ECONOMIC AND BUDGET ISSUE BRIEF
The Underfunding of State and Local Pension Plans
The recent financial crisis and economic recession haveleft many states and localities with extraordinary budget-ary difficulties for the next few years, but structural short-falls in their pension plans pose a problem that is likely toendure for much longer. This issue brief discusses alterna-tive approaches to assessing the size of those shortfalls andthe implications of those approaches for funding deci-sions:
By any measure, nearly all state and local pensionplans are underfunded, which means that the value of the plans’ assets is less than their accrued pension lia-bilities for current workers and retirees.
There are two leading approaches for valuing assetsand liabilities, and the reported amount of under-funding varies significantly depending on which one isused.
Decisions about how to address the underfundingcanbe informed by the choice between those twomeasurement approaches, but there is no necessary connection between the information provided by thetwo approaches and decisions about how much aplan’s sponsor should contribute each year. According to the Public Fund Survey of 126 state andlocal pension plans, which account for about 85 percentof pension assets and participants in state and localpension plans in the United States, those plans heldroughly $2.6 trillion in financial assets in 2009 but hadabout $3.3 trillion in liabilities for future pension pay-ments.
Thus, those assets covered less than 80 percent of liabilities, and unfunded liabilities (the amount by whichliabilities exceed assets) amounted to roughly $0.7trillion.
That share of liabilities covered by assets in2009 was the lowest percentage in the past 20 years (seeFigure1). By comparison, the amount of state and localgovernments’ debt that was outstanding at the end of 2009 was $2.4 trillion.That estimate of unfunded liabilities is calculated on thebasis of actuarial guidelines currently followed by stateand local governments. Another approach for measuringpension assets and liabilities, which more fully accountsfor the costs that pension obligations pose for taxpayers,yields a much larger estimate of unfunded liabilitiesforthose plans in 2009—between $2trillion and$3trillion.
In any event, most state and local pension plans probably will have sufficient assets, earnings, and contributions topay scheduled benefits for a number of years and thus will not need to address their funding shortfallsimmediately.But they will probably have to do so eventu-ally, and the longer they wait, the larger those shortfallscould become.
Most of the additional funding needed tocover pension liabilities is likely to take the form of higher government contributions and therefore willrequire higher taxes or reduced government services forresidents. Additional funding for pension benefits already accrued is unlikely to come from current workers; statelaws and court opinions indicate that efforts toward that
A series of issue summaries fromthe Congressional Budget Office
1.Liabilities are measured as the present value of promised benefits.Present value is the value today of a series of payments made in thefuture, calculated by applying a discount rate to those payments.The lower the rate of discount, the higher the present value.2.See National Association of State Retirement Administrators,
Public Fund Scorecard,
available at www.publicfundsurvey.org/publicfundsurvey/scorecard.asp(accessed March 22, 2011). Thedata do not include costs for retirees’ health care.3.See Alicia H. Munnell and others,
Valuing Liabilities in State and Local Plans,
Issue Brief 11 (Boston: Center for RetirementResearch at Boston College, June 2010). For earlier estimates, seeRobert Novy-Marx and Joshua D. Rauh, “The Liabilities andRisks of State-Sponsored Pension Plans,”
Journal of Economic Perspectives
, vol. 23, no.4 (Fall 2009), pp. 191–210.4.For a listing of actions taken in 2010, see Ronald K. Snell,
Pensions and Retirement Plan Enactments in 2010 State Legislatures
(National Conference of State Legislatures, November 23, 2010),available at www.ncsl.org/?TabId=20836.