Welcome to the Free Enterprise Nation’s problem pension road trip. Most tours of troubled pensions make the obvious stops in Illinois, Pennsylvania and New Jersey. Ours, however, hits lesser-known plans to show a variety of ways that states manage to underfund their pensions. We will start our tour in Montana.
Montana’s pension funding policy is based on a percentage of payroll, with no method for making up for a shortfall. This funding method would work fine if the plan was 100% funded and made its investment returns every year.
In the real world, however, the fund was 74% funded in June of 2010, and lost a significant amount of money when the markets crashed in 2008. If the state continues its funding policy, makes its full annual required contribution every year, and earns 7.75% annually, the funding level will drop steadily to around 50% in 2025. With a 74% funding level, Montana is not a lost cause, and can rebound with some policy changes.
We now head southeast to South Carolina, where the funding policy does include an additional payment for the unfunded liability. However, in 2008, the state approved increasing the assumed rate of return from 7.25% to 8%, which lowers the required contributions to where they are not adequate to address the shortfall. In addition, the state increased the smoothing period period (amount of time over which they have to recognise losses or gains on their books) from five years to 10 years, masking the losses incurred when the markets crashed and further lowering the annual contributions. So even though South Carolina routinely makes 100% of its annual required contributions, the funding level continues to drop every year, and was down to 67.8% in 2009. However, without the smoothing period, the funding level drops to 48%.
Even though it is out of our way, no pension road trip would be complete without a stop in Kentucky. The Kentucky Retirement Board sets contribution levels that take into account the normal amount plus the additional amount to address the shortfall. The problem lies with the state, which has made on average 45% of its annual required contribution for the past seven years and has shorted its contributions in 12 of the last 17 years. The state passed a pension reform law that requires an increase in contributions each year until the state is making its full contribution in 2025. In other words, the state’s pension reform guarantees that the state will make inadequate contributions for the next 15 years. Kentucky’s largest employee plan is 38% funded, with the level projected to continue falling. A consultant hired by the pension system predicts the funding level will hit 16% in 2017. This would set Kentucky’s pensions on the road to….
Prichard, Alabama. Prichard’s pension fund ran out of money in 2009. The city attempted to pay retirees out of the general fund budget for a couple months, then just stopped sending out checks. So now Prichard has retirees with no income, current employees paying into a defunct pension plan, and a city considering disbanding because it can’t find a way to rebuild its pension. While this may be an option for Prichard, Montana, South Carolina and Kentucky can’t disband, can’t file for bankruptcy, and have laws requiring that the promised pensions get paid. While addressing the problem will be financially difficult, continuing on with current policies will only see the problems get worse year after year until the plans are essentially insolvent.
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