Factoring in the Effect of Economic, Fiscal, and Financial Shocks on Public Pension Funding

Wednesday, June 11, 2014

Assessing the Affordability of State Debt, a working paper from the New England Public Policy Center at the Boston Federal Reserve, challenges the common perception that state and local governments deliberately decreased public pension fund contributions as a backdoor way to run deficits from 2001 to 2010, and finds that public pension sponsors actually increased contributions during that time. Unfunded pension liabilities grew significantly during the first part of this century – the average public pension plan was fully funded in 2001, but the ratio of funding to pension liabilities declined steadily thereafter. Public pensions are a form of deferred employee compensation; unfunded pension liabilities represent an implicit form of debt for labor provided. Some suspected that state and local governments deliberately decreased employer pension contributions as a backdoor means to run operating deficits that could help them weather fiscal downturns. This paper finds that chronic underfunding of public pensions was due to the riskiness of public pension plan asset portfolios, a higher assumed rate of return on these investments than was realized, and a failure of governments to increase contributions at the rate needed to maintain full funding.