Pensions Crisis: A Growing Concern in State and Local Funding

The pensions crisis is a growing concern in state and local funding, with many governments struggling to meet their pension obligations. According to a recent report, the total unfunded liability of state and local pensions in the United States is estimated to be over $1.5 trillion.

Many states and local governments have been underfunding their pensions for years, relying on overly optimistic investment returns to make up for the shortfall. This has led to a situation where many pension funds are severely underfunded, making it difficult for governments to meet their pension obligations.

The consequences of the pensions crisis are far-reaching, affecting not only public employees but also taxpayers and the overall economy. Without a solution, the crisis is likely to worsen, leading to increased taxes, reduced public services, and a decline in economic growth.

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Pension crises are complex and multifaceted, with various factors contributing to their development. There are six common contributors to pension crises, including incorrect actuarial assumptions, institutional constraints, poor governance, lack of expertise among stakeholders and decisionmakers, adversarial political culture, and conflicting incentives and interests.

A pension crisis can manifest itself in various ways, including an excessive budgetary burden, high taxes on residents, and benefit cuts. These issues can result in lower retirement security for affected employees and a lower-quality public-sector workforce with high attrition rates and poor recruiting.

Some of the specific causes of pension crises include past high discount rate assumptions, investments performing below the long-term rate of return, and a lack of action. These factors can be attributed to a lack of knowledge and expertise, poor governance, and mistrust among stakeholders.

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The Institutional and Legal Settings play a significant role in the pension crisis. State and local pensions are governed by a diverse set of laws and regulations, which can vary across locations and over time.

This diversity in legal frameworks has contributed to the underfunding crisis among public pension plans. The differences in laws across states also define which policy options can be pursued.

Some states include constitutional protections of pension rights, while others do not. This lack of consistency creates uncertainty and challenges for policymakers.

Public pensions have more latitude in setting actuarial assumptions, which can lead to opportunistic practices that downplay the magnitude of pension liabilities. This results in lower required contributions.

Public plans also have the freedom to select investment vehicles for investing public pension funds, allowing managers to shift portfolios to higher-return but riskier asset classes.

Here are some key differences between private and public pension governance:

The causes of pension crises are complex and multifaceted, making it challenging to pinpoint a single reason. Incorrect actuarial assumptions can lead to underfunding, making it difficult for pension systems to meet their obligations.

Pension crises can be caused by institutional constraints, such as inadequate funding flows or insufficient contributions from employers or sponsors. This can result in an excessive budgetary burden on states or municipalities.

Poor governance is another common contributor to pension crises. Lack of expertise among stakeholders and decisionmakers can also exacerbate the problem, leading to incorrect decisions and inadequate planning. Adversarial political culture and conflicting incentives and interests can further complicate the issue.

A recent report from the Pew Center on the States put the tab for unfunded pension liabilities at $452 billion, highlighting the severity of the problem. This staggering figure underscores the need for effective solutions to address pension crises.

Here are some common causes of pension crises:

These causes are not mutually exclusive, and often, a combination of factors contributes to a pension crisis. Understanding the sources of the problem is crucial in identifying effective solutions to address the issue and achieve the goals of reform.

A pension crisis can be a complex issue, but at its core, it's about funding shortfalls and unfunded liabilities. A pension crisis is typically defined by low funding ratios and benefit generosity, where pension promises made to employees aren't fully funded.

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This can lead to an excessive budgetary burden for employers or sponsors, making up an overly large share of the state or municipal budget. For example, in Pennsylvania, generous benefits and underfunding from the state, combined with worse-than-expected investment returns, pushed the state's two large public pension funds into multibillion-dollar holes.

Pension contributions can also result in high taxes on residents or crowd out other priorities, such as public services and infrastructure investments. A pension crisis can also result in benefit cuts and inadequate pension benefits, leading to lower retirement security for affected employees.

Here are some ways a pension crisis can manifest:

The implication is that even states and municipalities with apparently healthy pension funding ratios can have unsustainable pension systems if the system results in these other concerns.

The evaluation of reform options has led to some key findings that shed light on the pensions crisis. Reform option B would have minimal impact on the underfunding situation in the short run.

A mix of increased contributions (reform option A) and higher taxes (reform option C) represents a better sharing of the burden than cutting benefits (reform option B). This approach aims to balance the outcome goals, but may not achieve all the process goals.

