The Pension and OPEBs Crisis – The Hard Facts and Possible Solutions
The Current State of the Underfunding of Pensions and OPEBs
by James Spiotto
State and local government workers are approximately 12% of the nation’s workforce – 16 million employees.
While available cash to pay for employee benefits was decreasing, local and state governments sought to meet demand for services by adding more workers faster than other sectors:
- Since 1970, state and local employees have increased by over 80% and have increased more than any other percentage of overall government employees (federal, state and local) from 77.8% to 87.7% (between 1970 and 2015) while the population of the U.A.A. increase only by 54.9%.
- Extraordinary Personnel Growth and Future Pension Crisis* (Mortgaging Your Grandchildren):
OF STATE OF ALL
OF LOCAL OF ALL
|Percent Increase from 1970||84.2%||89.5%||9.9%||13.7%|
Pension obligations for municipal workers do not have priority in bankruptcy and no protection for deferred compensation:
- Demand for funding now.
- In 1995-1996 Orange County cut thousands to balance budget.
- Detroit and Stockton Bankruptcy Court ruling pension obligation can be impaired in Chapter 9 municipal bankruptcy proceeding.
State and local government employees have grown between 1946 – 2008 by 12.7 million employees, faster than the rate of growth in population. In 1946, there were 2.3 state and local government employees per 100 citizens. In 2008, that number was 6.5. Are we less effective? (Grandfather State and Local Government Spending Report by Michael Hodges)
Meanwhile, demographics and actuarial assumptions have changed and there has been increased attention focused on the ability of state and local governments to pay the accrued costs of benefits for the expanding number of government employees.
In the United States, the unfunded pension liability of state and local governments is believed to exceed $1 trillion with OPEBs ranging from $300 billion or more. Some economists have suggested that, given a realistic rate of return for investments as compared to the “unrealistic” rate of return on investments projected by State and Local Pension Fund, the real amount of underfunding is closer to $3 trillion or more due to assumptions on earnings on investments. The cost of unfunded health benefits promised to retirees could push the number even higher.
At the same time, the debt of state and local governments has almost doubled in the ten years from $1.197 trillion in 2000 to $2.8 trillion in the fourth quarter of 2010. Citicorp contends the market for state and local government debt in the U.S.A. is actually $3.7 trillion with individual holders being $1.8 trillion (rather than $1 trillion) or 50% of the market.
Wilshire Consulting has released its 2013 Report on State Retirement Systems: Funding Levels and Asset Allocation. The study includes 134 state retirement systems and concludes the following:
- Wilshire Consulting estimates that the ratio of pension assets to liabilities, or funding ratio, for all 134 state pension plans was 73% down from 77% in 2011, down sharply from an estimated 85% in 2008.
- For the 109 state retirement systems that reported actuarial data for 2012, pension assets and liabilities were $1.825 trillion and $2.660 trillion, respectively. Pension assets shrunk by 1.2% or $21.7 billion in 2012 from $1,847.6 billion in 2011 to $1,825.9 billion in 2012. Pension liabilities grew 4.8% or $122.2 billion. The average underfunded plan ratio of assets to liabilities equals 68% and of the 109 reimbursement systems, 95% of the systems had underfunded pension liabilities to market assets based on reported actuary data for 2012.
- Of the 133 state retirement systems that reported actuarial data for 2011, pension assets and liabilities $2.420 trillion and $3.269 trillion respectively, 93% are underfunded. The average underfunded plan has a ratio of assets to liabilities equal to 74%.
This is not a new problem. Historically, pension systems on the state and local level have been at various times underfunded for most of the last 50 years.
The average funding ratio has grown and declined over time:
|PERIOD||FUNDING % OF|
TOTAL PENSION LIABILITIES
* Source: Standard & Poor’s, Research: Managing State Pension Liabilities: A Growing Credit Concern, Jan. 2005.
- Historically, extraordinary personnel growth plus political pressure contributed to the rise of pension liabilities.
- The up market for investments in the late 1990s and between 2003-2007 has helped investor return and narrowed the underfunding gap and the recent market uptick since mid-2009 has also helped.
- However, there are implicit obstacles to solving pension liabilities .
- There is political pressure to increase pension benefits when current salaries are limited by restricted revenues.
- State and local legislatures listen and respond to employee unions and sometimes increase benefits without providing corresponding sources of funding.
- The ever increasing demand for infrastructure improvements and expanded public safety services have more than strained state and local budgets (estimated $3.6 trillion of infrastructure improvement required with the next five years) by 2020.
- Pension obligation bonds (“POB”) have masked the real systemic problem that needs to be addressed and have been a “Band-Aid” and short term fix for significant budget loopholes and the consistent current underfunding of pension obligations.
- Defined benefit plans (“DB”) (as compared to defined contribution plans (“DC”)) are for the most part doomed to failure – benefits promised cannot easily be provided, especially given the revenue restraints that state and cities face.
- The transition to a DC plan is less volatile, more predictable and, if funded currently, far safer.
- The transition to DC plan from a DB plan is costly and complicated and places risk and volatility cost on the public employee and taxpayer.
- Expectations of government employees and unions are high and not easily changed and efforts to increase employees’ contributions are not well received.
- Many state constitutions protect pension benefits from being changed retroactively and some prospectively.
- In the absence of state constitutional provisions, certain states have adopted legislation prohibiting diminishing or impairing public employee pension rights.
- A long-term fix is needed. Some contend that what must be done is to transition DB plans (that don’t work) to DC plans and to substitute increases in benefits to meet political needs with zero tolerance for underfunding as a current budget matter or with increasing benefits that have no funding source – approximately 90% of public employee pension plans are defined benefit plans while less than 15% of private pension plans are defined benefit plans.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved (2015).