The deepening public pension funding shortfall crisis was highlighted in two separate reports released this week.
One research paper by professors Joshua D. Rauh and Robert E. Novy-Marx said the $3.4 billion Philadelphia Municipal Retirement System will run out of assets to pay pension benefits in 2015, and the $3.7 billion Boston Retirement System and seven systems in Chicago will do the same in 2019, Among other cities in the paper, Cincinnati; Jacksonville, Fla.; and St. Paul, Minn.; are expected to run out of assets in 2020; New York in 2021; Baltimore in 2022; and Detroit and Fort Wayne, Ind.; in 2023.
The authors of the paper, “The Crisis in Local Government Pensions in the United States,” estimate the present value of the aggregate unfunded obligations of 77 defined pension plans sponsored by 50 major U.S. cities and counties at $383 billion as of June 2009. That contrasts with the value calculated by the pension systems, which estimate the total unfunded liability for the same systems at $190 billion as of the same date.
The pension systems use a Governmental Accounting Standards Board method that uses a higher discount rate, which results in lower total unfunded liabilities, they write in the study. The sponsors' median discount rate is 8%, the study said.
But Messrs. Rauh and Novy-Marx contend in their study the higher rate “misrepresents the value of pension promises. The field of financial economics is unified on the concept” on how to discount future expected cash flows. Instead, the two researchers used yields of a zero-coupon Treasury rate curve, ranging from about 0.5% to about 4.5%, depending on maturity, to discount unfunded liabilities, raising their aggregate value.
They assume in their forecast of solvency that investments on assets will grow 8% a year.
“It is clear that state and local governments in the U.S. are not far from the point where these pension promises will impact their ability to operate,” Mr. Rauh, associate professor finance at the Kellogg School of Management, Northwestern University, said in a statement about the study. “Once the funds themselves are liquidated, the extent to which promised pension payments are competing with other local resources will skyrocket, eroding a large portion of many municipal budgets.
“The fact that there is such a large burden of public employee pensions concentrated in urban metropolitan areas threatens the long-run economic viability of these cities, as residents can potentially move elsewhere to escape the situation,” he said in the statement.
“What is yet to be seen is how this burden will be distributed between state and local governments, and whether the federal government will be called upon for bailouts. If these issues are left unresolved, fiscal crises on the state and local levels may translate into significant losses for municipal bondholders.”
Mr. Novy-Marx is assistant professor at the Simon Graduate School of Business Administration, University of Rochester.
A separate study also released on Tuesday, by the Center for Retirement Research at Boston College projects public pension plan contributions could account for more than double their recent share of state and local government budgets by 2014.
Contributions as a percent of state and local government budgets averaged 3.8% in 2008. The ranges include 3.2% in Florida, 4.5% in Illinois and 5.2% in California.
But as state and local governments step up contributions, the average percentage could rise to 9.1% in 2014, using a 5% risk-free discount rate favored by economists. In Illinois, contributions would account for 13% of state and local government budgets, 12.5% in California and 8.7% in Florida.
Using an 8% discount rate based on expected long-term return generally used by public plan sponsors, the percentage of the average pension contribution as a share of state and local governmental budgets would rise more slowly, to 5%. In Illinois it would rise to 8.7%, 7.3% in California and 4.6% in Florida.
In the CRR study, authors Alicia H. Munnell, CRR director and the Peter F. Drucker Professor of Management Sciences at Boston College's Carroll School of Management, and Jean-Pierre Aubry and Laura Quinby, both CRR research associates — believe public pension contributions are likely to account for a larger share of state and local budgets in part because of lower stock market returns on pension assets compared with the 1982-2000 era.