Some states may face a severe pension fund reckoning, but the problems are manageable if lawmakers act now to address them through a combination of increased contributions and benefit cuts, according to Loop Capital Markets LLC.
“The state pension funding problem, while severe, is nonetheless still solvable,” Christopher Mier, Loop’s lead municipal strategist, said in an interview Thursday, a day ahead of the release of the firm’s annual pension funding review. The eighth annual report is among several topics that will be discussed during a conference call for issuers and investors hosted by Loop analysts Friday afternoon.
Other discussion subjects include the evolution of public-private partnerships and the growing use of such transactions for budgetary relief, as well as the impact of the Federal Reserve’s visibility on economic growth. Mier also will discuss his belief that the federal government won’t bail out local governments.
The pension funding solution is politically challenging for some states. It involves raising contribution levels at a time when many are still grappling with budget shortfalls, and extending the benefit cuts some states have enacted for future employees to current pensioners and vested employees.
“States need to recognize the funding problem and contribute as much as possible this year, and all future years,” Mier said. “Pension contribution 'holidays’ must be a thing of the past.”
In its report, Loop reviews a total of 244 of the largest state plans and finds that the funded ratios have worsened for almost all the plans that submitted funded ratios. About 93% of the 145 state plans reviewed in both 2008 and 2009 that submitted funded ratios saw declines. Only 58 of a total of 149 plans reviewed for fiscal 2009 reached the 80% funded ratio that is considered adequate.
Only 24 of the 73 plans with assets of more than $1 billion met the 80% threshold. “It is clear there is a serious issue that needs to be addressed, as the largest funding shortfalls are in the plans with the largest liabilities,” analysts said.
Overall, Loop found on a weighted average basis that 22 states are adequately funded and 28 fall short, with Louisiana at 60%, Illinois at 51%, New Hampshire at 59%, Oklahoma at 59%, and Kansas at 59%.
The report found that 25 states — up from 23 a year earlier — failed to meet the actuarially based annual required contribution needed to work towards an adequately funded plan. Alaska, California, Colorado, Delaware, Illinois, Iowa, Maryland, Minnesota, Missouri, Nevada, New Hampshire, New Jersey, New Mexico, North Dakota, Oklahoma, Pennsylvania, Vermont, Virginia, and Washington did not meet their contribution levels for all plans for the last three years.
New Jersey’s contribution represented just 9% of the ARC while Pennsylvania’s covered 33%. The states facing the most severe budgetary issues are those that did not fully contribute to their pension plans. The shortages will drive up future contributions.
States debt levels — including general fund deficits, bonded debt, and pension obligations — continue to rise. The top 10 states increased debt levels by 30 %. California, Florida, and Ohio together increased their debt load by more than $20 billion due in large part to growing unfunded pension liabilities. States face total economic debt of $1.1 trillion. When unfunded liabilities for retiree health care benefits known as other post-employment benefits are included, that figure rises by 45% to $1.64 trillion. Unfunded pension and OPEB liabilities total $1.13 trillion of that figure.
“These increases are staggering, and will pose a significant burden on future budgetary planning,” the report concludes.
Most pension plan managers rely on overly optimistic projected investment return rates. The average investment return assumption for the 244 plans’ reviews was 7.81%. That compares with the private sector’s more conservative 6% estimated rate. A lowering of the rate would drive up the size of unfunded liabilities and the ARC payment.
As part of its analysis, Loop looked at state actions to address funding problems. The report warns against quick funding fixes, such as selling off plan assets at the current steep discounts required. However, certain troubled plans, like those in Illinois, have had no choice but to sell assets, according to analysts.
Illinois was forced to take the action after lawmakers adjourned earlier this year without designating the funds needed to cover its fiscal 2011 payments. After the November election, lawmakers are expected to approve a $3.7 billion borrowing plan.
States have turned to long-term solutions, such as debt issuance. That may signal to investors that states are taking action to address their problems, but the move shifts pension funding from a soft burden to a hard one in the form of debt service with little repayment flexibility.
In 2009, 14 states shifted away from a defined benefit plan to a defined contribution or hybrid plan in hopes of reducing long-term liabilities, and Loop expects that trend to continue. The change limits future costs but does little to bring down current liabilities.
Many states have moved to alter benefits for future employees by limiting cost-of-living adjustments and increasing retirement ages. Those steps may reduce future costs but don’t bring down current liabilities. Cuts for current retirees and employees pose more difficult legal and political challenges even though such steps are needed, according to Loop. Retirees in Colorado, Minnesota, and South Dakota have filed lawsuits challenging recent legislation that curbs expected benefit increases for current retirees.