Market returns no substitute for employer contributions in state pension funding gap

For the past nine years, revenue growth and strong investment returns have helped state pension plans. However, the gap between poorly funded plans and strongly funded ones “has never been greater,” according to the Pew Charitable Trusts, coming in at more than $1 trillion for all 50 states.

While the Great Recession brought investment losses to plans in all 50 states, Pew’s research indicates that “the eight states with the best-funded retirement systems rebounded and were, on average, 95 percent funded by 2017.”

The same was definitely not true for the 20 states with the lowest-funded pension plans, which instead “saw the financial position of their systems decline steadily from 76 percent funded in 2007 to 56 percent in 2017.”

In 2017, the state plans studied reported a cumulative funding gap of $1.28 trillion. And while that is an improvement from 2016’s $1.35 trillion deficit, it was largely thanks to strong investment returns of about 13 percent for the median plan. However, that hides the $26 billion shortage in total employer contributions they should have made to keep pension debt from growing under assumed investment returns rates.

In addition, those high returns discounted the risk and volatility involved in the devotion of plan assets to stocks and to alternative investments that included private equity, hedge funds, and real estate. Says the report, “Based on investment returns posted since 2017, Pew estimates a deficit of approximately $1.5 trillion as of December 2018.”

The policy choices that lead to funding level decisions make the difference, the report finds, between plans that are well funded and those that are not—and the well-funded plans weathered the market downturn in far better shape than their poorly funded cousins.

In fact, plans that consistently made actuarially determined contributions and worked to manage risk and costs did so much better that they were nearly fully funded or even had surplus funding in 2017 even while keeping their contribution rates stable.

And those contributions were on average “less than a quarter of those of the three worst-funded states.”

The three best-funded plans in 2017, South Dakota, Tennessee, and Wisconsin, have all paid 100 percent of the contributions recommended by their actuaries, and also followed policies that automatically lower benefits or increase contributions when the market heads south.

Not so the poorly funded.

In fact, Kentucky, New Jersey, and Illinois are the worst funded in the nation, in part because policymakers ignored their actuaries and failed to make necessary contributions. Those three states, as a result, have less than half the assets they actually need to cover 2017 liabilities.

They’re also driving up the costs of their plans by underfunding, thus stealing money from other state needs; in Illinois, pension contributions went up 424 percent; in Kentucky, 267 percent; and in New Jersey, more than 100 percent from 2007 to 2017.

And in spite of that, the three states collectively fell $11.5 billion short of the amount needed to keep pension debt from growing.

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