Underfunded Public Pensions in the United States: The Size of the Problem, the Obstacles to Reform and the Path Forward (2024)
M-RCBG Faculty Working Paper No. 2012-08
Underfunded Public Pensions in the United States: The Size of the Problem, the Obstacles to Reform and the Path Forward Thomas J. Healey, Carl Hess, and Kevin Nicholson April 2012 Abstract Across the United States, state and local government-sponsored pension plans are in trouble. They are dangerously underfunded to the extent that their assets are unable to meet future liabilities without either outsize investment returns or huge cash infusions. Over the past several years, estimates of the total size of the public pension problem in the U.S. have ranged from $730 billion in unfunded liabilities to $4.4 trillion. Many financial economists believe that the true size of the total unfunded liability lies closer to the larger estimates than it does to the smaller.
In this paper we attempt to explain the complex nature of pensions as a form of deferred compensation, to describe the size of the problem faced by public pension plan sponsors, and – most important – to offer a series of potential policy changes that can address the problem of public pension underfunding.
In order to accomplish these tasks in a comprehensive manner, we analyze and explain a series of recent efforts to size the magnitude of the public pension crisis in the U.S., and further examine the myriad financial, accounting, legal and political causes of the current predicament. We will also examine case studies of those states and local governments that have succeeded in the face of pension challenges and those that have not. Only through understanding the mix of dynamic issues that affect public pensions will we be able to generate practical solutions to this growing problem.
Over the past several years, estimates of the total size of the public pension problem
pension problem
The pensions crisis or pensions timebomb is the predicted difficulty in paying for corporate or government employment retirement pensions in various countries, due to a difference between pension obligations and the resources set aside to fund them.
in the U.S. have ranged from $730 billion in unfunded liabilities to $4.4 trillion. Many financial economists believe that the true size of the total unfunded liability lies closer to the larger estimates than it does to the smaller.
Exacerbating the problem are rising government debt ratios in the wake of the global financial crisis, as well as poor investment returns which have negatively impacted funding. In practice, countries differ widely in how efficiently and effectively they've managed their retirement programs.
The biggest challenge facing pension and insurance funds today is the rapidly aging population. This will force funds to provide participants with payouts for a longer period of time.
The Best and Worst Funded Pension Plans in the U.S.
But nationally, the U.S. has only set aside $5.1 trillion to pay those benefits. This means there is a national public pension funding shortfall of around $1.49 trillion, as of June 30, 2023 (formally this shortfall is called unfunded liabilities.
Critics have argued that investment return assumptions are artificially inflated, to reduce the required contribution amounts by individuals and governments paying into the pension system. For example, bond yields, the return on guaranteed investments, in the US and elsewhere are low.
Recent studies reveal that public pension benefits have positive effects on local and state economies. In 2019, state and local government retirement systems in the U.S. distributed $155 billion more in benefits than they received in taxpayer-funded contributions.
What Happens When a Defined-Benefit Plan Is Underfunded? When a defined benefit plan is underfunded, it means that it does not have enough assets to meet its payout obligations to employees. If a plan is underfunded, then it must increase its contributions to be able to meet these obligations.
The data shows that public pensions have increased their risk exposure over the past 30 years, investing not just in publicly traded stocks but also more speculative assets like private equity. And those with lower funding ratios, in particular, were more aggressive in their investments.
Pensions are still common in the public sector, with 86% of government workers having access to them in 2022, compared with just 15% of private sector workers, according to the Bureau of Labor Statistics.
Pension plans are funded by contributions from employers and occasionally from employees. Public employee pension plans tend to be more generous than ones from private employers. Private pension plans are subject to federal regulation and eligible for coverage by the Pension Benefit Guaranty Corporation.
The worst funded pension plans are largely from Illinois, New Jersey, Connecticut, and Kentucky. Among the worst are a few plans funded on a pay-as-you-go basis.
Across the United States, state and local government-sponsored pension plans are in trouble. They are dangerously underfunded to the extent that their assets are unable to meet future liabilities without either outsize investment returns or huge cash infusions.
The Netherlands tops the Mercer ranking with a score of 85. Dutch retirees receive a flat-rate state pension and most workers are enrolled in a workplace pension scheme. Dutch employers famously use “collective defined contribution” schemes.
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Economic Factors. Traditional pension plans have been on the decline, primarily due to the economic strain they place on companies. Employers often bear the heavy responsibility of fully funding these plans; a task made more challenging by unpredictable market volatility and fluctuating investment returns.
However, since the 1980s, companies offering pensions are a dwindling breed. Instead, most employers offer defined contribution programs such as 401(k) plans. Only a handful of industries (such as the military, public works and education) still offer pension plans to their retirees. Why are pensions dying off?
“Companies started moving away from pension programs in the 1980s, mainly due to the high costs and because it is simply unpredictable to know how long the company will need to make payments to each retiree,” said Michael Arvay, founder and CEO of Marvelous Retirement Planners in Toledo, Ohio, in an email.
The percentage of workers covered by a traditional defined benefit ( DB ) pension plan that pays a lifetime annuity, often based on years of service and final salary, has been steadily declining over the past 25 years.
Introduction: My name is Arielle Torp, I am a comfortable, kind, zealous, lovely, jolly, colorful, adventurous person who loves writing and wants to share my knowledge and understanding with you.
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