Pub. 5 2017 Issue 2

www.uba.org 6 THE GROWING BURDEN OF UNDERFUNDED PUBLIC PENSIONS By Dana Sparkman C onnecticut’s governor recently proposed forcing local municipalities to assume part of the state’s pension lia- bilities for teachers, thereby reducing the state’s burden. This raises questions of what caused the need for this extreme proposal and if similar actions could follow elsewhere. Better transparency of pension liabilities makes the need for reform of pension plans increasingly apparent. Many plans’ unfund- ed liabilities are growing, which creates the need to make tough decisions about how to best manage those liabilities going forward. To understand why such a drastic measure was proposed, we must first understand the difficulty of funding defined-benefit pension plans. Growth of Net Pension Liabilities Defined-benefit pension plans promise employees specific benefits during retirement, despite investment performance. Employers gradually fund pension liabilities with annual contributions and investment returns, and net pension lia- bilities should decline over time as employers work toward a fully funded plan. However, Exhibit 1 reveals that adjusted net pension liabilities (ANPL) aggregated for states have been increasing according to Moody’s. Moody’s also projects that the combined ANPL for states will grow from $1.25 trillion in 2015 to $1.75 trillion in 2017. Exhibit 1 The state ANPL appears to decrease slightly in 2015 due to the transfer of some liabilities to local municipalities. The GASB standard that now requires municipalities to recognize their proportionate liability of shared plans also allows the plan spon- sor (usually the state) to remove that same amount from their books. The Baker Group’s internal database exposes a collective increase in local net pension liabilities of over $73 billion for those municipalities that have reported their 2016 financials already. Less than 10% of the municipalities for which we have 2015 and 2016 financials experienced a decrease in their NPL in 2016, and over 20% had NPLs that more than doubled. Causes of Net Pension Liability Growth Low investment returns, insufficient contributions, and as- sumption revisions can cause pension liability growth. A recent study performed by Moody’s reveals that the median investment return target for public pension funds is 7.5% whi le the median actual returns were just 3.2% and 0.52% in 2015 and 2016, re- spectively. Similarly, contributing less than the required amount leads to deficient assets available for liabilities. Employers will, ideally, contribute at least the amount needed to “tread water” or keep their NPL unchanged. The map produced by Moody’s shown in Exhibit 2 reveals which states contributed enough to tread water. Only half of the states met this benchmark. Another assumption change that causes rising NPLs is life expectancy. People are living longer now, so benefits will be paid for a longer period of time. Exhibit 2 Coping with High Net Pension Liabilities Underfunded pension plans are looking for new ways to manage rising liabilities. Some have reduced cost of living ad- justments and/or the dollar value of benefits, and some have increased the retirement age or required higher employee con- tributions. Most states legally protect pension benefits, mak- ing it nearly impossible to cut benefits for current employees/ retirees, but all states allow benefit reductions for new hires. Researchers from the Center for Retirement Research at Boston College conducted a study revealing the changes plans