The State Pension Time Bomb
Poor accounting rules and flagrant irresponsibility have sped up the states’ day of reckoning.
Nearly every state offers defined-benefit pension plans for public employees. Financed through a mix of employee and employer contributions along with the investment returns on pension funds, a defined-benefit plan represents a contractual obligation to dole out a set amount in annual payments for as long as the recipient lives, regardless of whether there are sufficient assets in the fund at the time of the employee’s retirement.
One would think this obligation to pay no matter what would have led states to invest conservatively and plan ahead. Instead, they have been following accounting rules that pretty much guarantee the funds will be unsustainable.
Pension funds need to assume a certain rate of return on their current assets in order to gauge whether or not the assets held today will be enough to pay future benefits. Obviously, the assumed interest rate or rate of return has a major impact on whether a pension plan is adequately funded. Most pension plans would rather play it conservatively and assume a lower rate of return, so that they ensure that the assets they have today will be enough to cover tomorrow’s promised benefits. But the states would rather put less money up front today, so they’re pinning all their hopes of being able to pay benefits tomorrow on an 8.5 percent annual growth rate. If that 8.5 percent growth rate doesn’t come to fruition, either tomorrow’s beneficiaries will see a cut in their benefits or taxpayers will be asked to pick up the tab. It would be much more prudent to assume an adequate risk-adjusted rate of return closer to the rate offered on 15-year Treasury bonds—3.5 percent, say—and fund their plan accordingly.
How big are the shortfalls? State officials estimated their plans’ unfunded liabilities at $452 billion, with total liabilities of $2.8 trillion. But when economist Andrew Biggs of the American Enterprise Institute calculated the figure with the methods used by private-sector pensions, he found that total liabilities amount to over $5 trillion, with the unfunded liability at $3 trillion.
DYI Comments: The States will be grappling with this problem for years to come but it will come to a head as Boomers begin to retire in large numbers during the 2020's. Will the Fed's have to come in with a bail out plan? Most likely a deal will be made with modest pension payment cuts, States adding in additional money, with the Fed's providing ultra low interest rate loan to the States to fund the remainder.
So far most States are moving to a 401k type of pension for new State employees. If the Fed's step in, which is highly likely, the deal will accelerate the process of 401k's for new employees along with the remaining State workers as well. They will receive one time deposit into their 401k from the State (Fed bail out) equivalent to their defined pension required at that time. Those who are already retired in the old system would remain and would self dissolve as the plan participants pass away.
In the mean time expect to see more and more headlines (articles) as the one's below.
Pension reform cowardice: James Varney
Investment research firm Morningstar, Inc., conducted a study analyzing state pension data, finding 21 states' retirement systems to not be fiscally sound.
The report employed two primary measures to assess pension funds. The funded ratios compare a system's total assets to its liabilities. The second measure, unfunded actuarial accrued liability per capita, pegs the amount each state resident would need to pay to fully fund the system.
Twenty-one states' aggregate funded ratios fell below 70 percent, which Morningstar considers the threshold for fiscally-sound funds. When measuring liability per capita, Alaska, Illinois and Hawaii recorded the highest amounts.
| City | Total Liability | % Funded |
| Charleston, W. Va. | $270 million | 24 |
| Omaha, Neb. | $1.43 billion | 43 |
| Portland, Ore. | $5.46 billion | 50 |
| Chicago, Ill. | 24.97 billion | 52 |
| Little Rock, Ark. | $498 million | 59 |
| Wilmington, Del. | $364 million | 59 |
| Boston, Mass. | $2.54 billion | 60 |
| Atlanta, Ga. | $3.17 billion | 60 |
| Manchester, N.H. | $436 million | 60 |
| New Orleans, La. | $1.99 billion | 61 |
DYI
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