More States May Turn to Lotteries to Fund Pensions

Untapped public assets could contribute ‘many billions of dollars’ to underfunded pensions.

Untapped public assets such as state lotteries could be used to add “many billions of dollars” of funding to struggling public pension systems, according to a report from Kroll Bond Rating Agency (KBRA).

State and local governments have accumulated substantial assets over time in the form of land, facilities, and enterprises, and according to KBRA, these resources are generally recognized at values that are “substantially less” than full value on the government’s financial statements.

“There have been several recent examples of states using the value inherent in the assets or entities they control in novel ways to finance critical needs such as reducing unfunded pension liabilities,” said the report.

The report cited New Jersey’s use of its state lottery revenues to help boost its underfunded pension system as an effective way of using untapped state resources to cover shortfalls.

In 2017, New Jersey contributed its lottery enterprise to three of its pension funds for a period of 30 years. According to the report, the New Jersey state lottery has annual net revenues of about $1 billion, which are forecast by the state to grow in the low single digits per year over the next 30 years. It also said the valuation of the lottery enterprise for the full 30-year period at the time of the contribution was $13.5 billion.

“This amount represented 7.3X the pension contribution the state funded in the prior year,” said the report. “In addition, it significantly increased the funded ratio of the state’s pension funds from 45% to 59%.”

However, coming up with a valuation for these kinds of assets can be challenging, particularly because many of them tend to be illiquid and have non-standard investment characteristics.

The report also said that because the use of these assets would be a non-recurring event, they would be put to better use toward long-term needs such as unfunded pension liabilities, or infrastructure projects. KBRA cautioned that liquidating fixed assets to finance short-term or operating expenses would be “problematic” from a credit perspective.

“Contributing assets that are illiquid or that do not generate cashflow to pension funds may improve some arbitrary ratios, but in our opinion, these kinds of transfers are not likely to improve fundamental credit characteristics,” said the report. “Management could do better by contributing assets that generate cash flow, and/or are expected to appreciate and then can be liquidated in the future.”

KBRA said it expects to see more states like New Jersey turning to public assets to help finance capital and other critical needs.

“As these plans are implemented,” said the report, “it will be important that they are thoughtfully used for long-term purposes, and the underlying causes of the current shortfalls are better managed going forward.”

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