State Pension Under-funding: Red or Blue Make a Difference?

The general practice of states paying for general workers’ retirement costs began about a century ago in 1911, with Massachusetts being the first adopter. Decades before states, municipalities and the federal government had been involved in the business of paying the cost of retirement for more beloved public employees – teachers, firemen, policemen, and military personnel. The initial years – the past 100 or so years – generally involved expansion of benefits for state employees.

Is the 100 year expansion period over? In the past few years, a number of states have introduced or passed legislation to minimize the public’s exposure to public sector pension risk. For example, Michigan (H.B. 4701 of 2011) reduced state employee costs by introducing a hybrid plan of defined benefit/defined contributions, which shifted more of the burden onto the employee.

Michigan and some other states went beyond what almost all states have done is the past few years, which is that most states shifted more of employee retiree costs onto the employees through higher contribution rates. This article simply addresses two questions: what states promise too much at the expense of taxpayers and, does political allegiance matter?

On the first question, the chart above represents the estimated pension funding ratio through 2011 for all 50 states – as reported by the plan sponsors (the larger the extrusion, the better the pension funding ratio). The highest funded pension public employees’ pension plans include the states of Wisconsin, New York, South Dakota, Delaware, and North Carolina. The least funded pension plans include Kentucky, Illinois, Connecticut, Rhode Island, and Colorado.

Because the numbers stem from plan sponsors and their actuaries, the numbers are not entirely one-to-one comparable – some plans, such as Minnesota and New Jersey (8.5% and 8.25% respectively), think their assets will grow faster than other states, such as Virginia and Vermont (7% and 6.25% respectively). The median actuarial discount rate is 8%. The 8% planned return is simply an inaccurate assumption.

Should the promised benefits be discounted at something more like 5%, then the median funding ratio becomes more along the lines of 60% instead of 74%. On a more theoretically sound basis, funding ratios should probably reported using the discount rate, and, when the discount rate becomes the dividing factor, total funded liability has decreased from 68% in 2001 to about 50% in 2011. That’s a lot of money to come up with for non-state employees – around $6 trillion.



The second question: does political affiliation matter? On the whole, Republican states have, on average, about a 2% higher funding ratio than Democrats. Republican states also are more consistent (smaller range). Democrats have the lowest average funding ratio and the largest range, while toss up states (Florida, Missouri, West Virginia, Ohio, Arkansas, and Nevada) seem to be the most consistent, with about a 0.2% lead on Republicans. So, political party does not really matter.

All in all, reported funding ratios are probably too high and political party kind of matters when it comes to funding future costs. The real question, though, is: is the 100 year period of public employee benefit expansion over? To put it another way, because it’s not a win-win proposition (unless you’re some kind of Pollyanna), are the next 100 years of public employee pension funding going to be viewed from the taxpayer perspective or the public employees’ perspective? Public employees generally won the past 100 years, but who will win the next 100?