The State of State Pension Funding and Underfunding: New Accounting Rules Paint a Clearer Picture. NCSL, August 10, 2016 David Draine

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1 The State of State Pension Funding and Underfunding: New Accounting Rules Paint a Clearer Picture NCSL, August 10, 2016 David Draine

2 The Pew Charitable Trusts More than 40 active, evidence-based research projects Projects include public safety, immigration, elections, transportation, pensions, and state tax incentives All follow a common approach: data-driven, inclusive, and transparent Pew s Public Sector Retirement Systems Project Research since 2007 includes 50-state trends on public pensions and retiree benefits relating to funding, investments, governance, and employee preferences Technical assistance for states and cities since 2011 No one-size-fits-all approach Key principles for reform: fiscal sustainability for states and retirement security for workers 2

3 2014 Funding Report: Key Findings State pension plans face a substantial funding gap between assets on hand and liabilities for promised pension benefits. Reported net pension liability in 2014 of $934 billion showed the first drop in the reported funding gap since before the Great Recession thanks to strong investment returns. Revised government accounting standards give a more complete picture of state pension plans fiscal health. New measure of contribution adequacy shows that the majority of states are currently not making payments sufficient to pay down pension debt with a total shortfall of nearly $29 billion. 3

4 State Pension Funding Over Time Liabilities grew faster than assets since

5 Pension Debt Dropped in 2014 First use of new accounting standards. 5

6 Pension Funding by State States vary tremendously in how well they ve funded their pension promises. Source: State Comprehensive Annual Financial Reports and state pension plan actuarial valuations and financial reports. All dollar figures in thousands. 6

7 State Pension Plan 2014 Assets and Liabilities New accounting standards allow a more complete picture of the financial situation of state pension funds. Funding Total Pension Liability - Beginning $3,553 Total Pension Liability - Ending (A) $3,702 Plan Fiduciary Net Position - Beginning $2,484 Plan Fiduciary Net Position - Ending (B) $2,768 Net Pension Liability - Ending (A - B) $934 Percent Funded 75% Change in Liabilities Change in Assets Total Pension Liability - Beginning $3,553 Plan Fiduciary Net Position - Beginning $2,484 Service Cost $73 Contributions - Employer $70 Interest $260 Contributions - Member $35 Benefit Payments -$198 Net Investment Income $367 Actuarial Experience $16 Benefit Payments -$198 Other -$2 Other $10 Net Change in Total Pension Liability $149 Net Change in Fiduciary Net Position $284 Plan Fiduciary Net Position - Ending (B) $3,702 Plan Fiduciary Net Position - Ending (B) $2,768 Source: State Comprehensive Annual Financial Reports and state pension plan actuarial valuations and financial reports. All dollar figures in billions. 7

8 ARC No Longer Available as Benchmark The ARC (Annual Required Contribution or Actuarial Required Contribution) has been used as the benchmark of contribution policy. Pew s data show that less than half of states had contribution policies that paid the ARC as recently as New GASB accounting standards no longer include the ARC as a mandatory disclosure for 2014 and subsequent reporting. While many states continue to report an ADC (Actuarially Determined Contribution), it does not have to meet the standards GASB set for the ARC. Contribution policies that are $100s of millions below the minimum GASB ARC standard are reported as the ADC. The ARC was no guarantee of contribution adequacy. Easy to design an ARC policy that would meet GASB standards and never pay down pension debt. In particular, open, 30 year amortization set as a level percent of pay would allow unfunded liabilities to grow indefinitely. Opportunity for researchers, stakeholders, and policymakers to find an appropriate replacement. 8

9 Different ARC Calculations, Different Results A look at four states that consistently paid the ARC shows how the ARC is calculated matters. 9

10 Net Amortization as New Measure of Contribution Adequacy A contribution policy needs to pay for new benefits and include a path towards paying down pension debt over time. With few exceptions, pension plans are based around a pre-funding policy. Given that, the appropriate goal is to maintain a target of full funding over a reasonable time frame. No single measure of contribution policy will tell the whole story. Net amortization measures whether contribution policies are expected to make progress on paying down the pension debt in a given year. Absent contributions, state pension funding gaps will grow due to the cost of new benefits and interest on the existing pension debt. The net amortization benchmark calculates how much the employer needs to put into the pension fund to keep pension debt from growing, after taking employee contributions into account. Based on plan expectations. In any year, good investment returns might make up for bad contribution policies or vice versa. Assessing funding policy should look at long-run expectations. Net amortization provides important information about contribution policy in the current reporting year long-run projections can help provide a more complete analysis. 10

11 Example of Net Amortization Calculation North Carolina and South Carolina both paid their ARC but follow very different contribution policies. The below calculation shows the steps in how Pew computes net amortization using these two states. Overall, North Carolina s pension promises are 99% funded compared to South Carolina at 61%. Source: State Comprehensive Annual Financial Reports and state pension plan actuarial valuations and financial reports. All dollar figures in thousands. 11

12 Most States Fall Short of Net Amortization Just 15 states made payments that would keep pension debt stable or pay it down. Source: State Comprehensive Annual Financial Reports and state pension plan actuarial valuations and financial reports. All dollar figures in thousands. 12

13 Conclusions With a reported pension funding gap of $934 billion for state-run pensions alone, the fiscal health of state and local retirement systems remains a key policy concern. Just 15 states made payments in 2014 that were sufficient to keep pension debt from growing based on plan s own assumptions low returns in 2015 and 2016 show that public pension systems can t invest their way out of their funding challenges. States and local governments would have needed to contribute nearly $29 billion more in order to be able to expect to make progress on paying down pension debt. States like North Carolina, Tennessee, and West Virginia show that good policy can keep public pension systems well funded or help a distressed system turn around. Policymakers in both well-funded and poorly-funded states need appropriate measures of funding, sustainability, and risk to understand the fiscal health of their retirement systems and to make data-driven policy choices. 13

14 Public Sector Retirement Systems Project David Draine, Senior Officer