California pension funds have massively hemorrhaged since the economic downturn of 2008. Indeed, Gov. Schwarzenegger “told reporters last week that the big pension funds could face an estimated $300-billion shortfall in covering the cost of pensions to current and future retirees.” According to the LA Times, this “tremendous drop in the portfolios' value is...
Unfunded Liabilities of State and Local Government Employee Retirement Benefit Plans
"Many state and local governments offer employees defined benefit pension plans, which promise a set lifetime retirement income based on wages and longevity. In contrast, income from defined contribution retirement plans — such as 401(k)s — depends on past contributions, the rate of return on those contributions and future returns. Pension plans are perceived as relatively risk-free because they are prefunded, to some degree, and their benefit payouts are not dependent on the stock market. In addition, taxpayers act as de facto insurers for government pension plans.
Many state and local government pension plans’ liabilities are calculated using discount rates that are not commensurate with the risk they may pose to taxpayers. Accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds’ assets. This typically high discount rate tends to reduce the size of a pension plan’s accrued liabilities. However, pensioners have a durable legal claim to receive their benefits and consequently, it is more appropriate to use a lower discount rate in calculating the plans’ accrued liabilities. Due to the use of high discount rates, the liabilities of state and local government pension plans are underestimated. For example, recent reports by the Pew Center on the States and others indicate that assets will cover about 85 percent of the pension benefits owed to participants. But other studies that adopted lower discount rates have found liabilities may actually be 75 percent to 86 percent higher than reported. As a result, taxpayers’ role as insurer may be much greater than anticipated.
In addition to pension benefits, state and local governments often also provide other retirement benefits, especially postretirement health care benefits. These nonpension postemployment benefits include such things as health insurance, dental and vision insurance, and prescription drug plans. Unlike pension plans, most of these nonpension benefit plans are completely unfunded. That is, assets are not being set aside to fund the obligations. The Pew Center on the States reports that nonpension benefit unfunded liabilities across all states were about $537 billion in 2008. Our estimates of the reported unfunded liabilities of state and local governments for pensions and other postemployment benefits total $1.03 trillion, but when these unfunded liabilities are recalculated using a more appropriate discount rate, the total unfunded accrued liability is much higher.
We analyzed 153 state and local pension plans, representing more than 85 percent of liabilities for state and local pensions and other benefits, and recalculated their liabilities using a lower discount rate. Our calculations show:
- Unfunded pension liabilities are approximately $2.5 trillion, compared to the reported amount of $493 billion.
- Unfunded liabilities for health and other benefits are $558 billion, compared to the reported $537 billion.
- Thus, total unfunded liabilities for all benefit plans are an estimated $3.1 trillion — nearly three times higher than the plans report.
To put these liabilities in context, state and local governments’ reported unfunded obligations under pension and other benefit plans amounting to 7.1 percent of U.S. gross domestic product (GDP) in 2008. When adjusted using a more appropriate discount rate, however, states’ unfunded obligations were 22 percent of U.S. GDP. All but 10 states and the District of Columbia have total adjusted unfunded liabilities above 15 percent of their state GDP, and four states — Alaska, Hawaii, New Jersey and Ohio — have adjusted unfunded liabilities above 35 percent of their state GDP."
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