Public sector pensions: How well funded are they, really?

I. INTRODUCTION AND SUMMARY

The financial health of defined benefit pension plans for state and local government workers is a matter of concern for elected officials, taxpayers and the financial markets, all of whom worry about governments' long-­term ability to meet their financial obligations. These pension plans have come under increased scrutiny as funding levels have dropped and required contributions have risen.

According to standard actuarial accounting, the average public pension has fallen to around 75 percent in 2011, versus 103 percent in 2000.1 Annual Required Contributions to public pensions have more than doubled since 2001,2 though researchers at the Center for Retirement Research at Boston College project that state and local governments will meet only around 79 percent of required payments this year. Public sector pensions, as of mid-­2011, were underfunded by around $885 billion, based on accounting rules established by the Governmental Accounting Standards Board applied to a large sample of plans from the Public Plans Database.3

However, reports from academic economists and nonpartisan government agencies strongly suggest that the true state of public sector pension funding is far worse than suggested by official plan disclosures.4 The accounting rules followed by U.S. public sector pensions are more forgiving than those required for private sector pensions or public sector plans in other countries. So-­called "fair market valuation" more fully reveals the value of public sector plan liabilities and shows that the average public employee pension plan in the United States is only around 41 percent funded while total unfunded liabilities as of 2011 are roughly $4.6 trillion.

While state and local governments around the country have enacted reforms to public sector pension plans, including contribution increases, less generous benefits for newly hired employees, and in some cases reductions in cost of living adjustments (COLAs) current beneficiaries, accurate accounting of public employee pension liabilities shows that elected officials must do much more to make these plans financially sustainable.

This paper first describes how public employee pensions currently measure their financial health; then describes the strong consensus from economists that current accounting rules significantly understate and overstate pension funding levels; and finally, describes how pension financing across the country would appear using accounting rules similar to those required for private sector pensions or which are used by public employee plans in other countries. 

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Footnotes

1 Munnell, Alicia H., Jean-­‐Pierre Aubry, Josh Hurwitz, Madeline Medenica and Laura Quinby. "The Funding Of State And Local Pensions: 2011-­‐2015" Center for Retirement Research, Boston College. May 2012.
2 Author’s calculations from Public Plans Database.
3 The database is available at http://pubplans.bc.edu.
4 Academic discussions of pension accounting include Novy‐Marx, Robert, and Joshua Rauh, 2009. “The Liabilities and Risks of State-­‐Sponsored Pension Plans.” Journal of Economic Perspectives 23(4), 191-­‐210; and Biggs, Andrew G. “An Options Pricing Method for Calculating the Market Price of Public Sector Pension Liabilities.” Public Budgeting and Finance, Fall 2011.

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