Reform options D and G are deemed politically infeasible, which means they won't be considered as viable solutions. This leaves us with a more limited set of options to address the pensions crisis.

The final plan includes pursuing reform options A, C, E, and F, which are determined to have minimal cost and are therefore included in the mix.

Actuarial assumptions play a crucial role in determining the funding and obligations of pension plans. Actuaries rely on a set of assumptions and models to calculate the contributions needed to fund benefits.

The discount rate assumption has a significant impact on the size of the annual contribution required to fund benefits, with a higher discount rate assumption reducing the present value of future liabilities.

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Pension boards determine the actuarial assumptions used in valuing pension funding and obligations, and these assumptions can be overly optimistic, resulting in an overstatement of pension funding and an understatement of future obligations.

There are three main assumptions pertaining to amortization: the amortization period, whether the amortization is closed or open, and the method for allocating costs over time.

The choice of amortization assumptions can determine whether required contributions are sufficient to cover new liabilities, and any of these assumptions carry the risk of being overly optimistic or being leveraged to defer pension payments.

Economic assumptions include the discount rate on future benefit payments, inflation rates, compensation growth, and payroll growth, which can affect estimates of future liabilities and revenues to cover those liabilities.

Demographic and other assumptions include retirement rates, employee turnover, mortality rates, and household composition, which also impact estimates of future liabilities and revenues.

Here are some key actuarial assumptions to consider:

By understanding these actuarial assumptions, pension boards and stakeholders can make informed decisions about funding and obligations, and potentially avoid overly optimistic assumptions that can lead to negative consequences.

Effective pension policy requires close cooperation and productive coordination among different groups that may have differing objectives. This is a challenge due to the complexity of public pensions and the large number of stakeholders and decisionmakers involved.

Public employee unions and elected officials are among the groups that may have differing objectives. Mistrust between these groups can lead to lack of cooperation and stalemates.

The complexity of the institutional environment in which pensions are set also contributes to mistrust. This environment includes many stakeholders and decisionmakers, such as voter/taxpayers, elected officials, workforce, employers, interest groups, plan managers and boards, and technical experts.

The number of stakeholders and decisionmakers involved can be overwhelming, making it difficult to achieve cooperation and coordination. Here are some of the key stakeholders and decisionmakers involved in pension policy:

Mistrust among these stakeholders can lead to stalemates and prevent effective policies for addressing underfunding. This can have serious consequences for the sustainability of pension systems.

Reform option B is expected to have minimal impact on the underfunding situation in the short run. This suggests that it may not be the most effective solution in the short term.

A mix of increased contributions (reform option A) and higher taxes (reform option C) is considered a better sharing of the burden than cutting benefits (reform option B). This approach aims to distribute the costs more evenly.

Reform options D and G are deemed politically infeasible, which means they are unlikely to be implemented due to their unacceptability or impracticality. This decision was likely made after careful consideration of the potential consequences.

Reform options E and F are determined to have minimal cost, so they are included in the final plan. This suggests that they are relatively inexpensive and can be implemented without significant financial burden.

The final plan involves pursuing reform options A, C, E, and F. This plan balances the outcome goals, but only some of the process goals will be achieved.

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A significant knowledge gap exists when it comes to pensions design and funding, making it challenging for stakeholders to address crises effectively.

Elected officials often lack the expertise necessary to tackle pension issues due to their focus on more pressing or politically prominent policy matters.

Voters and residents may have limited knowledge to assess the cost and benefits of public pensions, making it difficult for them to hold elected officials accountable for pension-related policies.

This limited understanding can lead to a lack of informed decision-making, which can exacerbate the pension crisis.

Key stakeholders often find themselves in a difficult position, trying to navigate complex pension issues without the necessary knowledge or expertise.

Here are some reasons why a knowledge gap exists:

Analyzing selected reforms is a crucial step in addressing pension design and funding issues. It requires careful consideration of the long-term consequences and resilience of potential reforms.

Elected officials may lack the expertise to pursue effective solutions to pension crises, as they often have more pressing or politically prominent policy issues to attend to. This can make it challenging for them to make informed decisions about reforms.

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To evaluate reform options, technical experts should be consulted to analyze the long-term impacts and resilience of each option. This includes stress testing investment portfolios and other key assumptions, such as payroll growth and longevity.

A mix of increased contributions, higher taxes, and cost-neutral reforms can be a more balanced approach to addressing pension underfunding. For example, a combination of reform options A, C, E, and F may be more effective than relying on a single approach.

