Economics, Entitlements

Leading and lagging on public-sector pensions, state by state

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The most important issue you probably won’t hear about during the run up to this year’s election is public sector pension liabilities. Even though it accounts for billions of dollars in spending and affects millions of state and municipal employees, the sad state of many pension funds barely makes a blip on the radar.

At its core, adequately funding pensions is about keeping a promise. Public sector employees were told while they were working what they would receive when they retired. Governments have a responsibility to ensure that they put enough money away to meet those obligations.

For “Leaders and Laggards” (release event next week!), we used the Pew Charitable Trust’s reporting from its “Widening Gap” series. The gap between the leaders (those that are up to date with their contributions and are continuing to make their required contributions each year) and laggards (those that are behind and are failing to make the necessary catch up payments) is vast.

In Wisconsin, for example, the pension fund is 100% funded, and in the 2012 fiscal year (the most recent Pew has data for) the government contributed 100% of its required contribution. In fact, in the two previous years, the government contributed 108 and 104% respectively to catch the state up. On Wisconsin!

In Illinois, by contrast, the pension fund is currently sitting 45% funded, and last fiscal year the government only contributed 76% of its required contribution. The total unfunded liability? $94.5 billion. Yes, you read that right, billion with a “b.” By comparison, Gov. Pat Quinn’s total 2015 budget proposal is only $65.9 billion.

But more than simply monkeying around with the retirement security of thousands of government employees, diverting funds to cover pension shortfalls requires sacrifices in other parts of the budget. Education and healthcare are any state’s two biggest line items, so increasing funding to pensions almost assuredly means taking money from someone who really needs it.

Gov. Quinn’s budget document says as much (from pg. 23):

Pensions were the fastest rising cost the governor inherited, crowding out the general funds needed for education, public safety and human services. Annual payments required to meet the statutory pension funding formula increased from six percent of general funds in fiscal year 2008 to 19 percent in fiscal year 2014.

It is easy for politicians of all political stripes to offer more generous pensions to public sector employees knowing that they will be long out of office when the bill comes due. It also hides the costs. Upping salaries is seen in the budget immediately, upping pensions is not. The political deck is stacked against doing the responsible thing and making sure the books are balanced.

According to Pew, here is the list of the 15 states that made 100% of their required contributions in fiscal year 2012:

  • Alabama
  • Arizona
  • Connecticut
  • Georgia
  • Maine
  • Mississippi
  • New Hampshire
  • New York
  • North Carolina
  • Rhode Island
  • South Carolina
  • Tennessee
  • Utah
  • West Virginia
  • Wisconsin

These are red states and blue states. These are states that have historically kept up with contributions and these are states that are catching up as fast as they can.

Their leaders, who have made the tough but fiscally responsible decision, should be lauded.

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2 thoughts on “Leading and lagging on public-sector pensions, state by state

  1. Of course, the Veterans Administration pension and medical care system is totally unfunded and must draw upon federal income and capital gains taxes every year for its financing.

  2. Rankings like these can be misleading, especially when based on a single measure such as percent paid of annual required contribution (ARC). The case of Connecticut, listed here as a “leader,” to be lauded for “fiscally responsible” pension funding, illustrates the pitfalls.

    I would dispute this conclusion, based on my study (in progress) of the Connecticut State Teachers’ Retirement System (CSTRS), conducted for StudentsFirst Institute (these are my conclusions, not to be attributed to SF). Yes, CSTRS pays 100 % of ARC. But CSTRS’ ARC has long been artificially depressed by some imprudent actuarial practices. Most importantly, CSTRS uses a discount rate of 8.5 percent, a rate that Fitch Ratings (among others) considers imprudently high. Many other states have lowered their discount rate recently, but not CSTRS.

    Moreover, CSTRS’ decision to write 100 percent ARC funding into law in 2008 is hard to consider a fiscally responsible act, since it was tied to the state’s issuance of $2.277 billion in pension obligation bonds, a highly dubious practice. That bet, in April 2008, turned sour immediately when the state’s borrowed funds, invested by CSTRS, got hit by the market crash that fall. Even though the states’ POB debt payments are highly back-loaded, they already outweigh the savings on direct contributions to CSTRS.

    As a result of these and other practices, CSTRS’ most recently reported funded ratio (2012) is 55.2 percent, among the lowest in the country. Factoring in the outstanding POB debt, the funded ratio would be 45.9 percent. Using Fitch’s preferred discount rate of 7 percent, I calculate that CSTRS’ 2012 funded ratio (including POB) would be 39.4 percent.

    On a per pupil basis, I estimate that Connecticut’s payments for the teachers’ pension fund rose from $472 per pupil (in 2014 dollars, i.e. corrected for inflation) in fiscal year 2002 to $2,045 this year, a rise of $1,573 per pupil (including POB debt service). Although the market has performed well since the last valuation, and some relief may be expected with the next valuation, there are other shoes to drop. CSTRS’ ARC is artificially depressed by $361 per pupil, due to the asymmetric treatment of past savings from the 1992 increase in employee contributions. That relief is slated to disappear in fiscal year 2023. At the same time, the back-loaded schedule for POB debt service will raise those payments from $245 per pupil currently to about $471 in constant dollars. In short, although some of the rise in state pension payments to date has reflected improved fiscal practices, they have been married to imprudent practices that threaten further hikes in the coming years.

    The example of CSTRS, which hardly merits “leader” status for “fiscally responsible” pension funding, illustrates the pitfalls of superficial rating systems based on a single measure that is both incomplete and subject to manipulation.

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