There’s a strange paradox going on in public pension funding.
On one hand, pension plan assets are higher than ever. Rising stock markets–the S&P 500 has tripled since reaching a low in March 2009 and over the last 10 years, the largest public pension plans have earned an average return of 7.45 percent, broadly in line with the median long-term goal of 8 percent–have boosted pension plan coffers to the highest level of assets they’ve ever had. Nationwide, state and local pension plans have collectively accumulated $3.7 trillion, an astonishing sum of money.
On the other hand, pension funding ratios remain virtually unchanged. According to the latest figures, pension plans have not made much of a dent in their long-term unfunded debt. How could this be? A recent article from The Arizona Republic summarizing a Moody’s Investors Services report helps illustrate why:
1. Insufficient Contributions: State and local governments have a tendency to under-fund pensions even during good times. But economic crashes hit pensions at the same time they hit state and local governments. When faced with the choice of contributing to under-funded pension plans or paying for current services like schools, roads, and prisons, politicians tend to opt for the latter.
2. Compound Interest: When governments delay contributions into the future, they’re inevitably raising the long-term cost of the debt. Like a creditor paying off only their minimum balance, states have pushed many of their costs out to some future day of reckoning.
3. Less Aggressive Assumptions: Many states responded to recent recessions by adjusting their investment assumptions down from 8.25 to 8 percent or from 8 to 7.5 percent. It’s important and a good policy for states to recognize a more modest investment return, but it forces them to admit much higher liabilities than they previously assumed.
4. Actuarial Miscalculations and Demographic Changes: Pension plan valuations depend on assumptions about a host of factors like how much employees will earn, how long they’ll stay, how long they’ll live in retirement, etc. Things like higher-than-expected pay raises, higher retention rates, and longer life spans all add liabilites to a pension plan. States have tended to err on the side of under-estimating their actual future costs.
The end result is that pension plans are in almost exactly the same shape they were during the worst of the recent recession. Pension plans were counting on rising stock market values to overwhelm these factors, but so far that bet hasn’t panned out. The horrifying truth is that the current bull market–which has already been one of the best periods in modern history in terms of both duration and strength–has been unable to significantly restore pension valuations. That’s a scary reality for taxpayers, retirees, and current workers, who must hope markets continue to rise. If not, and until we see more systematic reforms, we may see another round of contribution increases and benefit cuts.
– Chad Aldeman
This first appeared on teacherpensions.org
Last updated October 8, 2014