Politicians and average citizens do not typically discuss the unfunded liability of public pension funds, but they should.
That’s because unfunded pension liabilities affect the fiscal stability of entire states and millions of public employees, from teachers and firemen to city hall secretaries and anyone who works for state and county governments.
Now, the unfunded pension liability issue has surpassed crisis proportions. According to the Institute for Pension Fund Integrity (IPFI) based in Arlington, Virginia, the crisis now involves over $6 trillion. That is the equivalent of $18,676 for every man, woman, and child in the U.S. or nearly $50,000 for every household in America.
This problem is decades in the making. It is the result of political parties who wanted to award big pensions to a politically loyal audience or win over more public workers into the dominant party. It is a practice that continues today and affects entire public employee professions, such as teachers and police, who were attracted to entering and staying in those professions for their whole working careers while betting on the promise of adequate, and in too many cases, overly-generous and financially unrealistic pension payouts.
“After years of unrealistic and overly positive assumptions by plan actuaries and outdated mortality rates, public pensions now face a multi-trillion-dollar underfunding,” the IPFI said in a statement.
While the award of generous pensions was based on politics, it was also assisted by investment professionals who made too optimistic financial projections. These overly optimistic financial returns were often used to help sell a pension increase that would not have been politically attractive if a more realistic return assumption had been used.
To shed more light on the dire condition of state pension funds, the IPFI has created a new interactive Pension Gap Calculator, available at ipfiusa.org, that shows a state-by-state analysis of funds and what would happen in different rate of return and mortality table scenarios. The rate of return is often overly optimistic and explains, in part, why some public funds pursue more risky and expensive investments, such as hedge funds.
Since the Great Recession began in 2008, this long-term investment rate of return factor has been lowered from around 8.5% to a current level of 5%. In addition to rates of return, mortality tables are critical to pension plan design and are used by actuaries to set pension funding levels. As retirees live longer, the number of benefits owed to them increases, causing pension liabilities to rise.
How Bad is the Situation?
Using data from the Institute for Pension Fund Integrity’s Pension Gap Calculator, here is how the unfunded liabilities of some states would look like assuming a 5% rate of return and a mortality rate of zero:
Florida: $83.5 billion
Illinois: $205.6 billion
New York: $63.1 billion
California: $328 billion
Louisiana: $32.8 billion
Alabama: $30.5 billion
Texas: $148.2 billion
New Jersey: 207.5 billion
“The politicization of our public pensions must stop,” IPFI President Christopher Burnham recently said. He continued, “Without realistic return and mortality rate calculations, our nation’s retirement crisis will only grow larger. This calculator allows plan beneficiaries and taxpayers to see the effects of these miscalculations on their retirement systems in real-time.”
