The recent financial crisis and economic recession have left many states and localities with extraordinary budgetary difficulties for the next few years, but structural shortfalls in their pension plans pose a problem that is likely to endure for much longer. This issue brief discusses alternative approaches to assessing the size of those shortfalls and their implications for funding decisions.
The recent financial crisis and economic recession have left many
states and localities with extraordinary budgetary difficulties for the next
few years, but structural shortfalls in their pension plans pose a problem that
is likely to endure for much longer. This issue brief discusses alternative
approaches to assessing the size of those shortfalls and the implications of those approaches for
funding decisions:
- By any measure, nearly all state and local pension plans are underfunded, which means that the value of
the plans' assets is less than their accrued pension liabilities for current
workers and retirees.
- There are two leading approaches for valuing assets and liabilities, and the reported amount of underfunding varies significantly depending on which one is used.
- Decisions about how to address the underfunding can be informed by the choice between those two
measurement approaches, but there is no necessary connection between the information
provided by the two approaches and decisions about how much a plan's sponsor
should contribute each year.
According to the Public Fund Survey of 126 state and local pension plans, which account for about 85 percent of pension assets and participants in state and local pension plans in the United States, those
plans held roughly $2.6 trillion in financial assets in 2009 but had about $3.3
trillion in liabilities for future pension payments. Thus, those assets covered
less than 80 percent of liabilities, and unfunded liabilities (the amount by
which liabilities exceed assets) amounted to roughly $0.7 trillion. That
share of liabilities covered by assets in 2009 was the lowest percentage in the
past 20 years. By comparison, the amount of state and local governments' debt
that was outstanding at the end of 2009 was $2.4 trillion.
That estimate of unfunded liabilities is calculated on the basis
of actuarial guidelines currently followed by state and local governments.
Another approach for measuring pension assets and liabilities, which more fully
accounts for the costs that pension obligations pose for taxpayers, yields a
much larger estimate of unfunded liabilities for those plans in
2009—between $2 trillion and $3 trillion.
In any event, 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. But they will probably have to do so eventually,
and the longer they wait, the larger those shortfalls could become. Most of the
additional funding needed to cover pension liabilities is likely to take the
form of higher government contributions and therefore will require higher taxes
or reduced government services for residents. Additional funding for pension
benefits already accrued is unlikely to come from current workers; state laws
and court opinions indicate that efforts toward that end could be successfully
challenged in court in the majority of states.
Decisions about the amount and timing of the additional funding
for underfunded plans will depend on many factors, including competing budgetary
priorities, views on intergenerational fairness, and the amount of risk that
plans' sponsors are prepared to take. If the financial condition of state and
local pension plans worsened, the federal government might be asked to assist
in the funding of such plans. If granted, such assistance would raise the
federal deficit and debt, unless offset by higher taxes or lower spending in
other areas.
