Can State and Local Pensions Muddle Through?

The finances of state and local pension plans are headline news almost daily.1 Indeed, although these plans were moving toward prefunding their promised benefits, two financial crises in 10 years have thrown them seriously off course. Measured by the standards of the Government Accounting Standards Board, between 2008 and 2009 the ratio of assets to liabilities for our sample of 126 plans dropped from 84 percent to 79 percent. But this decline is only the beginning of the bad news that will emerge as the losses are spread over the next several years. Furthermore, the funded levels are closer to 50 percent if liabilities are discounted by a riskless rate, as recommended by economists and financial experts.2 What do these numbers imply for the future of these plans? Here’s what’s happening. States and localities have increased contributions and extended retirement ages for new employees, but these changes will take a long time to have any substantial effect. In most states, constitutional protections and court rulings have prohibited public employers from cutting benefits for existing employees. Thus, the only option for a quick fix would be an infusion of tax revenues. But the recession has decimated tax revenues and increased the demand for state and local servic es. Thus, the question is whether these plans have enough assets to muddle along until the economy and the stock market recover. Or do they face a liquidity crisis? That is the subject of this brief. The discussion is as follows. The first section looks at the simple ratio of assets to benefits over time and across plans in 2009. The second section moves to a more dynamic approach and investigates two concepts for estimating when plans would run out of money. Under a “termination” concept, where benefits earned to date and plan assets are put in an “old” plan and normal cost payments cover all future accruals, most plans have enough assets to last for at least 15 years. Under a more realistic “ongoi ng” framework, where normal costs are used to cover benefit payments, most plans have enough for at least 30 years.