Battered by the coronavirus pandemic and low interest rates, public pension plans are headed for a record shortfall, posing risks to the living standards of millions of employees and retirees.
Although pension investments have recovered from a March low point as equity markets rebounded during the summer, they’re likely to fall short of their 2020 targets by four to five percentage points, according to an analysis by the Pew Charitable Trusts.
The amount of the shortfall is a moving target because three-fourths of pension plan investments are in risky assets such as stocks, private equity or hedge funds in which values change daily.
Pew puts the total amount of unfunded liabilities for public pensions at $1.37 billion. The Equable Institute, a New York-based think tank, uses a figure of $1.62 trillion.
Because of the accounting methods used to calculate pension liabilities, the full scope of the COVID-19 impact on state pensions may not be known until 2022, said Anna Petrini, a senior policy analyst for the National Conference of State Legislatures (NCSL).
But it’s already clear that the slow but notable progress several states and local governments had made toward full funding of pensions has been disrupted by an assortment of problems triggered by the coronavirus pandemic.
Shutdowns induced by the pandemic sharply reduced state and local sales tax revenues. The extension of state income tax filings deprived states of revenues during the 2020 fiscal year, and these revenues have lagged in fiscal 2021 because of increased joblessness and lowered income.
Meanwhile, an absence of inflation has kept interest rates low, forcing pension-fund managers to avoid fixed-income investments and put an even higher percentage of assets into chancy equities. Spurred by the pandemic-caused recession, the Federal Reserve has promised to maintain low interest rates indefinitely.
Going forward, the economic outlook is as cloudy as the smoky skies covering the fire-ravaged West.
Some economists say the United States could permanently lose eight million jobs in the current recession, which began in February, a number uncomfortably close to the 8.6 million jobs the nation lost in the Great Recession of 2007-2009.
The duration of the present coronavirus recession depends on developments that are yet to occur such as a widely feared second surge of COVID-19 or the more hopeful progress toward a globally available vaccine.
“We are now in a recession that is different from any other recession we have seen in the modern era,” said Robert Dye, chief economist at Comerica, a financial services company headquartered in Texas.
Illinois, New Jersey and Kentucky, the three states with the worst-funded pension systems, have Democratic governors who have reacted to the looming pension shortfall in different ways.
In Illinois, one of nine states with a flat state income tax, Gov. J.B. Pritzker is asking voters at the Nov. 3 election to approve a proposal called the Illinois Fair Tax that would allow legislators to impose a system of graduated taxes as used in 32 other states and make money available for pension reform.
The Illinois Policy Institute opposes the plan, saying it’s a poor substitute for more immediate pension reform and will cost the state jobs. Illinois state pensions are 38.4% funded.
In New Jersey, with a pension system only 35.8% funded, Gov. Phil Murphy this month unveiled a fiscal 2021 budget that calls for a $4.89 billion contribution to the state pension system.
Because of dire economic conditions after the pandemic struck, Murphy in April extended the 2020 fiscal year for three months. The 2021 fiscal year budget for the Garden State begins on October 1 and lasts for nine months.
Kentucky, with the worst-off retirement plans in the nation at 33.9% of full funding, was forced to delay a payment into the state employees fund because of the pandemic. Earlier this year Gov. Andy Beshear signed bills easing pension contributions from local government. (The figures on percentage of funding used in this article are from 2018, the last full year for which complete data is available.)
Other states that because of crippled economies reduced contributions to pension plans this year include California, Maryland, Utah, Delaware, Georgia and Nevada, according to an NCSL database maintained by Petrini.
But two states, both with pension systems in relatively good condition, bucked the trend by increasing contributions to their retirement plans. They are New York, the early epicenter of the pandemic, and Florida, which has also been hard hit by COVID-19.
There is also cause for optimism in North Carolina, which this year became the 11th state to stress test public pensions, a practice favored by pension reformers. In a state riven by partisanship on other issues, this measure received overwhelming bipartisan support and was signed into law by Gov. Roy Cooper (D).
Pension reformers also mostly cheered a July decision of the California Supreme Court that unanimously upheld a lower court ruling banning “pension spiking” in 20 counties that administer pension plans under a 1937 law.
Under the spiking practice county employees boosted their pensions by cashing out unused vacation or sick leave or working extra hours at the end of their careers.
The decision came on the heels of another unanimous decision last year in which the California high court upheld a ban on “air time,” in which state workers were allowed to buy credits toward retirement service.
Both restrictions were part of a pension reform plan advocated and signed into law by then Gov. Jerry Brown (D) in 2012.
Pension reformers were also hoping the California Supreme Court might modify the California Rule, a 65-year-old legal doctrine that guarantees public workers the retirement benefits in effect when they start their jobs. The court instead affirmed the rule.
Since it is used by a dozen other states, the California Rule has an outsize impact on pension issues.
When the recession eases, states and local governments will be under pressure to improve funding of their pension systems.
It can be done when there’s a political will to do it. Wisconsin, just north of Illinois, the nation’s perennial pension problem child, has a fully funded state retirement system. In fact, it’s the only state that’s over-funded, with 103% of what it needs to provide benefits for every present and future retiree.
South Dakota, with pensions 100% funded, is also well off. Five other states have pension systems more than 90% funded. Listed alphabetically, they are Idaho, Nebraska, New York, Tennessee and Washington.
Whatever their funding level, states shouldn’t be faulted in the midst of a pandemic for giving pension reform low priority at a time their citizens are struggling to find work and provide food, shelter and health care for their families.
Until the coronavirus is in the rear-view mirror, many states will be content to follow a medical maxim and do no harm to their retirement systems.
That didn’t always happen in the aftermath of the Great Recession.
As a recent analysis by the Kansas City Fed observes, a number of states rushed to make structural changes to plans, leading to higher costs for the plans and lower benefits for state and local employees.
States can upgrade pension plans without reducing benefits for retirees by stress testing, increasing contributions from present employees or improving investment performance.
These last two options are probably not feasible until the economy recovers.
Better for states to take care of the jobless, hungry and medically needy now and tackle pension reform once the pandemic and the current recession have passed.
This article first appeared in State Net Capitol Journal.