Long-Term Liabilities Weigh on State Finances

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Long-Term Liabilities Weigh on State Finances

If not effectively managed, long-term liabilities can squeeze state budgets and constrain future public investments. Of the three liabilities that states regularly report on, unfunded pension obligations are the biggest in most states, ahead of unfunded retiree health care and outstanding debt. In recent years, states have narrowed the gap between promised pension benefits and money set aside to pay for them, but the shortfall still amounts to nearly half of states’ own-source revenue—$836 billion in fiscal year 2021.

Unfunded liabilities for pension and retiree health care plans are the gap between the assets that should have been set aside for the promised benefits and the assets that public sector retirement plans have on hand. These disparities can emerge or grow when policymakers provide insufficient funding or when state investment portfolios suffer market-driven losses, among other causes. Some states pay for all retiree health care benefits directly out of current revenue rather than pre-funding benefits as they accumulate—meaning that the entire liability is unfunded.

In addition to liabilities for public sector retirement benefits, states often take on debt to finance big expenses, such as expanding a congested highway or replacing aging wastewater treatment plants. By spreading the cost of durable infrastructure across the generations of taxpayers who will benefit, states can free up cash on hand to cover current day-to-day expenses. But it is critical that policymakers carefully consider their states’ existing obligations when assessing how much additional debt to take on.

Unfunded pension and retiree health benefits and outstanding debt are not always top-of-mind for state policymakers because they are paid for over decades. Yet, increases in the share of revenue used to pay for them can limit a state’s ability to make forward-looking investments and adequately fund policy priorities.

In fiscal 2021, once-in-a-generation returns on stock market investments and a decade of substantial increases in state employer and employee contributions allowed state pension funds to collectively narrow the gap between what they have set aside and what they owe in benefits.

Even so, states collectively reported $836 billion in unfunded pension benefits, equal to nearly half of their combined own-source revenue and a 14.4 percentage point increase over the fiscal 2007 share. Unfunded pension liabilities increased during and after the Great Recession of 2007-09 because of lower-than-expected investment returns. In the aftermath of the 2007-09 recession and through much of the recovery, the funding gap continued to grow from a combination of insufficient contributions, states making more conservative assumptions about future investment returns, and, in some cases, benefit enhancements that were not accompanied with sufficient funding to pay for the increased liability.

Unfunded retiree health care promises (which make up the vast majority of "other post-employment benefits,” or OPEB) declined as a share of states’ combined own source revenue from 53.1% in fiscal 2008 to 45.4% in fiscal 2019 as growth in 50-state revenue outpaced a rise in OPEB underfunding. In raw dollars, however, unfunded retiree health promises rose over this span, reaching $680 billion in fiscal 2019, the most recent year for which The Pew Charitable Trusts has compiled 50-state data. The drivers of this growth are difficult to pinpoint because of a change in accounting standards (which also led to a gap in the data for fiscal 2017), limited data disclosed under the prior reporting requirements, and changes to benefits and contribution policies.

States’ outstanding debt also declined as a share of own-source revenue. In fiscal 2021, 50-state debt reached the lowest point in the 14 years examined (18.7%), 4 percentage points below its fiscal 2008 level. After borrowing more heavily during the 2007-09 recession, states’ debt in dollar terms remained relatively stable because policymakers were cautious about issuing bonds. As with retiree health care, the share of outstanding debt to states’ own-source revenue declined largely as a result of growth in revenue over the years, especially in fiscal 2021. States had more debt in fiscal 2021 than in the previous years, but the share still fell because of the uptick in total revenue that year.

A state-by-state review of unfunded pension liabilities as of fiscal 2021 shows:

  • Illinois’ unfunded pension liability was the largest of any state at 212.3% of its own-source revenue, followed by New Jersey (168.5%), Connecticut (136%), and Kentucky (133.2%). Illinois’ liability has also risen the fastest since fiscal 2007.
  • Pension plan savings in fiscal 2021 exceeded what was owed in nine states: Delaware, Idaho, Iowa, Nebraska, South Dakota, Tennessee, Utah, Washington, and Wisconsin.
  • In 27 states, unfunded pension obligations grew relative to own-source revenue from fiscal years 2007 to 2021. Six states recorded increases of more than 50 percentage points: Illinois (103.3 points), New Jersey (96.3 points), Oregon (95.9 points), Alaska (70.6 points), Kentucky (58 points), and Pennsylvania (51 points).
  • 23 states have decreased their unfunded pension liabilities as a share of own-source revenue since 2007. Oklahoma (-75.5 points), West Virginia (-52.6 points), and Washington (-52.3 points) had the greatest declines.

A state-by-state review of unfunded retiree health care as of fiscal 2019 shows that:

  • Unfunded retiree health care liabilities as a share of own-source revenue were highest in New Jersey (139.4%), Illinois (136.5%), Delaware (109.9%), Connecticut (103.2%), and Texas (98.1%).
  • Alaska, Arizona, and Oregon were the only states whose retiree health plans had a surplus of assets relative to what they promised public workers.
  • Four states owed less than 1% of own-source revenue: Utah (0.42%), Indiana (0.49%), Kansas (0.54%), and Oklahoma (0.64%).
  • Since fiscal 2008, unfunded retiree health care liabilities relative to own-source revenue grew fastest in Illinois (by 34.3 percentage points) and Texas (29 points).
  • In 36 states, unfunded obligations have declined as a share of own-source revenue since fiscal 2008. The largest decreases were in Alabama (-79.8 percentage points), Alaska (-74.8 points), and Michigan (-72.6 points). Alaska and Michigan both set aside billions of additional assets toward pre-funding retiree health care obligations.
  • Nebraska does not report its retiree health care liability, and South Dakota stopped reporting its liability for retiree health care in 2014 and does not currently offer these benefits.

