The average US state pension plan is funded at a paltry 35%, as unfunded liabilities of state-administered pension plans total nearly $6 trillion—equal to $18,300 of unfunded pension liabilities for every US resident—according to a report from the American Legislative Exchange Council (ALEC).
The report surveyed more than 290 state-administered public pension plans, detailing assets and liabilities over a five-year period. Based on ALEC’s calculations, all but two state’s pension funds—Wisconsin and South Dakota—have a funded ratio below 50%, which it said is “especially troubling” because plans below an 80% funding ratio threshold are considered “at risk.”
In its calculations, ALEC used what it deems “a proper, risk-free discount rate,” and found that unfunded liabilities of state-administered pension plans now total over $5.96 trillion. It attributed much of the problem to state governments failing to make their annually required contributions (ARCs), which represent the appropriation needed to cover the cost of future pension obligations accrued in the present, along with amortization of prior unfunded liabilities.
“Unfunded liabilities in public pension plans continue to loom over state governments nationwide,” said the report. “If net pension assets are determined using more realistic investment return assumptions, pension funding gaps are significantly wider than even the large sums reported in state financial documents.”
ALEC said its figures differ from the states’ numbers because its calculations use a risk-free rate to reflect the constitutional and legal protections extended to state employee retirement benefits.
“The accumulation of unfunded pension liabilities per capita is the most alarming facet of the pension crisis,” said the report. “This metric reveals the personal share of liability for every resident in each state, an indicator of potential future tax burdens to be borne by residents for pension promises made but not funded.”
Alaska had the highest pension liabilities per capita by far at $46,774, followed by Connecticut and California, with $32,805 and $29,137 respectively, based on ALEC’s calculations. Meanwhile Connecticut, had the lowest funded ratio among all 50 states at 20.28%, followed by Kentucky and Illinois, which had funded ratios of 24.81% and 25.19%, respectively.
Tennessee had the lowest unfunded liabilities per capita at $8,466, followed by Indiana and Nebraska, with $8,690 and $9,043, respectively. And Wisconsin had the highest funding ratio at 60.54%, followed by South Dakota and Idaho with 50.73% and 47.20%, respectively.
ALEC suggested that one reform most pension plans could immediately adopt to improve their standing is to lower their discount rate to the private sector average, or to a risk-free rate. It said this would shift the estimated liability from the average amount states would be liable for in the future, to an estimate which covers all potential futures.
“This change would ensure the constitutional and legal protections afforded to state pension benefits are being met,” said the report. “This will increase the ARCs, as the target asset will increase to match the risk-free liability.
The report said that if contributions are made in accordance to the ARC, the health of the funds would rapidly improve.
“Even a global financial crisis would not threaten the fund’s solvency,” said the report. “It would truly be a guaranteed, ‘defined benefit.’”
A second reform ALEC suggested is variable benefit or contribution rates based on the funding on the plan. For example, it said Wisconsin was the best-funded pension system because it has a variable benefit rate, which means the disbursement varies over time. It said that lowering the payments from the fund during economic shocks allows Wisconsin’s pension fund to recover, which has let it provide retirement security with few significant changes to the plan since 1975.
“Current state workers and retirees are not the only people affected by the pension liability crisis,” said the report. “Taxpayers ultimately provide the wages for public sector employees and the financial resources to cover promised benefits of traditional, defined-benefit pension plans.”
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