How the State Pension Funding Gap Fares in an Unpredictable Economy
States have access to tools to manage the risks from market volatility
The 50-state pension funding gap—the difference between state retirement systems’ assets and their liabilities—stood at $1.24 trillion at the end of 2018. However, losses related to the COVID-19 pandemic could increase shortfalls by up to $500 billion, based on market returns through April 2020. A full accounting of losses will not be available until all states report fiscal year 2020 data. But we can look to 2018 numbers—the most recent year for which complete data is available—to anticipate how well each state is positioned to manage the current economic downturn.
A state’s funding level and Pew’s net amortization metric, which measures whether plans are making sufficient contributions to reduce debt if plan assumptions are met, serve as strong indicators of fiscal health. Although no states were able to avoid the impact of market downturns related to COVID-19, there is a significant disparity between states in good standing on both metrics—those that will have more cushion to deal with any setbacks—and states that score poorly on both.
The seven states with funded ratios of at least 90 percent in 2018 all met or exceeded the net amortization benchmark, in stark contrast to the nine states with funded ratios of less than 60 percent, with only Pennsylvania hitting that threshold.
However, all states can expect declines in revenue in the next fiscal year and may be faced with difficult budget decisions in an attempt to preserve other important public services. Reductions in required contributions will only increase pension costs over the long term and could force deeper budget cuts down the road.
Ultimately, differences in state pension funding levels are driven by policy choices. Well-funded state plans provide a roadmap for how states can sustainably fund retirement benefits without breaking the bank or breaking promises to workers—by making contributions that are sufficient to reduce debt over time and using tools to manage risk. And although funding policies and their application vary widely, plans that pay down a portion of debt each year are among the most robust.
In addition to setting a strong actuarial funding policy and following through on making required contributions, Pew finds that lowering investment return assumptions, implementing pension stress testing, and adopting cost-sharing policies contribute to strong fiscal health positions. Policymakers may want to explore these tools as they navigate an uncertain economy. For example, adopting lower investment return assumptions reduces the risk of missing targets in the future. Stress testing can take the expected impacts of the pandemic on state economic and revenue forecasts and estimate what they will mean for pension funding levels and costs.The 10 states with statutes requiring pension stress testing can use this information to assess whether policies are in place to navigate the current downturn and plan accordingly.
Several well-funded states, such as Tennessee, Wisconsin, and South Dakota, also include cost-sharing provisions that distribute unexpected losses or gains among employers, employees, and retirees. These three states reported steady and consistent budget costs from 2014 to 2018 while remaining at or near full-funded status. By distributing risk among employers, employees, and retirees, cost-sharing policies such as variable benefits and contributions that these states use can provide a cushion for budgets in the case of economic downturns or financial market instability.
It’s almost certain that every state will encounter funding challenges due to the current economic landscape, and they must pursue different solutions to address their unique problems. But it’s important to note that although many state and local pension plans are still vulnerable to market volatility and recession, others have weathered past economic downturns well.
David Draine is a senior officer, Aleena Oberthur is a manager, and Keith Sliwa is a senior associate with The Pew Charitable Trusts’ public sector retirement systems project.