New Jersey, Illinois, Kentucky, Connecticut, Chicago, Detroit, Dallas: these are but a few of the states and cities making headlines because of uncontrollable pension underfunding that threatens the solvency of their retirement plans, the fiscal integrity of their governments, and the sacred promise made to their employees and retirees.
In their search for solutions, stakeholders have not utilized the public wealth at their disposal, beyond tax dollars, to formulate a financial resolution to this growing and intractable public crisis.
For the past 15 years, academics and financial analysts have warned about a worsening funding crisis among state and local defined benefit funds. According to the Center on Retirement Research at Boston College, public pension plans were underfunded in 2015 to the tune of $1.2 trillion (based on the average plan actuarial rate of 7.6%) and $4.1 trillion (using a less risky 4% corporate-like bond rate). The average funded ratio in CRR's public pension plan universe was 74% in fiscal year 2015 using actuarial rates. Among the 160 plans in CRR's database, 20.1% of plans were less than 60% funded, and 44% of plans were between 60% and 79% funded.
Plan contribution requirements are especially challenging for state and local governments that operate with annual balanced budget requirements. Again, CRR reports the 2015 required contribution as a percent of payroll in their public pension plan database was 18.6%, up from 12.5% in 2008 and 6.7% in 2001. This is not a sustainable trend. In some cases, states' and local government's pension underfunding threatens their credit ratings and potentially their ability to borrow. Just as important, the fallout surrounding the future of public pension plans has raised questions of public trust in the retirement institutions charged with the duty of delivering pension benefits to 35 million American workers and retirees.
There are multiple reasons for the public pension plan funding crisis. Two consecutive financial crises in the 2000s imposed dramatic asset drawdowns in all pension plans, both public and private, destroying trillions of dollars of retirement wealth. It took eight years for most plans to recover their 2007 asset values. These investment losses coincided with costly demographic trends, including an aging workforce and rising longevity. As plans mature, they are generating negative cash flow (annual benefit payments plus administrative expenses exceed annual employee and employer contributions), creating a further drag on funding progress. Finally, historically low interest rates have inflated plan liabilities and have raised serious questions about the reasonableness of funding assumptions greater than 7%.