Another Report Paints Bleak Outlook for Public Pension Plans

We have been watching closely the emerging public pension plan funding problems and have suggested that the public sector may soon become the next big area for 401k growth.

A just released study from the Center for Retirement Research at Boston College paints a dire picture for the future of public defined benefit pension plans. The study is significant not only for its message, but also because the messenger (CRR) has historically been a staunch supporter of DB plans as the most efficient and effective means to provide retirement security to American workers.

In April 2008, just months before the financial meltdown, a CRR review of state and local pension funding status at that time was titled “The Miracle of Funding by State and Local Pension Plans”.

The current study analyzes current and near-term projected future funding levels for the same 126 large state and local pensions using the plans’ own valuation data and methodologies – but now finds that the miracle has vanished. (It should be noted that there is significant debate and mounting concerns among governmental accounting experts that these valuation methods are too lenient and that the true public pension funding deficit is far worse than is being disclosed by the plans. The CRR report does not specifically address these concerns.)

But even setting aside this issue, the CRR report offers a very pessimistic outlook for public DB plans and no substantive or practical ideas to solve the problem:

“The conclusion that emerges from this update is that while states and localities were on a path toward full funding of their pension liabilities, they were seriously knocked off track by the financial crisis. The first glimpse of the dimension of the damage is becoming evident with the actuarial valuations for 2009. (Since three-quarters of plans have a fiscal year ending June 30, the 2008 valuations were closed before the crisis hit.) Between 2008 and 2009, the ratio of assets to liabilities for our sample of 126 plans dropped from 84 percent to 78 percent. But this decline is only the beginning of the bad news that will emerge as the losses are spread over the next several years. The ultimate outcome will depend on the performance of the stock market, but under our most likely scenario, funding ratios will decline to 72 percent by 2013.

The key question is what should be done. A major increase in contributions is not realistic at this time. States and localities may have only limited ability to increase employee contributions, because some state courts have ruled that the public employer is prohibited from modifying the plan for existing employees. Higher contributions from new employees will take a long time to have any substantial effect. Thus, if funding levels are to be restored quickly, the money must come primarily from tax revenues. But the recession has decimated tax revenues and increased the demand for state and local services. Thus, finding additional taxes to make up for market losses will be extremely difficult (emphasis added). One small step that would be viewed as a commitment to responsible funding would be for states and localities to at least pay their full ARC. Otherwise, the only option is to wait for the market and the economy to recover.”

We, too, believe that finding additional tax dollars for public pension funding will be “extremely difficult” or, more accurately, near impossible in the next several years. The pressure will be extreme for state and local governments to mimic what has already taken place in the private sector and shift workers to a 401k-style retirement system.