Which States Have the Worst Pension Liabilities?

Which states are likely to have the worst pension liability problems in the future? A couple of studies, one from the Pew Center on the States and the other from the Center for Retirement Research at Boston College, indicate that while a few are in decent shape, some are much worse than others.

The Pew report, “The Trillion Dollar Gap: Underfunded State Retirement Systems and the Road to Reform,” released in February, examined the pension and health care benefit obligations of most of the state pension plans: 231 plans in all fifty states were reviewed.

The report found that at the end of 2008, nine states had pension funds with less than 70% of the assets needed to meet their long-term obligations:

New Hampshire 68%
Kentucky 64%
West Virginia 64%
Massachusetts 63%
Connecticut 62%
Rhode Island 61%
Oklahoma 61%
Kansas 59%
Illinois 54%

Seven had funding levels in excess of 95%:

New York 107%
Florida 101%
Washington 100%
Wisconsin 100%
North Carolina 99%
Delaware 98%
South Dakota 97%

Using aggregate scoring criteria that included funding ratios, unfunded liability size, and current levels of funding, the Pew study concluded that there are nineteen states with pension plans that raise “serious concerns:” Alaska, Colorado, Connecticut, Hawaii, Illinois, Indiana, Kansas, Kentucky, Louisiana, Massachusetts, Maryland, Mississippi, Nevada, New Hampshire, New Jersey, Oklahoma, Rhode Island, South Carolina, and West Virginia.

The report also examined state retiree health-care and other non-pension benefits, finding that only nine states have set aside at least 50% of the assets needed to fund these obligations. While both kinds of pension obligations are significant, the pension plans are believed to present the greatest budgetary risk to the states. While non-pension obligations can usually be altered relatively easily, state pension obligations are legally binding and must somehow be paid.

The Boston College study, “The Impact of Public Pensions on State and Local Budgets,” took a different approach, focusing on six states and analyzing how each one’s pension liabilities can be expected to grow as a percentage of state and local budgets.

In aggregate, spending for public pension plans is projected to grow from the current level of 3.8% of state and local government non-capital spending to 5-9.1%, when amortized over 30 years, starting in 2014. This approach assumes that states actually begin to tackle their pension funding problems through appropriate funding. However, the aggregate number is misleading, as there are significant variations when the same analysis is done at the level of individual states.

The study considered three states with plans that are generally funded each year by the plan sponsors at 100% or more of their required contribution – Florida, Georgia, and Massachusetts – and three states that have received a lot of press attention recently for their budget problems: California, Illinois, and New Jersey.

In most states, annual pension contributions reoresent 1-4% of government spending, with 29 states having contributions in the range of 3-4%. As a percentage of the budget, when the study examined the increases needed for these six states, there was considerable variation among them:

State 2008 Contribution 2014-2043 Projected Contribution
Florida 3.2% 4.6 – 8.7%
Georgia 2.8% 4.3 – 8.3%
Massaschusetts 4.2% 4.6 – 7.6%
California 5.2% 7.3 – 12.5%
Illinois 4.5% 8.7 – 13.0%
New Jersey 3.2% 7.9 – 12.0%

Both the Pew and the Center for Retirement Research studies noted that most state pension plans calculate their obligations using an assumed long-term yield of 8%. Most economists believe that this rate does not accurately represent the level of risk associated with such liabilities and suggest that a discount rate closer to 5% is more appropriate. The upper limits for the ranges given above reflect a 5% discount rate and are probably closer to reality.

The studies note that many states have not been contributing 100% of their annual required pension contributions. and these states are expected to suffer more severe long-term impacts from their pension liabilities.

Taken together, the studies suggest that many of the 19 state indentified by Pew as raising “serious concerns” are likely to see their pension expenditures increase substantially as a percentage of total spending. The require increases will likely crowd out other spending even if states are willing to attack the politically unpalatable job of addressing liabilities proactively. The Center for Retirement Research brief also considered what might happen in one state (Illinios) if the state continued to avoid dealing with the issue until the pension funds were exhausted. If Illinois continued to fund its pensions at current levels and then began paying out pension benefits using current-year budgets after exhausting its pension funds, pension spending would rise to only 10% of state and local spending, but the elevated expense would have to continue well past 2043 in that scenario. Perhaps more significantly, at the state level the expense would rise to 16% of budget from current levels just below 6%.

With the national economy still recovering, states have little hope of growing their way out of pension funding problems in the near-term. Even in a state like New York, listed as having fully-funded pension plans, questions have arisen as to whether the use of an 8% discount rate has caused the state to significantly underestimate its funding needs. The nineteen states identified in the Pew study are likely to have painful budget cuts looming in the next few years in order to keep their pension obligations from mushrooming. Actions taking by the states in the near-term will be critical to avoiding the need for more drastic measures ten or twenty years from now.

About the author

Thomas Fisher, CFP®

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