Here's a breakdown of the types of reforms that may be considered:

By carefully evaluating and selecting reforms, decision-makers can create a more effective and sustainable plan to address pension design and funding issues.

Reform objectives typically involve ensuring sufficient funds for new and legacy benefit obligations, quality public services and a quality workforce, employee retirement security, effective governance structure, and accurate and reasonable actuarial assumptions.

In the past decade, reforms have prioritized funding obligations, which is crucial for addressing the pension crisis.

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Reformers should identify a menu of plausible and effective reforms that address the pension crisis causes and recognize potential trade-offs. This involves evaluating the selected reforms with respect to long-term consequences and resilience.

Some of the most common reform options include increasing employee contributions, reducing benefits, and converting or offering the option of a defined contribution or hybrid plan. Here are some statistics on the feasibility of these options:

These statistics are based on a compilation of policy reforms reported in various sources, including the National Association of State Retirement Administrators.

Misaligned incentives can lead to opportunistic behavior, where one group takes advantage of circumstances or exploits information available to them but not to others. Policy pension boards are often composed of individuals with conflicting incentives, such as political leaders seeking reelection.

These conflicting incentives can cause decisionmakers to prioritize their own objectives over the objectives of the pension system. Individuals will often pursue policies that meet their personal or professional objectives over those of other stakeholders.

For example, policy pension boards may have incentives that conflict with making policy changes necessary to ensure the pension fund is fully funded. This can lead to a lack of transparency and accountability in decision-making processes.

The people behind the reform are key to its success. They are a diverse group of stakeholders, including government officials, community leaders, and ordinary citizens.

To achieve the reform objectives, a multi-faceted approach is required. This involves engaging with various sectors of society, including education, healthcare, and the economy.

The reform will be led by a dedicated team of professionals, comprising experts in policy-making, law enforcement, and social services. They will work tirelessly to ensure the reform is implemented effectively.

The team will be supported by a network of community organizations and advocacy groups, who will provide valuable insights and help to raise awareness about the reform.

Identifying a reform strategy is a crucial step in addressing the pension crisis. It involves evaluating multiple initiatives and considering their long-term consequences and resilience.

Reformers should start by identifying a menu of plausible and effective reforms that address the causes of the pension crisis. This requires analyzing the issues that define the crisis and the potential trade-offs involved.

A menu of reform options typically falls into four broad categories, including increasing employee contributions, benefit reduction, converting or offering a defined contribution or hybrid plan, and converting or offering a defined contribution or hybrid plan.

The feasibility of reforms varies based on the issues that define the pension crisis and the causes. According to a compilation of policy reforms, the following types of reforms have been implemented:

These statistics provide a snapshot of the types of reforms that have been implemented across the country, highlighting the varying approaches to addressing the pension crisis.

Illinois is struggling with a severe pension crisis, with its pension funds facing the possibility of going broke within the next decade. The state's lawmakers and governors have failed to set aside enough money for state pensions, and have even skipped some payments altogether.

The tab for unfunded pension liabilities in the US is staggering, with a recent report from the Pew Center on the States putting it at $452 billion. This is a significant burden for states like Connecticut, California, and Illinois, which are struggling to make ends meet.

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In California, the pension tab is running at over $3 billion a year, diverting money from other important government services. This is a concern for Governor Schwarzenegger, who is trying to close a $20 billion deficit.

Here are some state-specific issues that are contributing to the pension crisis:

Pennsylvania's pension funds have also been hit hard, with generous benefits and underfunding from the state contributing to a multibillion-dollar hole. The state didn't set aside enough money to make good on the pension promises it made.

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The pension crisis is a complex issue, but the good news is that there are potential solutions. A menu of targeted, feasible reforms can help address the crisis.

The reform options fall into four broad categories, and each has varying levels of support from current and new employees. For example, increasing employee contributions is supported by 56% of current employees, 70% of new employees, and 44% of both groups.

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Benefit reductions, such as increasing the age or tenure requirements, are also on the table. This option is supported by 24% of current employees, 68% of new employees, and 18% of both groups.

Other options include reducing the multiplier, which is supported by 10% of current employees, 38% of new employees, and 10% of both groups. Additionally, converting or offering the option of a defined contribution (DC) or hybrid plan is supported by 6% of current employees, 26% of new employees, and 6% of both groups.

Here are the reform options and their levels of support:

These options may have varying levels of support, but they can help address the pension crisis.