By Tatiana Follett
In 2018, the aggregate 50-state pension funding gap improved slightly to $1.24 trillion from $1.28 trillion in 2017, according to a June report from The Pew Charitable Trusts.
'Funding gap' indicates the difference between a retirement system's assets and its liabilities. In 2018, state assets covered 71% of expected retirement benefit costs for state and local workers.
The report highlights four areas that help build pensions which are resilient and stable enough to weather economic downturns:
Focusing on debt reduction.
Decreasing returns and discount rates.
Establishing cost predictability through cost-sharing.
Implementing stress-testing programs.
According to Pew, only seven states' pensions are at least 90% funded. Nine states have severely underfunded systems whose assets cover 60% or less of expected benefit costs. Still, 25 states now have positive net amortization rates. If the trend continues, half of the states will be reducing their pension debt in the coming years. The report notes that states with underfunded systems face higher state contributions to cover the cost of benefits. Pew states that prioritizing pensions is not only important for stability in retirement systems, but also for maintaining a balanced overall state budget.
Some state pension funds are lowering expected return and discount rates to achieve greater sustainability. When states lower their expected rates of return on investments, they mitigate the risk of missing their targets during economic downturns.
However, lowering the discount rate can increase calculated liabilities and require taxpayers to foot the bill for higher employer contributions. Cost-sharing policies can alleviate the burden of these increases by diffusing the extra cost among employers and employees/plan members.
Data from well-funded states with cost-sharing policies, such as Wisconsin, Tennessee and South Dakota, and those without cost sharing policies, such as New York and North Carolina, highlight the added stability from cost-sharing arrangements.
Between 2008 and 2018 New York and North Carolina each experienced around a 6% change in employer contribution rates. South Dakota, Tennessee and Wisconsin experienced changes between approximately 0.1% and 2.1%. Although each of the five states have well-funded retirement systems, those with cost-sharing procedures benefit from added stability and predictability.
The report also discusses the importance of stress-testing public pensions. These tests can help refine and formalize the work states are already doing to assess their pension funds' exposure to risk and offer officials and plan members a glimpse of how their plans would fare under different economic and investment-return scenarios.
Hawaii's annual stress tests, implemented in 2017, indicate that the state's fiscal policies are improving its pension fund's stability. In total, ten states have already adopted stress-testing and another four are considering stress-testing policies.
In the last three to four months, the COVID-19 global pandemic has negatively affected many areas of state fiscal health, including pensions. The Pew Charitable Trusts estimates that pension funds are headed toward their first fiscal year losses since 2009. These losses could total up to $500 billion.
However, a report by the Center for Retirement Research at Boston College concludes that most pension plans will maintain sufficient funds to pay benefits indefinitely. Thus, while pension funds will likely face some decreases in asset-to-benefit ratio, this will not impact most states' ability to continue fulfilling benefit requirements.
Pew finds that states with certain funding policies, such as lower investment return assumptions, cost-sharing measures and stress-testing, are more likely to maintain a higher benefit-to-cost ratio than those without some or all of these funding policies.
While pension funding levels vary considerably by state and plan, periods of economic volatility present an opportunity for policymakers to examine how well-funded plans achieve and maintain fiscal sustainability.
For more information on pensions, see NCSL's Pension Legislation Tracking Database.
Tatiana Follett is an intern in NCSL's Employment, Labor and Retirement program.