In 2001, some of the largest public pension systems in the country were at full capacity.
The plan serving workers in the state of Kentucky, for example, was 125.8% funded, meaning it had 25.8% more money to pay for everything it owed retirees. current workers and workers who are expected to retire within the next 30 years.
But not even two decades later, Kentucky’s pensions and other previously over-funded plans were in crisis. What happened?
In Kentucky, lawmakers have approved additional benefits for plan members, even making them retroactive. There and in other states, lawmakers have decided not to make the necessary payments, freeing up budget money for tax cuts or other spending. And in every city and state across the country, the financial crisis has hit investment hard. At one point, a few reckless decisions turned into a crisis.
In 2019, Kentucky’s employee retirement system was only 16.5% funded, making it one of the least well funded pension plans in the country, according to data from the Center on Retirement Research of the Boston College.
As market returns remain strong and most states and residents weather the coronavirus crisis much better than expected, it can be tempting to view public pensions as homeless. “Worries about pensions facilitate states, localities on stimulus, stocks,Shouted a recent Bloomberg News headline.
But the example of Kentucky, Pennsylvania, New Jersey, and a few others, shows how essential it has become for pension plan sponsors to be disciplined in sticking to a funding plan – even , or perhaps especially, when the odds seem to be in their favor.
“Well-funded pension systems are an attractive target for employees and employers who wish to approve additional rewards,” said Matt Fabian, partner of Municipal Market Analytics.
What appears to be “extra” money, in other words, can be attractive for a raid.
Pension funds are not slush funds, but they may appear that way to governments. Fabian says the temptation is “why I think pension funds are not suitable for political employers.” They are a budget gadget tool.
Cutting payments or increasing benefits is not in itself a red flag, says David Draine, senior executive of Pew Charitable Trusts, as long as “you follow the rules and do what your actuaries tell you.”
The problem, Draine said in an interview, is that cities and states often take pensions too much. when times are good and times are bad, it becomes extremely difficult to compensate.
“You can’t treat good news any differently than you treat bad news,” Draine said.
It should be noted that some recent research on public finances suggests that the notion of a public pension crisis is greatly exaggerated. This is because the current standards are designed for a system in which municipalities have on hand all the money they will need to pay all plan members for the next 30 years, which some analysts think this is not necessary.
But Kentucky’s current funding levels, the Pennsylvania State Employee Retirement System at 57%, the New Jersey Teachers’ Pension and Annuity Fund at 40%, and a few others are of deep concern. The longer it takes to make reforms, the righting the ship becomes more and more difficult: the returns on investment are accruing to a smaller asset base, for example.
Many struggling states “have entered their pension crisis by writing lucrative benefit allowances and ignoring them,” Fabian said.
Now their retirement costs are “higher, possibly materially,” he told MarketWatch. “The problem is that the employer can defer compensation in an opaque fashion through benefits that are not immediately incorporated into the government budget.”
Draine has a more optimistic outlook. At the start of the pandemic, many public finance observers were concerned about precisely this issue, he noted. “Were states going to take retirement leave because of COVID? This is a once-in-a-generation pandemic, so if you ever meant to say it’s a good time not to make payments it’s a story to tell. “
In reality, most lawmakers have remained disciplined, noted Draine, and are now also benefiting from market outperformance and federal stimulus funds. In 2020, the S&P 500 SPX,
increased by 18.4% and since the start of the year it has increased by 13%. Other assets are also benefiting from a global economy that is coming back to life: the price of CL00 oil,
is up 50% this year, for example.