Wednesday, October 23, 2013

The State Pension Black Hole

I have often posted on the state of our pension plans and their current funding levels because I believe that the pensions of baby boomers are in jeopardy.  A recent study by Cory Eucalitto at State Budget Solutions looks at the frightening level of funding for America’s state pension plans, an examination that should send chills down our spines since taxpayers are ultimately on the hook for the shortfalls.

The author examined data from over 250 state defined benefit pension plans holding $2.597 trillion in assets in fiscal 2012.  In the past, the valuation of public pension plan liabilities was vastly understated and varied widely based on the discount rate used; the higher the discount rate, the lower the size of the pension plan needed to meet the requirements of the future.  As such, with a higher discount rate, pension plan funding looks far better than it does with a lower discount rate.  According to official state reporting, the overall funded level of state pension plans is 73 percent when using a discount rate of around 8 percent, still hardly what one would call stellar.  Unfortunately, in today’s stock and bond market environment, the odds of getting an 8 percent return on an investment is somewhere between slim and nil for pension plan administrators.  For the purpose of this study, the author uses a more realistic market-valued approach, discounting the pension plan liabilities by the yield of a 15 year Treasury bond or roughly 3.2 percent.  Using this lower and more realistic discount rate, the average state pension plan in the United States is only 39 percent funded.  As you will see, the level of underfunding of pensions, where the ultimate liability owed to pension plan members exceeds the pension plan’s funding, varies greatly from state to state with no states having what could even remotely be considered healthy funding levels, particularly when measured in relation to the size of their economy and the number of taxpayers in the state.

Let’s start by looking at the nation’s four largest pension plans and the size of their unfunded liability in dollars:

California – Assets: $459 billion  Unfunded Liability: $640 billion
New York – Assets: $230 billion  Unfunded Liability: $260 billion
Texas – Assets: $184 billion  Unfunded Liability: $244 billion
Florida – Assets: $128 billion  Unfunded Liability: $153 billion

The four most poorly funded states are:

Illinois – 24 percent
Connecticut – 25 percent
Kentucky – 27 percent
Kansas – 29 percent

The four most well funded states are:

Wisconsin – 57 percent
North Carolina – 54 percent
South Dakota – 52 percent
Tennessee – 50 percent

As you can see, even the nation’s best funded state pension plans are just over half funded.

If we look at the unfunded liability level on a per capita basis, the four highest states are:

Alaska - $32,425 per capita
Ohio - $24,893 per capita
Illinois - $22,294 per capita
Connecticut - $21,378 per capita

On a per capita underfunding basis, the four lowest states are:

Tennessee - $5,676 per capita
Indiana - $6,581 per capita
North Carolina - $6,874 per capita
Nebraska - $7,212 per capita

In total, the unfunded liabilities in all state pension plans is $4.1 trillion or just under one-quarter of the national debt.  That works out to $13,145 on a per capita basis on a nationwide, average basis.

Lastly, obviously a state’s capacity to fully fund its public sector pension plan varies with the size of its economy with larger economies having a greater potential ability to top up shorfalls.  Here are the four states with the highest levels of underfunding as a percentage of Gross State Product:

Ohio – 56 percent of GSP
New Mexico – 53 percent of GSP
Mississippi – 48 percent of GSP
Alaska – 46 percent of GSP

The four states with the lowest levels of underfunding as a percentage of Gross State Product are:

Delaware, Tennessee and Nebraska – 13 percent of GSP
Indiana – 14 percent of GSP
North Carolina – 15 percent of GSP
North Dakota – 16 percent of GSP

The provision of state pension plans to state employees is a promise made.  With the odds that pension benefits will be cut being fairly low, this analysis shows that there will be a huge funding hole that will have to be filled somehow if pension promises are to be kept.  Unfortunately, I think that we all know who will be filling that $4.1 trillion black hole.

1 comment:

  1. Discounting liabilities by the rate of 15-year treasuries overstates the problem, since the pension funds invest in securities that give higher returns than 3.2%.