State and local pension funds were underfunded by roughly $700 billion in 2009, about 22 percent less than their future needs, the Congressional Budget Office said in an issue brief issued late Wednesday. That’s the lowest level of pension funding in 20 years.
Yet that low level of assets was driven largely by the sharp downturn in stock and bond markets that year that has since reversed. The result, the report noted, is that “most state and local pension plans probably will have sufficient assets, earnings, and contributions to pay scheduled benefits for a number of years and thus will not need to address their funding shortfalls immediately.”
The study looked at 126 state and local pension plans with $2.6 trillion in assets, which account for about 85 percent of the state and local plans in the U.S. Total liabilities for the plans stood at $3.3 trillion in 2009. CBO used the same data used by The Fiscal Times, whose review of state pension plans found just two states were fully funded in 2009.
While the CBO took no position on what states and municipalities should do to close the funding gap, it noted that its size was largely determined by assumptions that were highly speculative. Retiree payments stretch out over several decades, while assets to pay those liabilities are recalculated every year.
For instance, Government Accounting Standards Board-approved assumptions currently in use blend asset prices over a three-year period and project their market value will grow by about 8 percent a year to cover future liabilities. If existing market prices were used for assets held in 2009, when stock prices plunged to a 10-year low, and the future growth rate assumption were lowered to 5 percent, the unfunded liabilities would skyrocket to $2.2 trillion or 55 percent of future liabilities.
CBO offered reasons for and against moving to a fair-market approach to assets, which would create a far more volatile measure of long-term underfunding. “The fair-value approach may discourage risk taking on the part of fund managers,” the report noted. On the other hand, the increased volatility would make “budgeting for the required contributions more difficult.”
After noting the various steps states have taken to reduce their pension shortfalls – a mix of cutting benefits, raising taxes and increasing employee contributions – the CBO report noted that while “the amount of underfunding of state and local pensions is substantial, it is not necessarily in the best interests of taxpayers for states and localities to completely prefund their pension liabilities.
“Ultimately, judgments about the amount and timing of additional funding that should be provided for underfunded plans depend on many factors, including competing budget priorities, views about intergenerational fairness, and the amount of risk the sponsors are prepared to take.”
While it might make sense to fully fund police and fire pensions, for example, since those are current services that do not provide future benefits, putting off full funding for teacher pensions could be justified based on the idea that the returns from education lie in the future. “The services provided by school teachers might be justifiably financed, at least in part, by future taxes on people who are now students,” the report said.
Related Links:
Underfunded State Pension Plans Create Credit Risk (The Fiscal Times)
Ten States Where Pensions are Running Out of Money (24/7 Wall St.)
