 shows that, long before anyone could imagine a pandemic hitting the United States, , unfunded pension liabilities totaled nearly $5 trillion.
For years, state pensions have not been properly funded. Decades of irresponsible fiscal policy contributed to the budget nightmare in Illinois, for example. Rather than make the full Actuarially Determined Contribution (the payment required to cover normal costs and amortize liabilities from previous years), Illinois statute allows the state to make a payment amount that is based on its own calculations.
By FY 2018, Illinois had $359.6 billion in total unfunded liabilities or just over $28,000 in unfunded liabilities per capita (49th in the country – with 50th being the worst – for both total and per capita unfunded liabilities). While it is second to only California in total unfunded liabilities, Illinois’ shrinking tax base and BBB-/Baa3 credit rating are very troubling. Now, Illinois is looking to Congress and the Federal Reserve to bail the state out.
In addition, putting politics above fiduciary responsibility has deeply hurt pension investments. The California Public Employee Retirement System (CalPERS) lost millions of dollars in the bull market because it chose to divest based on a political agenda. Such risky decisions will only hurt more in a bear market. While New York State has held off proposals for fossil fuel divestment, the state does incorporate environmental, social and governance considerations into its investment process.
The problem with any type of investing (or divesting) based on a political agenda is that it allows politics to undermine fiduciary duty (providing the highest return at the most reasonable level of risk).When state leaders try to make a political statement when investing or divesting in retirement funds, billions of dollars in investment performance can be left on the table, and public workers are stuck with an underfunded pension system.
But not all pension news is doom and gloom. Many pension plans began seeing the positive effects of reform. For example, the Tennessee Consolidated Retirement System started enrolling new hires in a hybrid pension plan in 2014. A hybrid plan combines a traditional pension (which pays out a smaller amount at retirement) with a 401(k)-retirement account (which employees can invest pre-tax dollars in while working). Now, Tennessee currently has the lowest unfunded liabilities per capita in the country at $5,454 per resident.
In addition, Maine and Wisconsin have set up plans that vary contribution and benefit rates based on how well the plan is funded. If the plans fall below a certain funding ratio (assets divided by liabilities) an automatic “trigger” is set off, which alters contribution rates, benefit rates, or cost of living adjustments until funding ratios rise again.
Since 2016, Maine’s unfunded liabilities have decreased by almost $10 billion, and Wisconsin has had the largest pension funding ratio (assets divided by liabilities) at 70.37%, maintaining its status as the best funded pension system in the country since 2012.
Going forward after COVID-19, states should look to emulate sustainable pension reforms and sound funding practices will secure retirement savings for workers, lower the burden on taxpayers and prepare pension systems for future economic downturns.