Provocative title, but it’s true. Public pensions are on average only about 72% funded, ranging from Connecticut at just 52% to South Dakota and Washington DC fully funded. This wasn’t always the case; in fact, back in 2001, the average public pension in the US was fully funded. However, a combination of (1) constant increases in raise benefits (liabilities have grown from about $2 trillion in 2001 to about $5.3 trillion), (2) the untenability of cutting benefits or raising taxes and (3) aggressive assumptions over 7-8% consistent asset returns in a period that encompassed the Financial Crisis. Sure, there have still been returns, but not enough to cover that liability increase. Harvard has a nice piece drilling into this.
As a result, we’ve reached the point, where the average American owes $4,400 in debt due to underfunded pensions (sorry Illinois residents, you actually owe $10,500 on average). It’s possible half of states have pensions they cannot cover. Unless those pensions are nullified (which is not possible in some states where its protected by the state constitution), this debt will inevitably have to be paid (via higher taxes). Several states face extreme budget scenarios.
And in the meantime, this is just one of many risks facing the market that has shrugged off a complete global economic collapse and inflated multiples higher than ever before. There are massive underlying issues like possible widespread municipal financial conditions that are likely to be exposed with the current economic climate. When they surface, these issues could impac the market. So again, I point you to the original piece cautioning on being invested in this market.
The states with the biggest problems are Illinois, Connecticut, Pennsylvania, Kentucky, New Jersey, Rhode Island, Hawaii, South Carolina and Massachusetts. We’ll go through some state level data below. If you are due a public pension as a state employee, you can review your specific pension plan’s underfunded status here. If you have a private pension, you should be able to inquire and find the funded status of the pension (discussed below) and the annual required contributions they need to cover the hole. Many of the private pensions also assume aggressive rates of return. Comment below if need help.
Below I show the evolution of funding over time so you can see how bad it has gotten, along with some state-level summary data. Note: We are being conservative here despite the shock factor. Assets are likely already down double digits in many states, and revenue has likely fallen further – we’re showing 2018 data.
This is a simple calculation of a plan’s assets versus its liabilities. For example, if a plan has about $66bn in liabilities (benefits it must pay), but only $33bn of assets, it’s only about 50% funded. That’s actually a real example of Connecticut. For the US as a whole it’s 72%.
Any liability not covered by assets (uncovered liability) is basically debt that will have to be borne by taxpayers. In this Connecticut example, there’s a $33bn shortfall. They have about 3.5mn residents, so the average person in that state owes about $9,000. Notice the increase since 2001 for the US as whole (some states like Connecticut and Illinois look far worse).
Annual Required Contributions
This is a benchmark/industry term used when evaluating pension plans and refers to the amount of money a plan would need to contribute to cover the benefits it must pay out in a given years as well as to close the underfunded amount within 30 years. We take this relative to payrolls, and you can see it has climbed to almost 20% of payrolls from 5% in 2001. Again, this highlights the reluctance to step in front of a problem politically and to stop growing benefits (along with overly optimistic hopes of covering the gap with an equity market boom).
We show the funding ratio and the Annual Required Contributions and categorize states into bad, medium, seems ok. The bubble size represents the size of the plan in dollars.
So take stock; I think there are massive underlying, systemic issues just like the housing crisis that have not yet manifested. The market is assuming the Fed just smooths us past a bump. But if underlying issues are exposed, it cannot be undone. Do not be fooled by the market and look to it for comfort because it is a feckless child.