A state-by-state review of debt as of fiscal 2021 shows:

  • The highest debt levels were in Hawaii (equivalent to 72.8% of own-source revenue), Connecticut (72.1%), and Massachusetts (52.1%).
  • Debt as a share of own-source revenue was lowest in Wyoming (less than 0.1%), Iowa (0.1%), and Nebraska (0.4%).   
  • Debt grew in 11 states between 2008 and 2021 when measured as a percentage of own-source revenue. The largest increases were in Alaska (18.7 percentage points), Colorado (12.7 points), Hawaii (9.5 points), and Delaware (6.9 points). 
  • Among 38 states with declines in debt as a share of own-source revenue since 2008, the largest drops were in California (-18.7 percentage points), Nevada (-16.0 points), North Carolina (-12.3 points), and New Jersey (-10.6 points). Data is unavailable for New York.

Changes in annual funding needs

Nationally, the amount needed to adequately fund state pension plans in fiscal 2007 was 5.7% of own-source revenue. By fiscal 2021, that had increased to 7.8% due to the lingering effects of investments that fell short of expectations, employer contribution shortfalls, unfunded benefit increases, and ballooning pension debt—the gap between pension assets and liabilities—costs stemming from past decisions.

In fiscal 2007, more than half of states set aside less than what their actuaries had calculated as necessary to adequately fund public pensions, with a combined pension contribution of 4.8% of state revenue instead of the 5.7% that was needed. Over time, policymakers significantly boosted the share of state resources going into public pension plans, with actual contributions for all 50 states in 2021 roughly matching the 7.8% of revenue that was needed. Managing this increase required fiscal discipline and tough choices as the rise in contributions crowded out other spending priorities but meant that states were no longer collectively leaving the cost of unfunded liabilities to future generations.

Nationwide, the contributions needed to fund retiree health care benefits have stayed relatively stable as a share of own-source revenue, dropping from 4.3% in fiscal 2008 to 3.5% in 2019. Actual contributions to state retiree health care plans, however, consistently fell short of those levels, totaling only about 1.5% of state own-source revenue in fiscal 2008 and 2019.

In the 50 states, the combined annual cost to service outstanding debt relative to own-source revenue grew slightly during the 2007-09 recession, but changed little between fiscal 2008 and 2021, falling from 3.7% to 3.2%. California, Nevada, Ohio, and South Carolina experienced the greatest declines in debt service payments. On the other end of the spectrum, debt service increased in 17 states over the 14 years. Only Alabama, Alaska, Hawaii, and New Jersey’s payments increased by more than one percentage point.

In fiscal 2021, contributions to state pension plans nationally roughly equaled Pew’s “net amortization benchmark,” which measures whether employer contributions were sufficient to keep pension debt from growing on an annual basis (provided plan assumptions are met). To achieve this, contribution amounts must be big enough to both cover pension benefits that current state employees are earning and either reduce or hold flat any unfunded liabilities already on the books. Twenty-four states contributed less than was necessary, with the widest gap in Texas, followed by Illinois and New Jersey.  

The number of states meeting or exceeding their contribution benchmarks has been rising in recent years, reaching 26 in fiscal 2021. In fiscal 2007, 20 states contributed sufficient funding and the number fell to 15 by fiscal 2014 as states struggled to recover from the 2007-09 recession.  

States have made less progress in meeting the contribution levels necessary to keep retiree health care debt from growing. In fiscal 2019, the most recent year with available data, only 10 states met or exceeded the target: Arizona, Idaho, Indiana, Michigan, North Dakota, Oklahoma, Oregon, Rhode Island, Utah, and Wisconsin. The gap between the actual contribution and the benchmark was greatest in Texas, followed by California, New Jersey, and Illinois.

For states with significant retiree health care liabilities, adequate funding ensures that future generations do not have to pay for services being provided today and that money is set aside for benefits that retirees are counting on. If states continue to fund below the necessary threshold, they will face growing debt for retiree health care benefits and associated pressure on their budgets.

Differences among payment practices

States typically are legally bound to keep their pension benefit promises, though their annual contributions may fluctuate, causing them to fall behind in paying down unfunded liabilities. States vary in whether they set contribution rates to match actuarial requirements or have a statutorily fixed contribution rate that may fall short of funding needs. Even states that apply actuarial funding may suspend adequate funding because of budget concerns or follow a policy that pushes the bulk of the costs to future generations.

Many states set aside nothing for future retiree health care costs, preferring to fund retired employees’ health insurance on a pay-as-you-go basis, though some have committed to pre-funding future retiree benefits. Public retiree health care benefits have fewer legal protections than pensions, though political or social considerations may also prevent states from reducing these benefits. 

States usually cover their annual debt obligations before other long-term expenses in accordance with constitutional or statutory requirements. They also face other long-term budget pressures, such as expenses for deferred maintenance and upgrades to infrastructure. But state budgets generally do not account for these future costs.

For more information, see Pew’s “Public Retirement Systems Need Sustainable Policies to Navigate Volatile Financial Markets” and “Do States Have Enough Saved for Retiree Health Care Benefits?” issue briefs.

Why Pew assesses long-term liabilities

Failing to manage long-term liabilities—whether public debt, retirement promises, or other bills—can hamper states’ ability to make needed investments and provide critical services to future generations. Pew tracks reported data that shows the magnitude of states’ long-term liabilities and the costs to manage them as a share of their revenues.

David Draine is a principal officer and Keith Sliwa is a principal associate with The Pew Charitable Trusts’ public sector retirement systems project; Joanna Biernacka-Lievestro is a manager and Riley Judd is an associate with Pew’s Fiscal 50 project.

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