The Long-Term Impact of State Retirement Programs on State Fiscal Health in the Wake of the Economic Crisis

The recent political battles over the pension and health benefits of state employees are sometimes portrayed in the press as a consequence of greedy public-sector unions winning overly generous concessions from short-sighted state legislators willing to promise unsustainable future benefits to solve immediate political problems. Something like this story may well be true in some states, but it is important to remember that as recently as 2000, state and local pension funds were in quite good shape. This was due largely to the buoyant stock market in the 1990s and to improved funding standards enforced by the Government Accounting Standards Board (GASB). One national survey of 125 state and local pension funds at the end of the century showed aggregate assets equal to 103 percent of liabilities. Since then, however, the collapse of the technology stock bubble, the subdued asset price appreciation in the 2000s and the implosion of stock prices in 2008-09 have caused a dramatic increase in unfunded pension liabilities. Although stock prices have partially recovered from their Great Recession lows, the ratio of assets to liabilities in public pensions remained as low as 77 percent in 2010.

If anything, the funding situation is even more dire for retiree health benefits. With health-care costs exploding and the pool of retired state workers growing rapidly, the annual costs of these programs is bound to escalate rapidly. By one estimate, only about five percent of future liabilities are currently funded. Faced with these stark realities, many states have been hard at work negotiating painful changes in their retiree benefit plans since 2007. These changes include increased employee pension contributions, lower cost-of-living adjustments and increased deductibles and co-pays for current employees; and for new hires, later retirement ages, scaled back health benefits, and a shift to defined contribution plans. State labor force reductions during the recession have also reduced projected retirement benefit liabilities.

The question Alicia Munnell and her colleagues at the Boston College Center for Retirement Research propose to answer is whether these changes in state pension and health benefits have been sufficient to reduce unfunded liabilities to manageable levels. They plan to limit their estimates to 15 states, for all of which the BC Center has already secured pension and health plan actuarial valuation reports between 2001 and 2010. Once constructed these data sets will be subject to two different methods for projecting liabilities, a deterministic analysis and a stochastic analysis using Monte Carlo simulations to determine the impact of alternative market returns on future pension costs. Munnell and her team will calculate the annual required contribution (ARC) in each state necessary to keep pension funds solvent and pay health benefits to future pools of retirees. These calculations will be made for the most recent fiscal year and then projected out to 2015, 2020, and 2030. In this way, they will be able to estimate the extent of the unfunded liabilities for retiree benefits that have been caused by the unanticipated shock of the Great Recession and its low-growth aftermath, and they will assess the adequacy of benefit reforms subsequently undertaken by the states.