Threat of unfunded liabilities overrated, say researchers

The doomsday scenario of “unfunded liabilities” emptying state and local pension funds is overrated, according to new research.

Unfunded liabilities associated with public retirement costs are now estimated to be in the trillions and economists at the Brookings Institution admit the cumulative debt “is often a huge and scary number.”

But, they argue, the overall concerns ignore how stable such debt is when viewed long-term.

“There’s an assumption that fully funding pensions is the right thing to do,” said Louise Sheiner, policy director of the Hutchins Center on Fiscal and Monetary Policy at Brookings. “Most of the work in this area has been about calculating how unfunded these plans are [and] that’s led to a lot of concern that these plans are in a huge crisis.”

A recently released paper by Ms. Sheiner and co-authors Byron F. Lutz of the Federal Reserve Board and Jamie Lenney of the Bank of England urges leaders of state and local government pension funds to step back and see unfunded liabilities in the context of the massive debts that public financing systems often can absorb.

“The way we look at it, an unfunded pension liability is similar to a government having debt, and a government’s debt is sustainable so long as its size relative to the economy isn’t continuously increasing,” they wrote.

Several states including Illinois, New Jersey, and Kentucky, however, recently have dealt with significant pension crises, with officials scrambling to pay more to cover unfunded public employees’ retirement costs. Lawmakers in those states have proposed tax increases and limiting pension benefits in response to unfunded liabilities.

Earlier this year, the American Legislative Exchange Council estimated that the average state pension plan is funded at just 35%, with unfunded liabilities of state-administered pension plans totaling nearly $6 trillion. ALEC researchers surveyed more than 290 state-administered public pension plans, studying assets and liabilities over a five-year period.

Analysts say the overarching issue stretches back to the Great Recession of 2009, which drained as much as 20% of the value of some state funds.

Earlier this year Virginia’s pension fund admitted it is in a worse position to handle a similar market meltdown than it was before the Great Recession. This, despite Wall Street’s current 10-year bull market and pension reforms made by state lawmakers.

One of the nation’s biggest public funds, Virginia’s system serves about 705,000 current and past state employees, school teachers and city and county public sector workers.

In an interview earlier this year, Virginia Secretary of Finance Aubrey Layne said, “If we were to go through what we did in ’08 and ’09, we’re screwed. I don’t know what else to say.”

Last month, the Richmond Times-Dispatch reported that the fund is expected to lower its expected rate return from 7% to 6.75% or 6.5%.

Such a drop could potentially increase employer contribution costs by more than $200 million a year, eat into government budgets for other services, or trigger tax hikes.

On Wednesday, Maryland’s State Retirement and Pension System said its portfolio returned 6.46% on investments for the last fiscal year, falling short of an anticipated 7.45% return.

But according to the Brookings report, the worst is over because the 2008 market crash and drop in the value of retirement funds uniquely coincided with the start of baby boomer retirements.