Low interest rates are one of several factors contributing to higher levels of unfunded pension liabilities at state and county pension plans across the country.
The California Public Employees’ Retirement System (CalPERS), the largest U.S. public pension plan with 1.8 million total members covered by 3,000 employers, reported a 0.6 percent net return on investments for the 12-month period that ended June 30, 2016.
The California State Teachers Retirement system (CalSTRS), which manages retirement funds for California’s 896,000 public school educators from 1,700 school districts, reported a 1.4 percent net return for the 2015-16 fiscal year ending on June 30, 2016.
Both California funds have a target annual return of 7.5 percent. CalPERS and CalSTRS had $62 billion and $74 billion in unfunded liabilities, respectively, as of the 2013 fiscal year, according to the Public Policy Institute of California. CalSTRS now states that it is on track to achieve full funding by the year 2046.
The New York State and Local Retirement System reported an average rate of return of 0.2 percent for the fiscal year on March 31, 2016, compared to its stated goal of 7 percent.
The Oregon Public Employee Retirement System (PERS) reported a 2 percent investment return in 2015, compared to its goal of 7.75 percent, resulting in an increased liability of $3 billion.
A 7.7 percent average rate of return is now the target set by most state and county pension funds across the country, according to a 2015 report by the National Association of State Retirement Administrators. The Center for Retirement Research at Boston College estimates that every 1 percent decrease in investment returns results in a 12 percent increase in liabilities.
The inability of state and municipal pension plans to properly fund current liabilities at the same time that rates of return are falling is causing significant underfunding. The situation is putting pressure on public pension managers and elected officials across the country.
New public pension accounting standards are also bringing more attention to underfunded municipal liabilities. The Government Accounting Standards Board issued GASB Statement No. 67, Financial Reporting for Pension Plans, and No. 68, Accounting and Financial Reporting for Pensions in recent years. The new reporting standards for government-administered pension plans took effect for reporting periods after June 15, 2013 under Statement No. 67, while new employer reporting standards followed one year later under Statement No. 68.
The Pew Charitable Trust reports that as of 2013, states owed almost $1 trillion in unfunded pension benefits as well as $587 billion in unfunded retiree health care liabilities. Looked at another way, Wilshire Consulting estimates that state pension obligations are only 75 percent funded as of 2013, despite that fact that most states strive to maintain an 80 percent funding level.
The State of Illinois alone has $101 billion in unfunded pension liabilities and $56.4 billion in unfunded retiree health care benefits, according to The Pew Charitable Trust. Illinois is listed by the Trust as having the third highest level of debt and unfunded retirement costs as a share of state personal income (after Alaska and Hawaii) as of 2013. In June 2016 Moody’s Investors Service downgraded the credit rating of some of the state’s general obligation bonds to Baa2, down from Baa1, which is two units away from junk bond status.
The City of Chicago is struggling with its own pension challenges. The City’s Municipal Employees’ Annuity and Benefit Fund, which covers 70,000 workers, reported that unfunded pension liabilities more than doubled to $18.6 billion at the end of 2015 from $7.1 billion a year earlier. Moody’s reduced the city’s credit rating to junk bond status in 2015.
Municipalities are responding with a wide range of measures to increase pension funding, reduce benefits, and cut expenses. Representative actions include the following.
Chicago implemented a property tax hike in 2015 to better fund the police and fire retirement funds. The mayor also seeks an increase in water and sewer levies as a means to support municipal retirement benefits.
Pennsylvania officials are evaluating a range of pension plan changes, including the possible adoption of less expensive 401(k)-style plans.
Connecticut now devotes 10% of its budget toward unfunded pension liabilities, which doubled in the past decade.
Oregon plans to increase pension funding rates, which is likely to translate into expense reductions such as teacher lay-offs, larger class sizes, and public safety cuts.
Detroit’s municipal bankruptcy was settled, in part, with pension cuts of 4.5 percent approved by certain retirees. Benefit reductions were also seen in the areas of cost-of-living adjustments and health care costs.
Pension Funding Litigation a Certainty
As states and municipalities struggle to fund pension obligations in a low interest rate environment, court battles in New Jersey, Illinois, California and Michigan may serve as precedent for similar challenges likely to unfold across the country.
ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.